A Lot Of Moving Parts

There are lot of moving parts driving market sentiment at present.  US economic news has helped to buoy markets this week after US Q3 GDP was revised higher in its second estimate, to 2.1% q/q while October durable goods orders came in stronger than expected.  However, the news that President Trump signed the Hong Kong Human Rights and Democracy Act after almost unanimous passage in Congress, has fueled some cautious.  Investors now await any retaliation from China and whether the Bill will get in the way of a Phase 1 trade deal.

On the trade front both the US and Chinese governments have said that there are closing in on a Phase 1 deal but as yet there has been no confirmation, with less and less time to agree a deal before the end of the year and more importantly before the next phase of tariffs kicks in on December 15.  One sticking point between the two sides appears to be what extent will the US administration roll back tariffs, with China likely wanting not only the tariffs scheduled to be implemented in mid-December to be rolled back but also the ones implemented in August.

Such a roll back in tariffs would be take place in exchange for increased Chinese purchases of US goods and perhaps stricter intellectual property regulations, but more structural issues such as state subsidies, technology transfers etc may be put back to later deals.  In the meantime markets do not appear overly concerned, with risk assets and equities in particular continuing to rally and volatility continuing to decline.  If there is no deal announced in the weeks ahead, markets could face a set back, but if agreement on a deal is to be merely pushed back into Q1 2020, the damage will be limited.

After its sharp fall over October the US dollar has gradually clawed back ground over recent weeks, helped by US asset market outperformance and consequently strong inflows into US assets.  As we move towards the end of the year it appears that the USD will maintain its top spot, much to the chagrin of the US administration and their preference for a weaker USD.

Cautious Sentiment Towards A Trade Deal

Markets continue to focus on the potential for a “Phase 1” trade deal between the US and China.   The stakes are high. President Trump who stated that tariffs on Chinese goods would be “raised very substantially” if no deal was struck between the two sides.  US officials also poured cold water over comments by Chinese officials at the end of last week that there had been an agreement to reduce tariffs in phases.  Markets will take a cautious tone given such comments but it is still likely that a deal of sorts will agreed upon in the next few weeks.

Both sides want a deal and while Trump has said that China wants one more than he does, the US administration may want to avoid fueling market turmoil as attention increasingly turns to next year’s US elections.  This suggests that a Phase 1 deal is more likely than not, but agreement on later Phases will be much harder given that there are various structural issues that remain unresolved such as technology transfers, intellectual property theft and state subsidies.

For now what is important is that markets believe that there is progress towards a deal and an eventual signing probably sometime in December.  Despite the harder rhetoric from the US side this still looks like the most likely outcome which in turn suggests that equities and other risk assets have room to rally.  In the meantime, the situation in Hong Kong where protests have intensified will weigh not just on Hong Kong’s markets but markets across the region adding another reason for market caution in the short term.

On the data and events front attention will be on US October CPI, retail sales and a crop of Fed speakers including Fed Chair Powell who is unlikely to change the view the Fed is on pause for the time being.  Elsewhere Chinese data has been less than impressive this week, with October aggregate financing and new yuan loans both coming in weaker than expected.   This is likely to be echoed by the retail sales and industrial production data this week too.

On the FX front, the US dollar has made up around of its October losses amid some deterioration in risk appetite.  Further moves will depend on the progress towards a trade deal, with the USD likely to be pressured should it become clearer that a deal is likely to be signed and vice-versa.  US retail sales data will also have some impact in the short term, but with the Fed on pause and US data holding up the USD the will be driven by driven by the gyrations in risk assets.

Bumpy Ride Ahead

Just as it looked as though there was some hope of stabilisation in global economic conditions, the September US ISM (Institute of Supply Management) Index released on Monday was not only weak but it was a lot worse than expected at 47.8 (below 50 means contraction).  Markets clearly took fright, with the sell off in stocks intensifying yesterday in the wake of the US ADP jobs report for September, which recorded an increase of 135k jobs by private sector employers, its weakest reading in three months.

This all sets up for a nervous wait ahead of tomorrow’s September jobs report in which markets will be on the look out for any slowing in nonfarm payrolls and/or increase in the unemployment rate.  The consensus expectation is for a 148k increase in payrolls in September and for the unemployment rate to remain at 3.7%, but risks of a weaker outcome have grown.  The US dollar has also come under pressure as US economic risks increase.

Rising geopolitical risks are adding to the market malaise, with the impeachment enquiry into President Trump intensifying and risks of a hard Brexit in the UK remaining elevated.  On the latte front UK Prime Minister Johnson published his plans for a Brexit strategy yesterday replacing Theresa May’s “backstop” plan with two new borders for Northern Ireland.

If the proposal isn’t agreed with the EU, there is a strong chance that Johnson will be forced to seek another extension to Article 50 from the end of October, prolonging the three and a half years of uncertainty that the UK has gone through.  GBP didn’t react much to the new plan, and surprisingly did not fall despite the sharp sell off in UK equities yesterday, with the FTSE falling by over 3%.

