Regulatory Crackdown

How much can global markets withstand the combined US and Chinese regulatory onslaught on Chinese tech stocks and Chinese companies listed in the US? Notably Chinese regulators have called for talks with the US Securities and Exchange Commission over the decision to halt US IPOs of Chinese companies. Given that regulators on both sides do not seem to be letting up, the risks are skewed towards increased contagion though Chinese stocks have already fallen sharply over recent weeks, with the CSI 300 down around 15% since its high in February.

Unfortunately Chinese stocks and investors in these stocks are the casualties of a regulatory crackdown on consumer internet stocks and more recently Chinese private education companies. While the idea is not to provoke market volatility, regulators in China are unlikely to back off quickly even as the tone of the crackdown is likely to be less aggressive in the weeks ahead.

Stocks ended last week and began this week softer amid such concerns while the softer than expected US Q2 GDP print last week didn’t help matters.  More evidence that peak US growth has passed was delivered yesterday, with the US ISM manufacturing index surprising to the downside in July, declining to 59.5 — its lowest level since January but still at a relatively high level. US economic surprises (according to the Citi index) are negative and at their lowest in over a year.

The below consensus outcome for China’s manufacturing purchasing manager’s index which slipped closer towards contraction is unlikely to be helpful for markets either as the data adds to signs of moderating economic growth in China.  China’s softer July PMI releases have left a sour taste for Asian markets given more evidence of moderation in activity while the spread of the Delta variant amid low vaccination rates, still points to underperformance of regional markets. 

US dollar sentiment has continued to improve as reflected in speculative futures data (CFTC IMM data on non-commercial futures) which shows that the market holds the biggest net aggregate USD long position since March 2020.  Nonetheless, it still seems difficult to see dollar upside momentum increase given very low US real yields.  Moreover, the fact that the market is now long USD according to the IMM data, means scope for any short covering rally has dissipated.

Key data and events this week include the Bank of England (Thu) and Reserve Bank of India (Fri) policy decisions and US jobs July report (Fri).  No rate changes are likely from any of these as was the case with today’s decision by the Reserve Bank of Australia. As for US payrolls, the consensus expectation looks for a strong 900,000 increase in July and for the unemployment rate to fall to 5.7%.  

Absorbing The Fed’s Message

Markets absorbed a high inflation reading in the form of US core Personal Consumption Expenditure (PCE) price index without flinching at the end of last week, further acknowledgement that the Fed’s “transitory” inflation message is belatedly sinking in to the market’s psyche.  Core PCE inflation exceeded expectations for April, surging 0.7% m/m after a 0.4% gain in March (consensus: 0.6%). On a y/y basis, core PCE inflation surged to 3.1%—its highest level in almost three decades. High inflation readings are likely to persist over the near-term, if for no other reason than base effect, but price pressures will likely ease by the end of the year. 

The market’s sanguine reaction has helped US Treasury yields to continue to consolidate.  Also helping to restrain yields is the fact that positive US economic surprises (data releases versus consensus expectations) are close to their lowest level since June 2020 and barely positive (according to the Citi index), in contrast to euro area economic surprises, a factor that is helping to support the euro.

Cross-asset volatility measures remain very low, with the glut of liquidity continuing to depress volatility across equities, interest rates and FX.  Given that markets’ inflation fears has eased, it is difficult to see what will provoke any spike in volatility in the near term.  All of this this does not bode well for the USD.  Sentiment as reflected in the latest CFTC IMM speculative data on net non-commercial futures USD positions, remains downbeat.  This is corroborated in FX options risk reversal skews (3m, 25d) of USD crosses. 

In particular, USDCNY will be closely watched after strong gains in the renminbi lately.  Chinese officials are trying to prevent or at least slow USD weakness vs. CNY. The latest measure came from China’s central bank, the PBoC instructing banks to increase their FX reserve requirements by 2% to 7% ie to hold more foreign currency as a means of reducing demand for the Chinese currency.  Expect official resistance to yuan appreciation pressures to grow.      

