It’s never over ‘til it's over: Brexit and Trade War

Market Analysis /
Stephen Innes / 11 Dec 2019

UK Election 

In the race for Number 10, the massively awaited poll from YouGov predicts a majority Tory victory, although the race has tightened considerably.

A lot of UK election GBP weight has come off quickly on the narrowing of the lead in the polls, rekindling thoughts of 2017. Make no mistake, the next 48 hours and the series of official and defacto polls will be crucial as it could give us a further indication on whether we continue veering in a similar direction to 2017. One thing's for sure when it comes to UK election, and as history reminds us: it’s never over ‘til it's over.  

GBPUSD Chart, Source: AxiTrader
GBPUSD Chart, Source: AxiTrader

 

Markets 

Another sideways day Tuesday with the S&P500 flat heading into the close and US 10-year treasury yields up 2bps to 1.84%. European equities were a touch weaker, with gold and oil little changed. Media reports suggest the US and Chinese negotiators are working to delay the implementation of tariffs set to be introduced on December 15, even as a Phase One agreement remains elusive so far.

S&P Chart, Source: AxiTrader
S&P Chart, Source: AxiTrader

And, to no one's surprise, China's commitment to hefty agricultural import quotas remains the primary sticking point on that agreement, although significant concessions on intellectual property rights, currency and access to China's financial services markets are seemingly getting ironed out.

Trump is demanding China provide a quantitative target for farm purchases, a critical piece of the trade talk jigsaw puzzle to pave the way for a deal, but the all-important rollback in tariffs is still missing. It's not clear then that the probability-adjusted risk-reward has gone up in any meaningful way in this report. Hence the markets remain in a state of trade talk limbo, waiting for the solemnity of a Trump tweet for confirmation that, at a minimum, December tariffs are not put into effect. 

Presumably, if trade discussions are moving in the right direction, hope remains alive that the Trump administration won't move forward with a possible deal-ending tariff hike on Chinese goods scheduled for December 15, and that seems to be glossing things over. 

Beijing is not entirely enamored to lock themselves into such a considerable import quota nearly twice their previous level of agricultural imports. Committing to a quantified target leaves China open to enforcement mechanism reprisal if they cannot comply for whatever reason – even a valid one around the domestic containment of swine flu. So, this is something that needs to get ironed out as, while certainly not a bridge too far, it remains a source of contention and a major sticking point. 

It’s been a fraught end of the year with event risk aplenty; investors have turned to profit protection mode with de-risking driving flows. Volumes suggest buying by systematic funds has dried up with the spike in volatility and a rise in cross-asset correlation, meaning liquidity should begin to wane – and it's only December 12. But the massive tail risk is still wagging and it's the elusive Phase One of the US-China trade deal. 

Nonetheless, the market continues to price in peak tariffs and a probable rollback of the last tranche of tariffs imposed in September. However, traders then turn a blind eye to the US passage of Hong Kong and Xinjiang bills, which could ultimately be critical for the market's assessment of the quality of the US and China relationships going forward. Reinforcing this point, China Global Times Editor-in-Chief Hu Xijin tweeted: US Congress passed many China-related bills, China can't respond to all of them. The principle of the Chinese government, as I know, is that if the US takes real action that harms China's interests, Beijing will take countermeasures and make US side pay due to price. 

So, while the markets remain anchored in a sea of trade talk calm, it could be little more than the calm between two storms as we enter 2020. 

 

FOMC 

Friday's stellar employment report should add to policymakers' confidence that consumer spending will be able to hold the line amidst the soft patch in business investment. Thus, Chair Powell could reiterate his recent remarks which indicate that the Committee sees policy in the right place, barring a "material reassessment" to the outlook. In this light, we could also expect Powell to echo a similar view from October that while the bar to cutting rates is high, the bar for hiking is even higher as prudence would suggest the FOMC fade the strength in the massive jobs report. After all, it's seldom wise to place too much emphasis on the noisy jobs reports that are subject to significant revisions. 

And who cares about CPI? The Fed has already signaled that it will put up with more inflation and CPI should only accelerate to 2%. Over or under 2% – a bogey should not change anything. 

 

Oil markets

Oil fell from its highest close in almost three months after the API inventory reported a build bearish to consciences while uncertainty over the December tariff deferral added to the soft tone.

Separately, Bloomberg reports based on a calculation by Ziad Daoud, Bloomberg chief economist in the Middle East, that Saudi Arabia's 2020 budget is based on Brent at $65/b, down from an $80/b assumption in 2019. This doesn't exactly provide a ringing endorsement to construct a bullish oil narrative around, so, despite all their compliance efforts, Saudi Arabia still thinks oil prices should remain close to the current level.  

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

I know I’m repeating myself self-ad nausea on this one, but 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.

Although the Saudi Oil Minister has stated on many occasions that the latest compliance efforts have nothing to do with the Aramco IPO, regardless of his best efforts to distance Saudi oil policy from the IPO, it's hard to pull the wool over seasoned oil trader eyes. As such, the market may test OPEC compliance resolve post IPO.

The question is: does the API build and the UK poll wobble provide oil bears with a bit more conviction?

The December 15 deadline for the imposition of new US tariffs on Chinese goods is rapidly approaching. While indications are that both sides are looking to a delay that would avoid escalation, concerns will linger until that’s finally announced. 

While the familiar backdrops remain the same, oil traders will turn focus to the policy statement from the China Central Economic Work Conference, released on December 12, which could be the next commodity risk event to watch (see currency market views below).

 

Gold markets

Gold is still in no man's land after giving back most of last week's gains post-US payrolls. Activity is still reasonably slow ahead of FOMC but could also be a function of year-end trading malaise. 

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

Gold topside so far remains limited in this current environment as momentum remains for higher bond yields going into year-end. 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.

With the FOMC statement likely to toe a steady policy line, 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. 

For now, the narrowing in the UK election polls is giving rise to Brexit uncertainty and keeping a small bid under gold at this morning’s open.

 

Currency markets

The policy statement from the China Central Economic Work Conference released on December 12 is a risk event to watch. It will set the economic policy theme for 2020. The expectation of a massive fiscal investment is the market's baseline view going into the conference, but the scale needs to be defined. So, there should be much focus on commodity exporters like the NZD and AUD as well as the basket of ASEAN currencies as China infrastructure spending announcements will most likely impact them. 

EURUSD 

EURUSD price action was disappointing after German ZEW data. Expectations were the strongest since Q1 2018, but the pairs are still struggling to take out the key 1.1100. This lackadaisical response could be a function of year-end position squaring and traders unwilling to take on much risk ahead of the FOMC meeting, although I'm struggling to see how the Feds will even think about offering up any surprises.

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

 

AUDUSD 

The Aussie is trading oddly low considering the liftoffs in copper, iron ore and palladium. With the China PMIs bottoming, new orders looking decent in various countries and even the dreary German data picking up, the Aussie should start to pick up some attention – even more so if the policy statement from the China Central Economic Work Conference confirms the market’s bullish China infrastructure suspicions. 

AUDUSD Chart; Source: AxiTrader
AUDUSD Chart; Source: AxiTrader

USDMYR

Very little to report as action remains very muted again ahead of the FOMC and traders sit tight awaiting definitive signs of some semblance of a Phase One trade agreement getting tabled – or, at a minimum, an official US announcement that the December tariffs are deferred.

USDMYR Chart, Source: TradingView
USDMYR Chart, Source: TradingView

 

Read more articles from Stephen Innes: https://www.axitrader.com/int/market-news-blog/stephen-innes

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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