The fact that the US has now been given the green light to impose tariffs on EU goods after the EU lost a World Trade Organisation (WTO) ruling adds a further dimension to the trade war engulfing economies globally.  The US administration will now move ahead to impose 25% tariffs on a range of imports from the EU, with the tariffs implementation likely to compound global growth fears.  If the EU wins a similar case early next year, expect to see an onslaught of EU tariffs on EU imports of US goods.

This is taking place just as hopes of progress in trade talks between the US and China in talks scheduled for next week have grown.  But even these talks are unlikely to be smooth given the array of structural issues that remain unresolved including technology transfers, Chinese state subsidies, accusations of IP theft, etc.  Additionally, the fact that the US administration has reportedly discussed adding financial restrictions on Chinese access to US capital suggests another front in the trade way may be about to open up.

The bottom line is that there is a host of factors weighing on markets at present and adding to global uncertainty, none of which are likely to go away soon.  Now that fears about the US economy are also intensifying suggests that there is nowhere to hide in the current malaise, implying that risk assets are in for a bumpy ride in the weeks ahead while market volatility is likely to increase.

 

 

 

 

Bonds Under Pressure, UK Parliament Rejects Election Again

Market sentiment remains positive as hopes of a US-China trade deal continue to provide a floor under risk sentiment amid hopes that the escalation in tariffs can be reversed.  Weak Chinese trade data over the weekend has largely been ignored and instead markets have focused on further stimulus unleashed by China in the wake of the cut in its banks’ reserve ratios, which freed up around USD 126bn in liquidity to help shore up growth.  Expectations that the European Central Bank (ECB) will this week provide another monetary boost by lowering its deposit rates and embarking on a fresh wave of quantitative easing, are also helping to support risk sentiment though a lot is already in the price in terms of ECB expectations.

One of the casualties of the turn in sentiment has been bonds, with yields rising in G10 bond markets.  For example US 10 year yields have risen by around 18 basis points since their low a week ago.   The US dollar has also come under pressure, losing ground in particular to emerging market currencies over the past week.  Safe haven currencies such as the Japanese yen (JPY) and Swiss franc (CHF) have fared even worse.   As I noted last week I think the bounce in risk appetite will be short-lived, but how long is short?  Clearly markets anticipate positive developments in US-China trade talks, and it seems unlikely that risk appetite will deteriorate ahead of talks, at least until there is some clarity on the discussions.  Of course a tweet here or there could derail markets, but that is hard to predict.

Sterling (GBP) has been another currency that has benefited from USD weakness, but also from growing expectations that the UK will not crash out of the EU without a deal.  Developments overnight have done little to provide much clarity, however.  UK Prime Minister Boris Johnson failed in his bid for an early election on October 15, with MPs voting 293 in favour of an election against 46 opposed;  Johnson required two-thirds or 434 MPs to support the motion.  Johnson is now effectively a hostage in his own government unable to hold an election and legally unable to leave without a deal.  Parliament has been suspended until October 14, with Johnson stating that he will not delay Brexit any further, reiterating that he is prepared to leave the EU without an agreement if necessary.

This would effectively ignore legislation passed into law earlier blocking a no-deal Brexit forcing the PM to seek a delay until 31 Jan 2020. Separately parliament passed a motion by 311 to 302 to compel Downing Street to release various documents related to no-deal Brexit planning, but officials are so far resisting their release.  A lack of progress in talks with Irish PM Varadkar in Dublin on Monday highlights the challenges ahead.  GBP has rallied following firmer than expected Gross Domestic Product data (GDP) yesterday and growing hopes that the UK will be prevented from crashing out of the EU at the end of October, but could the currency could be derailed if there is still no progress towards a deal as the deadline approaches.

 

Will The Risk Rally Endure?

There has been a definitive turnaround in risk sentiment this week, with equities rallying and bonds falling.  Whether it can be sustained is another question. I think it will be short-lived.

Markets are pinning their hopes on trade talks which have been agreed be US and Chinese officials to take place in October.  These would be the first official talks since July and follow an intensification of tariffs over recent weeks.  However, talks previously broke up due to a lack of progress on various structural issues and there is no guarantee that anything would be different this time around.  Nonetheless, such hopes may be sufficient to keep market sentiment buoyed in the short term.

Data overnight was bullish for risk sentiment, with the US August ADP employment report revealing private sector gains of +195k, which was higher than expected.  The US ISM non-manufacturing index was also stronger than expected, rising to 56.4 in August from 53.7 previously.  This contrasted with the slide in the manufacturing PMI, which slipped in contraction below 50, reported earlier this week.  The data sets up for a positive outcome for the US August jobs report to be released later today, where the consensus (Bloomberg) is for a 160k increase in payrolls and for the unemployment rate to remain at 3.7%.

As risk appetite has improved the US dollar has come under pressure, falling from its recent highs.  Nonetheless, the dollar remains at over two year highs despite speculation that the US authorities are on the verge of embarking on intervention to weaken the currency.  While I think such intervention is still very unlikely given that it would do little to change the factors driving the dollar higher, chatter about potential intervention may still keep dollar bulls wary.  While intervention is a risk, I don’t think this stop the USD from moving even higher in the weeks ahead.

