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Asia Morning: Trade Talk Euphoria Dominates but the Hong Kong Bill and Huawei Threaten to Upset the Apple Cart

Market Analysis /
Stephen Innes / 18 Nov 2019

The market sees a trade deal between the US and China as more feasible after US economic adviser Larry Kudlow and Commerce Secretary Wilbur Ross were singing from the same song page suggesting a “Phase One deal” was near. While the signing of the deal will likely provide another boost to equity market sentiment, arguably more vital to defining the quality of the US-Sino relationship beyond Phase One are the evolving (or devolving) narratives around Hong Kong and Huawei. So while trade talk euphoria is still resonating, traders are nervously eyeing the developments on Hong Kong and Huawei.

Also bullish for stock sentiment, investors are starting to think that business sentiment is now forming a bottom on a global scale and is likely to show modest improvement moving into 2020, with risks of near-term recession declining. Much of this view is dependent on a Phase One deal with China getting signed, auto tariffs being put aside and hard Brexit risk subsiding. Yet, should an agreement not be reached and trade taxes are raised further, it's conceivable the global economy will continue to slide, very possibly into a recession in the quarters ahead. It seems to be either a case of green shoots or another false dawn. 

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


Short Strokes

This week will be all about short strokes – at least that’s how Larry Kudlow, the head of the US National Economic Council, described the current state of play in the trade talks. If a short stroke is in reference to golf, in which a player concludes each hole by making short strokes with a putter, there have been more than a few tap-ins missed and, indeed, neither the US nor China will concede a gimmie.

Trust remains a considerable problem, and there’s still little clarity on how that trust gap might be bridged, especially given (1) China has made it abundantly clear that removing existing additional tariffs is a precondition for reaching a deal, (2) the US insists on China agreeing to sufficiently ‘stronger language’ on IP to trigger a tariff rollback, and (3) China continues to waffle at providing a numerical target for farm purchases. Singularly each issue doesn’t appear to be a bridge too far, but collectively that could be another story altogether.
 


FOMO
 
The tendency for equity markets to chase and react to the latest trade headlines is obscuring underlying economic fundamentals. Within a brief span, we've moved from recessionary fear-mongering to trade talk euphoria. All of which is probably leaving a lot of market purists scratching their heads, wondering where the good news is coming from to corroborate this market rally.
 
Last week provided few positives on the global economic data front, with weak numbers virtually coming out of every corner of the globe. Yet the bull market in hope and expectations continues to roll on. There’s a high level of complacency setting in, and you certainly don't have to look too hard to find examples. It is notable how investors are now willing to discount lousy news despite equity markets being at all-time highs.
 
The fear of FOMO as equity markets grind higher into year-end is increasing as investors desperately want that significant dividend payout that sits at the end of the trade talk rainbow.

And while there is a massive payout waiting, the big question remains in the absence of material de-escalation in the form of a credible roadmap for a rollback in tariffs, is the uncertain probability of a lasting détente worth the risk? 
 
 
Hong Kong and Huawei

Speaking of complacency, that’s one of the things that makes me nervous about the situation in Hong Kong. Investors remain relatively sanguine about potential equity market toxic developments, both domestically and from the US as Hang Seng vols remain low.

The US Senate is sounding very confident about getting the Hong Kong bill legislation to the floor. If passed, possibly as early as this week, Congress will need to reconcile the versions and put it up to the President to sign into law. Meanwhile, Huawei’s temporary general license expired today, and with only a two week extension granted it suggests there are more than a few issues to iron out, which could ultimately prove detrimental to the broader US-China engagement.

However, President Trump has been conspicuous by his absence when it comes to the Hong Kong escalation. Perhaps Trump sees a trade deal with Beijing as a more significant priority as he makes his case for re-election and doesn’t want the Hong Kong bill to act as a stumbling block. But if the bill passes by an overwhelming majority in the Senate, it will be difficult for the White House to hold out against this bipartisan pressure and possibly put a snag in trade talk lines. 

Oil Markets

Oil prices edged up for the week ending Nov. 15, with the cost of West Texas Intermediate (WTI) for December delivery up 0.84 percent and Brent crude oil for January up 1.26 percent.

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


Despite the larger than expected EIA inventory build and the IEA offering up a slightly more bearish price outlook, suggesting non-OPEC supply growth will outdistance the expansion in global oil demand next year, traders stayed primarily focused on US-Sino trade developments where optimism continues to build after U.S. Commerce Secretary Wilbur Ross said in an interview on Fox Business Network, “We’re down to the last details now”.