Data so far this week has been mixed. China’s May NBS manufacturing purchasing managers index released yesterday slipped marginally to 51.0 from 51.1 previously (consensus 51.1) while the non-manufacturing PMI increased to 55.2 from 54.9 previously. Both remained in expansion, however indicative of continued economic expansion. China’s exports are holding up particularly well and this is expected to continue to fuel manufacturing expansion while manufacturing imports are similarly strong. 

Today’s Reserve Bank of Australia decision on monetary policy delivered no surprises, with policy unchanged and attention shifting to the July meeting when the bond purchase program will be reviewed.  On Friday it’s the turn of the the Indian central bank, Reserve Bank of India (RBI), with an unchanged policy outcome likely despite the growth risks emanating from a 2nd wave COVID infections cross the country and attendant lockdowns.  Last but not least, is the May US jobs report for which consensus expectations are for 650,000 gain in non-farm payrolls and the unemployment rate falling to 5.9% from 6.1% previously.

India’s Covid Worsening, Central Banks and US Data

A number of holidays this week points to quieter week for markets.  However, as I note below, there are still a number of risk events on the horizon. 

A growing focus is the divergent trend in the path of Covid in emerging markets and in developed economies, with the former especially in some parts of Asia, Latin America and Africa, seeing a significant worsening, which will likely result in delayed recoveries and lead to some EM asset market underperformance. 

India’s Covid situation worsens dramatically

As all the headlines show, India’s Covid situation has become particularly dire though a lack of large-scale lockdowns has led to only a limited mark down in growth forecasts there even as risks intensify.  Already there has been a political cost, with Indian PM Modi’s BJP party losing a key state election in West Bengal and losing ground in other state elections.  Virus cases are still on the rise and sadly the picture will worsen before there are any signs of improvement.  

Covid cases in India have been trending higher since February and hit record highs this weekend, above 400,000. The number of cases is approaching 20 million, with over 215k deaths, while the country has administered 157.2 million vaccine doses.  However, at the current rate of vaccination of 2.26 million per day, it will take 2.2 years to cover 75% of the population with a two-dose vaccine. 

US dollar consolidating

After losing ground in April (the USD index DXY fell close to 3% over the month) the US dollar (USD) looks likely to consolidate this month.  USD positioning has already improved over recent months, suggesting limited scope for short covering.  Seasonal factors are unlikely to be particularly influential this month.  However, I am cognizant that cross asset market volatility has eased significantly, while risk assets are already priced for a lot of good news.  Nonetheless, risk factors are increasingly rising, especially increasing Covid cases in many emerging markets as noted above.  This leaves the market prone to bouts of risk aversion, which could result in some bouts of USD strength amid an overall backdrop of consolidation.

Key data and events

This week is an important one for both data and events.  There are several central bank decisions including in Australia (Tue), Thailand and Poland (Wed), Malaysia, UK, Turkey, and Brazil (Thu).  None of the central banks are expected to change policy settings except Brazil, with the consensus looking for a 75bp hike there.  In the UK, there is uncertainty over the future path of QE and whether the Bank of England extends asset purchases or takes the first steps to bringing asset purchases to an end echoing the Bank of Canada by announcing tapering. 

On the data front, the main highlights include the US ISM surveys (today and Wed), US April jobs report (Fri) and China trade data.  Both the US ISM surveys and payrolls are likely to reveal robust readings.  Fiscal stimulus and easing Covid likely helped to boost US jobs growth in April while the unemployment rate likely fell.  Meanwhile the ISM surveys will likely remain around historical highs for similar reasons.  Overall, the data will continue to paint a picture of strengthening US economic recovery. Meanwhile China trade data is likely to reveal strong exports and imports growth, though much of this will likely be due to base effects.