Conversely China’s currency, the renminbi has reversed some of its recent losses, but this looks like a temporary retracement rather than a change in trend.  China’s economy continues to weaken as reflected in a series of weaker data releases and a weaker currency is still an effective way to alleviate some of the pressure on Chinese exporters. As long as the pace of decline is not too rapid and does incite a sharp increase in capital outflows, I expect the renminbi to continue to weaken.

A Host Of Global Risks

Last week was a tumultuous one to say the least.  It’s been a long time since so many risk factors have come together at the same time.  The list is a long one and includes the escalation of the US-China trade war, which last week saw President Trump announce further tariffs on the remaining $300bn of Chinese exports to the US that do not already have tariffs levied on them, a break of USDCNY 7.00 and the US officially naming China as a currency manipulator.

The list of risk factors afflicting sentiment also includes intensifying Japan-Korea trade tensions, growing potential for a no-deal Brexit, demonstrations in Hong Kong, risks of a fresh election in Italy, growing fears of another Argentina default, ongoing tensions with Iran and escalating tensions between India and Pakistan over Kashmir.

All of this is taking place against the background of weakening global growth, with officials globally cutting their growth forecasts and sharply lower yields in G10 bond markets.  The latest country to miss its growth estimates is Singapore, a highly trade driven economy and bellwether of global trade, which today slashed its GDP forecasts.

Central banks are reacting by easing policy.  Last week, the New Zealand’s RBNZ, cut its policy rate by a bigger than expected 50 basis points, India cut its policy rate by a bigger than expected 35 basis points and Thailand surprisingly cutting by 25 basis points.  More rate cuts/policy easing is in the pipeline globally in the weeks and months ahead, with all eyes on the next moves by the Fed.  Moving into focus in this respect will be the Jackson Hole central bankers’ symposium on 22/23 August and Fed FOMC minutes on 21 August.

After the abrupt and sharp depreciation in China’s currency CNY, last week and break of USDCNY 7.00 there is evidence that China wants to control/slow the pace of depreciation to avoid a repeat, even as the overall path of the currency remains a weaker one. Firstly, CNY fixings have been generally stronger than expected over recent days and secondly, the spread between CNY and CNH has widened sharply, with the former stronger than the latter by a wider margin than usual.  Thirdly, comments from Chinese officials suggest that they are no keen on sharp pace of depreciation.

Markets will remain on tenterhooks given all the factors above and it finally seems that equity markets are succumbing to pressure, with stocks broadly lower over the last month, even as gains for the year remain relatively healthy.  The US dollar has remained a beneficiary of higher risk aversion though safe havens including Japanese yen and Swiss Franc are the main gainers in line with the move into safe assets globally.  Unfortunately there is little chance of any turnaround anytime soon given the potential for any one or more of the above risk factors to worsen.

What To Watch This Week

Market expectations for Fed FOMC interest rate cuts have gyrated back and forth following a recent speech by NY Fed President Williams, one of the key decision makers within the Fed FOMC. He appeared to support a 50bps rate cut at the meeting at the end of the month, but unusually this was clarified later.  If anything, as the clarification may suggest, the bigger probability is that the Fed eases policy by 25bps in an insurance cut.

There will be no Fed speakers in the days ahead but the Fed will assess developments this week in helping to determine the magnitude of easing. Attention will continue to centre on US earnings, with more than a quarter of S&P 500 companies reporting Q2 earnings this week.   On the data front, US Q2 GDP and July durable goods orders will command most attention.  The consensus looks for a slowing in GDP growth to 1.8% q/q in Q1 from 3.1% q/q in Q1 while durable goods orders are expected to increase by 0.7% m/m.

A major central bank in action this week is the European Central Bank on Thursday. While policy easing is unlikely at this meeting, the ECB is likely to set to set the market up for an easing in deposit rates at the September meeting.  ECB President Draghi could do this by strengthening his forward guidance, but as a lot of this is priced in by the market, a dovish sounding Draghi is unlikely to weigh too much on the EUR.

In the UK this week it’s all about politics. Boris Johnson is widely expected to be announced as the new Prime Minister.  GBPUSD has clung onto the 1.25 handle, as worries about a no deal Brexit continue to impact sentiment towards the currency.  Once Johnson is sworn in he and the government could face a no confidence motion, which could gain support should it be seen as an alternative to the UK crashing out of the EU.

National elections in Japan yesterday resulted in a victory according to Japanese press for Shinzo Abe’s coalition, its sixth straight victory, with the governing LDP winning over half the 124 seats. The results were no surprise, and unlikely to have a significant market impact, but notably Abe suffered a setback by not gaining a supermajority. He therefore cannot change the country’s pacifist constitution.

In emerging markets, both Russia and Turkey are likely to cut interest rates this week, with Russia predicted to cut its key rate by 25bp and Turkey to cut by at least 200bps if not more.  Elsewhere geopolitical tensions will remain a major focus for markets, as tensions between the UK and Iran intensify.

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