Going “The Extra Mile”

Risk assets ended last week on a soft note as Brexit uncertainties intensified amid a lack of progress towards a transition deal.  However, news overnight was a little more promising, as PM Johnson and EC President von der Leyen agreed to “go the extra mile” to try to agree up on a deal.  “Incremental” progress has reportedly been made and talks could now continue up to Christmas.  Sterling (GBP) rallied on the news and further gains are likely on any deal.  However, gains may prove short lived, with markets likely to focus on the economic difficulties ahead of the UK economy.  A no deal outcome is likely to result in a much sharper decline in GBP, however.

Progress towards fresh US fiscal stimulus progress faltered leaving US equity markets on shaky ground.  As it is, US stocks have struggled to extend gains over December after a stellar month in November and in recent days momentum has faded further.  Last week 9 out of 11 S&P sectors fell, suggesting broad based pressure.  Whether it is just a case of exhaustion/profit taking after solid year-to-date gains – for example, Nasdaq is up almost 38% and S&P up 13.4%, ytd – or something more alarming is debatable.  The massive amount of liquidity sloshing around and likely more dovishness from the Fed this week, would suggest the former.  

At the same time the US dollar (DXY) and broader BDXY are down almost 6% and 5% respectively, this year and most forecasts including our own look for more USD weakness next year.  Some of this is likely priced in as reflected in 27 straight weeks of negative aggregate USD (vs major currencies) positioning as a % of open interest (CFTC). The USD looks a little firmer this month, but gains are tentative and like equities this could simply reflect profit taking.  For example, in Asian currencies that have performed well this year such as the offshore Chinese yuan (CNH) and Korean won (KRW), fell most last week, partly due to increased central bank resistance. 

This week is a heavy one for events and data.  The main event on the calendar is the Federal Reserve FOMC meeting (Wed).  The Fed could include new forward guidance stating that quantitative easing (QE) will continue until there is clear-cut progress toward the employment and inflation goals.  The Fed may also lengthen the average maturity of asset purchases. Central bank decisions in Hungary (Tue), UK, Norway, Indonesia, Taiwan, Philippines (all on Thu), Russia, Japan and Mexico (all on Fri) will also be in focus though no changes in policy are likely from any of them.   On the data front China activity data (Tue), Canada CPI (Wed), US retail sales (Wed), and Australian employment (Thu) will be main highlights.

Chinese renminbi (CNY) set to stay firm amid trade talks

Since the beginning of November, the onshore CNY and offshore CNH have strengthened by around 3.5% versus USD. Both are now trading at pivotal levels close to their 200 day moving averages. Their appreciation cannot be solely attributed to USD weakness, with the CNY CFETS trade weighted index appreciating by around 1.8% over same period. In other words China’s currency has outperformed many of its trading partners.

The relative strength of the CNY may be an effort by China to placate the US authorities ahead of trade talks. Indeed according to my estimate China has been selling USDCNY over the last few months, albeit not in large amounts. Interestingly China has not used the counter cyclical factor to push CNY lower as fixings have been stronger than market estimates only around 50% of the time over the last 3 months.

Much of the strengthening in the CNY move came after the US administration announced a pause in the trade war at the start of December, with a delay in the planned increase in tariffs from 10% to 25% on around half of Chinese exports to the US. The implication is that China does not want to antagonise the US administration with CNY weakness, despite the fact that recent Chinese trade numbers have been awful.

China had given itself some room to allow CNY appreciation by previously letting the currency fall by around 5.8% in trade weighted terms (from around 19 June 18 to end July 18) in the wake of the imposition of US tariffs. Its appreciation over recent weeks looks modest set against this background. As such CNY is likely to maintain a firm tone around the trade talks this week.

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