The market sees a trade deal between the U.S. and China as more feasible, which is bullish for oil.

While the signing of the Phase One deal will likely provide another boost to oil market sentiment, arguably more key to defining the quality of the US-Sino relationship beyond Phase One are the evolving (or devolving) narratives around Hong Kong and Huawei. If the Hong Kong bill legislation passes by an overwhelming majority in the US Senate, it will be difficult for the White House to hold out against this bipartisan pressure that could throw a trade deal into jeopardy.
 

Gold Markets

Gold continues to track US-Sino trade developments and their impact on the financial markets, notably equities. Comments from Larry Kudlow that negotiations are down to the final stages were echoed by Commerce Secretary Wilbur Ross. These definite trade talk overtones effectively undercut gold prices and intensified selling pressure in New York on Friday that had already begun in Asian and European trading.

But there may be a reason for gold to catch a bid this morning. While the signing of the deal will likely provide another trigger to sell gold, arguably more key to defining the quality of the US-Sino relationship beyond Phase One are the evolving (or devolving) narratives around Hong Kong and Huawei.

Things are looking mighty ugly in Hong Kong, which suggests local fixed income markets may pay closer attention as risk appetite continues to sour. The uptick in geopolitical risk and uncertainty over the Huawei licensing after US companies were granted a mere two week extension has put a bid under gold markets out of the gates.

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


The US Senate is sounding very confident about getting the Hong Kong bill legislation to the floor. If passed, possibly as early as this week, Congress will need to reconcile the versions and put it up to the President to sign into law. Meanwhile, Huawei’s temporary general license expires on Monday. Failure to extend the trade license could be very detrimental to the broader US-China engagement.
 
Gold has undeniably lost lustre in the past month, most notably from the anticipation of a reconciliation between the US and China in trade negotiations, which has seen gold ETFs turning net sellers last week with outflows of $2 billion after a frenetic five months of buying.
Optimism on the trade front triggered a rally in stocks. Gains in equities cut off a newfound oxygen supply for gold when President Trump threw doubt that a tariff rollback was imminent earlier in the week. Into weeks end, however, investors struck a clear preference for risk-on assets.

And despite the USD also dipping as its haven appeal waned, weakness in the greenback did not support gold as US yields held convincingly above 1.80% as treasuries pared losses but traded in a range as improved US retail sales were offset by a poorer NY Fed's empire state survey for November and weaker than expected US industrial production numbers. But with the US economy supported by consumption, the positive retail sales print suggests it really is courageous to bet against the US consumer.

The tendency of the gold market to chase and react to the latest trade headlines is obscuring underlying fundamentals where weaker global economic data suggest more central bank policy easing. But with the Fed on an indefinite pause, it waters down the central bank easing narrative as US economic data releases remain slightly bullish. While lower for longer global interest rates continue to support, without a dovish impulse from the Fed gold my languish over the near terms.

Gold may be in for further declines if and when Phase One is finally signed off. But longer-term – and potentially gold bullish – major trade issues have yet to be explicitly resolved, suggesting a credible and comprehensive trade deal – one which leads to better growth outcomes and less policy stimulus than expected among global central banks – might still be a bridge too far. 

 

Possible trade talk outcome scenarios

 

Scenario  1: An enforceable, credible and comprehensive trade deal is reached and the Fed turns hawkish

10 Year UST  2.25 %

S&P 500        3400

Gold              $1335-65 /oz

 

Scenario  2Trade detente where tensions simmer but macro data levels out and Fed remains neutral

10 Year UST   1.85 %

S&P 500         3150

Gold               $1450-80 /oz

 

Scenario 3Trade talks go sideways, leading to a global recession and the Fed turns dovish

10 Year UST  1.40 %

S&P 500        2750

Gold              $1650-80 /oz


 
Currency markets

G-10
 
The dollar slipped against the more global trade-sensitive currencies like the Euro and Pound as optimism around the US-China trade deal increased on comments from Kudlow and Wood. But the US dollar rallied against the Yen as US stocks surged to record highs on Friday. However, it’s a bit of a wobbly start on equity markets this morning and USDJPY has traded a touch lower out of the gates.
 
Asia FX
The market is watching the critical Asia bellwether Yuan which determines where the next Asia FX goalposts will center.
Today skews negative concerning Hong Kong risk amind a lack of clarity on Huawei.

USDCNH Chart, Source: AxiTrader
USDCNH Chart, Source: AxiTrader

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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