Positive Start To The Week

Markets start this week on a positive note in the wake of 1) the strong US December jobs report, which revealed a larger than expected increase in non-farm payrolls of 312k and decent growth in average hourly earnings of 0.4% m/m, 2) positive comments by Fed Chairman Powell on the US economy, while noting that the Fed will be patient if needed and 3) the 1% banks’ reserve requirement (RRR) cut by the PBoC in China.   Powell’s comments will also weigh on the USD this week against the background of long USD positioning, helping EM currencies.  He speaks again on Thursday.

Events this week will be key in determining the tone for markets further out, however.  In the UK parliament returns after its holiday break, with debate on the “meaningful vote” taking place over the week and markets will watch for any sign that May’s proposed deal gains traction.  The FT reports that she is facing a fresh challenge, with senior MPs signing up to block the government from implementing no-deal measures with parliament’s consent. x

China’s RRR cut (announced on Friday) will help to put a floor under risk sentiment.  The total 1% easing will release RMB 800 bn of liquidity, according to the PBoC, ahead of the Chinese New Year. A cut was widely expected in the wake of weak data and strongly hinted at by Premier Li prior to the PBoC announcement. The PBoC already cut the RRRs four times in 2018, and more should be expected to come, including MLF and other targeted easing.

Focus will centre on trade talks between US and Chinese officials beginning today.   Both sides are under pressure to arrive at a deal in the wake of pressure on US asset markets and weakening Chinese growth, but the differences between the two sides remain large. The US delegation will be led by Jeff Gerrish, the deputy trade representative and he is joined by officials from the agriculture, energy and treasury departments, suggesting that talks will centre on more detailed content.

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China easing as data softens

China’s decision over the weekend to cut the required reserve ratio (RRR) by 100bp (effective Oct 15), the fourth cut this year, will inject around CNY 750bn in liquidity into China’s money markets. The decision to ease comes in the wake of a run of recent soft data.   There should be no big surprise.  China is reluctant to ease policy via a policy rate cut to avoid fuelling any increase in leverage and therefore continues to embark on targeted easing in the form of RRR cuts.

It is likely that further RRR cuts in addition to fiscal stimulus are in the pipeline to cushion the slowdown in the economy.   Indeed, growth was already slowing before the US tariffs impact bites and will likely slow further in the months ahead as the impact of tariffs has a greater effect.   Recent forward looking data including the official and CAIXIN purchasing managers’ indices (PMIs) of manufacturing confidence have softened, with the exports component of the PMIs dropping significantly.

Such cuts will weigh on China’s currency, CNY/CNH and a continued spot depreciation versus USD is likely.   After its sharp decline in June/July FX the PBoC has succeeded in stabilising the CNY (in trade weighted terms) however.   Any decline in foreign exchange reserves has been limited as reflected in the latest FX reserves data, which revealed that FX reserves dropped by $22.7bn only in September, suggesting that as yet there have not been significant capital outflows (ie panic) from China and limited need for FX intervention to support the CNY.

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