Asia Morning: De-risking

Market Analysis /
Stephen Innes / 10 Dec 2019

Equities started the week a touch softer, the S&P500 down 0.2% heading into the close and similar declines seen in Europe. US 10-year treasury yields fell slightly while oil closed lower in the NY trading session.  

The bond market duration was better bid on Monday, after Friday's correction on the back of a surprisingly strong US jobs report. A significant fall in China's exports to the US is the primary catalyst. 

But ahead of this week’s FOMC and December 15 deadline for the US to levy a 15 percent tariff on about $160 billion of Chinese goods, investors have been de-risking and are showing little appetite to add to new equity positions before Christmas. Overall, however, it still feels like the positive momentum remains intact and that the equity markets could move higher – that is, of course, if we can clear Brexit and US-China risk.


December 15 looms ominously 

This weekend is the December 15 tariff deadline so the market is sitting anxiously, waiting to clear this hurdle before a more extensive trade domino effect ensues.

But it does make sense that equity investors de-risk as, if the US greenlights December tariffs this Sunday, it would not only be extremely detrimental for global growth but would erode much of the trade talk goodwill and could derail hopes for near-term trade deal. And given the market has bought into the December tariff defers in a big way, all hell could break loose if the tariffs don't get postponed. Indeed, that would be a bitter pill for investors to swallow as the reality check sets in that they’ve yet again been taken down the trade talk garden path only to end up at the cliff edge of trade war purgatory. 



Given that critical economic data metrics indicate the US economy is in a strong position heading to the year-end finish line, the Fed is likely to signal as little as possible this week, other than to echo recent guidance from members' latest remarks which indicate that the Committee sees policy in a good place barring a "material reassessment" to the outlook. In this context, we could expect Chair Powell to reiterate that while the bar to cutting rates is high, the bar for hiking is even higher.

China looking inwards 

There's a new twist in the debate around de-globalization and the rise of more nationalistic government policies. Beijing has ordered that all government offices and public institutions remove foreign computers and software equipment within the next three years aimed at boosting the domestic tech supply chain.

The shift in office hardware purchases supports the argument that China will continue to insulate itself by looking inwards to defend against external shocks in years ahead. It seems that they are taking this US trade war lesson to heart by gearing up internal supply chains to ward against possible re-escalation of tariff wars. However, what will be key is what happens in the private sector, while questions remain over what is defined by "domestically made."


Oil markets

There were few headlines to sway sentiment and data thin on the ground too. But no news on the trade talk front is not necessarily good news as December 15 looms ominously on the horizon. It's probably a bit too early for trade talk jitters to set in on the run-up to Sunday, so the markets could still be struggling with the voluntary nature of the over-compliance agreement. But there should now be little doubt that OPEC will say what’s needed to maintain a floor on the oil price: not much below the current level. OPEC has sent the right messaging but actual delivery will depend on compliance from Iraq, Nigeria and Russia.

WTI Chart, Source: AxiTrader
WTI Chart, Source: AxiTrader

I'm a bit surprised by all the bullish inference as OPEC's prime strategy of the past year has been limiting downside risk in the face of weakening demand and still-strong US supply growth. So, in line with that strategy, OPEC has kept the so-called OPEC straddle in check, which should cushion downside risks but not necessarily push oil prices higher. But the bullish market moves make sense in the context that traders seem to have been taken by surprise on Friday, with Bloomberg reporting a 46% increase in short bets on WTI last week and a 24% drop in the WTI net long position. So, it looks like shorts were squeezed. 

While risks remain in year-end on US-China trade talks, the OPEC decision removes a fundamental uncertainty. The upshot is that prices aren't likely to fall off a cliff anytime soon if OPEC has a say in the matter.  


Gold markets

Despite the rising risks building around the possibility of the coming weekend's US tariffs, very little haven demand has been noted. But gold has been finding a small bid amid demand for bond markets duration and as equity investors de-risk into the holiday, which is putting downward pressure on equity markets and bond yields – both a slight positive for gold.

XAUUSD Chart, Source: AxiTrader
XAUUSD Chart, Source: AxiTrader

Overall, it does still feel momentum remains for higher rates going into year-end as the global reflation trade continues to resonate – that is, of course, if we can clear Brexit and US-China risk, which is bearish for gold.

I expect activity to start slowing down a bit ahead of the year-end holidays, but it's worth noting the strong seasonality for gold to rally in January, which could even be brought forward to December given the plethora of macro uncertainties in 2020 – especially if the Fed reiterates a very high bar for raising rates in 2020 which could embolden gold investors.

Ultimately, much of the short-term momentum will depend on trade talk sincerity and whether a Phase One deal is signed, sealed and delivered. As such, gold is likely to stay on the defensive near term. 


Currency markets

The Euro 

While the strong US employment report washed out some of the EURUSD longs that were built up last week, the dreary China trade data did little to bolster the global reflation trade. But the bid has returned quickly, suggesting a market bias for long EUROs going into 2020 remains in place on the expectation of improving European data, or at least not worsening. Also, the proxy Brexit vote trade seems to be alive and well where traders view the Euro to coattail GBP gains this week.

EURUSD Chart, Source: AxiTrader
EURUSD Chart, Source: AxiTrader

The Malaysian Ringgit 

With a plethora of event risks, this week included the FOMC and the run-up to December 15 US tariff deadline; the Ringgit appears to be more than content to coattail the movement of the regional currency bellwether Yuan. There were few headlines to sway sentiment, with data also thin on the ground.  

But, on the back of the weaker China export data and a broadly stronger USD at the end of Friday's robust US jobs report, demand has remained relatively small for the local currency.

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The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.


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