Is it time to move past the narrative on trade tariffs, if not trade friction?
The stage is set for signing the Phase One deal this week, but don't forget the details are still sketchy. Importantly for risk – and given the very modest expectations of a breakthrough on some of the more material issues around this truce – the hurdle to disappoint should be relatively high, but when things look too good to be true it might be time to pause to consider the unpredictability of the Trump Twitter Feed.
On the US data front, this week's docket will provide an update on inflation trends, consumer spending and the manufacturing sectors. While all are important in the Fed policy decision process, inflation metrics will be keyed on. Core inflation trends are expected to remain steady in the CPI (Tuesday) and PPI (Wednesday) data, but these prints and inflation directions be will be an essential policy-forming theme this year. Fed officials will enter the nub of their policy review over the next several months—the critical debate centering on where or not the FOMC will adopt an average inflation targeting strategy. As Chair Powell has said, persistently low inflation is "one of the major challenges of our time."
Asia's focus will fall on the Bank of Korea which is expected to keep its policy rate unchanged on January 17. In addition, all eyes will be on the China high-frequency data release where economists expect retail sales growth to accelerate to 8.2%, from 8% in November; fixed asset investment growth rises slightly to 5.3, from 5.2% in the same period, and IP growth to moderate somewhat, to 6% in December from 6.2% in November, although the better than expected manufacturing PMI of late poses upside risks to this outlook.
With investors optimistically expecting China’s GDP growth to remain steady at 6% in Q4 (unchanged from Q3) resulting in annual average growth of 6.2% for 2019, these high-frequency data points are critical metrics in confirming this view.
No one knows where currency markets will trade in the future; not me, not fundamental or technical analysts, and certainly not Wall Street. But while the future is impossible to see, the present is bright for anyone willing to listen to the story the market tells us every day – or at least George Saravelos of Deutsche Bank:
"If last year taught us anything, it was not to shy away from changing views in response to events. Tweets mattered more than macro forecasts. And it looks like 2020 will be similar: still challenged by uncertainty but also low vol, at least to start." With low vol and investors increased yield-seeking appetite, "Carry is King."
The persistent strength of the dollar, especially against the low yielding currencies, has surprised many. And while the greenback will become a major focal point during the US presidential election and the Fed could eventually end up cutting rates to stoke inflation following the strategy review, these events are later in the year. For now, some themes are evolving, particularly in Asian currency given the slightly better regional economic environment.
Outside of last week's oil price shocker, Asia exporter currencies, and in particularly high yielders, have been in massive demand as inflows have notably increased into the INR, IDR, PHP and MYR. Traders are also in a riskier mood as the Yuan, Asia’s key bellwether, is trading on an even keel which bodes very well for ASEAN currencies in general into 2020. But the USDHKD remains bid as traders fade the move lower as it approached the bottom of the trading band.
The Indonesian Rupiah dropped to 13757 from 13880 on the back of comments from Bank Indonesia's Hendarsah, who said the central bank would allow the Rupiah to strengthen further. A similar explanation was offered up last year. Still, the central bank is having a more significant effect this time around as the Yuan is shifting on a stronger tack.
With the P1 deal getting signed this week and risk sentiment roaring, FX flows last week were characterised by risk-on buying of USD – even more so after the Middle East de-escalation which triggered a top side frenzy for USDJPY. These stories could still further evolve this week.
One notable exception that I'm a bit puzzled by is CHF, which is trading very bid as large flows are going through the market during European hours despite the risk-on tone. Other than to suggest hedge funds view the Franc as fair value at current levels and an excellent hedge against all the ills of the world, I'm a bit perplexed by the Swissy resilience.
Nonetheless, there’s been a lot of interest in EURCHF topside structures. The feeling here is that the Swissy benefitted disproportionately from recent tensions in the Middle East, perhaps because Japan's dependency on oil imports from the Persian Gulf (c. 85%) made the Yen an unreliable haven. So, as the Middle East tensions de-escalated, the EURCHF could fly on a more pronounced long CHF unwind. But it hasn't worked out that way so far.
We saw quite a reversal of fortunes in gold last week in the wake of Middle East de-escalation. But, given the economic and geopolitical headwinds which lie ahead in 2020 and for those with gold risk appetite left, this could be an excellent contrarian entry point for gold longs.
If the likes of UBS, Citi and Deutsche Bank – who are big guns in the gold market – like gold as a critical hedge and are calling for multiple Fed rate cuts this year, take notice. When it comes to gold's bullish ambitions, it always boils back to real yields. So if the Fed blinks you might look back at current levels with nostalgic longing in H2 2020.
As far as last week’s geopolitical knock-on effects go, détente is where we stood on Friday as geo pressure on gold has eased after the US House of Representatives voted to limit President Trump’s ability to authorise military action against Iran, a report from the Pentagon suggested Iran sought to avoid casualties by intentionally targeting unpopulated areas of the US airbases hit with missile attacks earlier this week, and Iran’s Revolutionary Guard Corps said the strikes had not been intended to cause loss of life.