Chinese Data Softens

It was a tough week for risk assets last week as stocks dropped, volatility increased and the battle between retail investors and hedge funds intensified, with the latter on the losing side. The end of the week saw US and European stocks drop.  Whether the decline in stocks is due to over extended valuations, vaccine variants, vaccine supply pressures, weak activity data or more likely a combination of all of these, asset markets go into this week on a more unstable footing, with risks skewed towards pull back extending further.  It’s hard to blame day traders for the drop given that most of activity from retail traders is buying of stocks, and now silver, with heavy short position, but they are likely contributing to the rise in volatility.  The US dollar (USD) could be a key beneficiary given the massive extent of short positioning in the currency.

Data in China is showing some softening in momentum.  China’s Jan official purchasing managers index (PMI) kicked off this week’s data and event schedule yesterday, with both the manufacturing and service sector PMIs disappointing expectations; the manufacturing PMI fell to 51.3 in Jan (consensus 51.6, last month 51.9) and services to 52.4 in Jan from 55.7 previously.  China’s softer PMI once again contrasted with a series of Asia manufacturing PMIs, released this morning. Later today the US Jan ISM manufacturing index is likely to register a modest decline (consensus: 60.0 from 60.7 previously). Also in focus today is India’s budget announcement, with the Fiscal Year 2021 budget deficit likely to be around 6-7% of GDP, much higher than the original 3.5% estimate.  

Over the rest of the week there are interest rate decisions in Australia (Tuesday), Thailand, Poland (both on Wednesday), UK (Thursday) and India (Friday).  Among these the Reserve Bank of India has the most potential for a surprise relative to market expectations, with a rate cut likely.  The highlight of the week is likely to be the US January jobs report at the end of this week (consensus 55k).  Deliberations on US fiscal stimulus will also be in focus, with a group of 10 Republican Senators writing to President Biden with a $600 billion stimulus proposal, well below the $1.9 trillion put forward by the administration.  Democrats have hinted that they may push through stimulus via reconciliation, which not require Republican support in the Senate, but such a move would likely sour any mood of cooperation in the Senate. 

A Stellar Month

November has turned into a stellar month for risk assets, with major equity benchmarks globally, especially those that are dominated by value/cyclical stocks, performing particularly well.  Investors have been willing to bypass the escalation in Covid infections in the US and Europe and instead focus on the upside potential presented by new vaccines and a new US administration, with a line up including former Federal Reserve Chair Yellen, that is likely to be more trade friendly.  Ultra-low rates and likely even more moves in a dovish direction from the Fed as well as plenty of central bank liquidity continue to support risk assets.  While challenges lie ahead (weakening growth, Covid intensification, lack of fiscal stimulus, withdrawal of Fed emergency measures) as well as technical barriers to further short-term gains, the medium-term outlook has become rosier.   

China’s economy has led the recovery and provided plenty of support to Asian markets, commodity prices and currencies. This week’s data and events kicks off with China’s official manufacturing purchasing managers index (PMI) (consensus. 51.5) (Mon) which is likely to remain in expansion, providing further support for China linked economies and assets.  However, the impact on oil will also depend on the OPEC+ meeting (Mon and Tue). Despite the sharp 30% rally in oil prices over the month further output increases are likely to be delayed as producers look to solidify gains. That said, a lot of good news appears to have been priced into the oil market already.  In contrast, the US dollar has been a casualty of the improvement in risk appetite and has shown little sign over reversing its losses. Subdued over recent days by year end selling, the USD may show more signs of life this week. 

The other key event this week is the Nov US jobs report (Fri) where a slowing pace of job gains is likely (consensus 500,000, last 638,000), with new COVID restrictions taking a toll on employment. US Nov ISM surveys are also likely to soften (Tue & Thu), albeit remaining firmly in expansion.  In Canada, the federal fiscal update (Mon), Q3 GDP (Tue) and jobs data (Fri) will be in focus.  Australia also releases its Q3 GDP report (Wed) while In Europe the flash Nov HICP inflation reading will garner attention but most attention will be on ongoing Brexit discussions, which seem to be stuck on remaining issues such as fishing rights. Central bank policy decisions in Australia (Tue), Poland (Wed) and India (Fri) are likely to prove uneventful, with no policy changes likely. 

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