Gold's surge back through $1600/oz earlier this week to levels not seen since 2013 has further cemented its safe-haven relevance. As the market retraces and ponders its next move, it’s worth highlighting some of this year stories so far.
Physical demand remains tepid. Demand from India, the second-largest importer of gold, remains weak, and the $5 discount to loco London prices highlights the lack of interest to chase the price. China import tariffs were approved early in response to the timing of Chinese New Year holidays but there has been minimal uptake in physical from mainland reports.
UBS suggests discretionary investors are on the sidelines, but insiders report CTAs have maxed long gold again. According to Deutsche Bank, long-term holders were net buyers on the rally. Sovereign activity is mixed, while private wealth and ETF accounts were all modest buyers.
Not all signals are aligned as risk continues to froth, but the outlook for gold remains constructive. The market is not that overbought on an overall total global asset proportional basis, although the market is nudging towards a new high watermark for the overall IMM commitment to trader positioning. But with gold underweight on an entire global asset comparable basis, it does give rise to support the dip above 1500, with a view for a test of the recent highs in due course.
Oil prices dropped on Friday, extending days of losses as the threat of war in the Middle East receded and investors switched attention to economic growth prospects and the rise in US crude oil and product inventories. But things haven't strayed too far south, suggesting markets have seemingly found a tentative geopolitical risk balance. After all, we were only 48 hours away from what appeared to be a full-blown US-Iran war so it's difficult to be cheerful, especially given the existing levels of risk.
The markets have called the end to Trump's battle against Iran, but I think it's not very likely this is over. The reality is the current US-Iran friction is merely the latest episode in a forty-year war; don't believe for one moment the US has forgotten 1979.
But what could be significant for the near term is that, given the militias loyalty to Shia cleric Muqtada al-Sadr, they will likely honor his request to stand down. In addition, US intelligence services reportedly intercepted communications from Iran to militia groups urging them not to target US interests. Risks remain skewed to the upside, but I expect a period of relative stability. These dovetails might reduce a significant proxy retaliation risk for supply disruption, especially if there are no apparent attempts to disrupt oil supplies during the weekend. Given the current compounding effects of Middle East risk fading to dust and the piling-on impacts of this week's bearish EIA inventory data, oil prices could be under the cosh early next week.
The global oil market is expected to be well-supplied in 2020 and demand growth could stay weak, keeping a lid on prices, the head of the International Energy Agency told Reuters on Friday: "We are expecting a demand growth of slightly higher than 1 million barrels per day," said the IEA's executive director, Fatih Birol, adding that growth could remain weak, compared with historical levels.
There’s also an implied surplus of 1 million bpd oil, ensuring that the global market is well supplied: "Non-OPEC production is very strong. We still expect production coming from, not just United States, but also Norway, Canada, Guyana, among other countries," Birol said, referring to oil producers outside the Organization of the Petroleum Exporting Countries (OPEC). "Therefore, I can tell you that the markets are, in my view, very well supplied with oil, and as a result of that, we see prices remain at $65 a barrel."
But for those brave traders who still have risk appetite left, oil on a correlated risk basis might look a tad cheap relative to risk on levels. Global growth momentum remains skewed to the upside and a P1 trade deal will be signed next week. Given that there’s some residual threat of disruption to physical supply, I think this is a reasonably solid floor. And if not here, it's not much further south of today's current midpoint.
The Yuan Outlook
We enter 2020 amidst a backdrop of blue skies in the global manufacturing/tech cycles coming through and a thaw in the US-China trade tensions.
RMB NEER has weakened by 7% in the past 18 months, where most of that weakness was centered around the numerous trade escalation episodes when the effective tariff rate on total Chinese exports to the US rose from 3% to a threat of 21%.
During the current trade truce, including 50% unwinding of September 19 tariffs, the effective tariff rate eases by only 1.5%. Nonetheless, this decline should translate into relief for the RMB where most market models have it pegged exactly where the PBoC has centered the third reference rate midpoint. That itself is very reassuring and provides traders something definitive to work with while suggesting the PBoC are at the top of their game on their policy settings.
Although I suggested all paths lead through the PBoC, the Fed's policy direction will also be a key impetus to the USD/RMB outlook. If global manufacturing activity continues to improve or dollar weakens amidst sustained weakness in US economic activity, then USDCNY will also drift lower. Also, a Fed policy pivot would suggest a move to 1.1500 on the Euro, and given the sensitivity of the CNY to the EUR the USDCNH will then decline to 6.80.
But for risk sentiment in general, absent a Fed pivot the Phase One deal ensures a more stable Yuan this year which is excellent for Asia risk, but there will be a downside skew to 6.80 if Phase Two talks progress well. Indeed, this would be excellent for global risk as the P1 deal suggests the RMB will not be a source of EMFX weakness this year and should provide a boost to global equity markets.
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Soaring US yields trigger the wrecking ball effect as yields become a source of volatility for risk, rather than a source of support