With equity markets hitting all-time highs on the cusp of the Federal Reserve Board embarking on an easing cycle, it’s about as unambiguously bullish a signal one can get which has triggered a massive wave of investor optimism in across equity markets
Oil prices went full circle ending the week where they started. Scanning the CME Commitment of Traders data, it appears oil traders have fallen into the summer doldrums as there has been little shift in WTI crude oil positions the past several weeks.
So, despite the dreary l worldwide manufacturing data slump, the central bank easing effect has buttressed oil prices by effectively curbing downside volatility.
But look for markets to remain sandwiched between trending weekly inventory draws and constant concerns about the global economic downturn. All the while Middle East tensions are providing a modicum of support, but those risks are failing to move the dial to a noticeable degree amidst this definitively wobbly economic backdrop
News last week that Saudi Arabia and Kuwait are making progress on talks about re-starting 500kb/d of production in the shared Neutral Zone added to the pressure on oil, but it appears supply risks and US-China trade talks this week are the focus.
Gold prices have been relatively steady although Gold’s wings were clipped by the stronger US dollar response which has likely sent some investors to the sidelines ahead of FOMC. I would expect the market will be dominated by pre FOMC position squaring, and since overall risk remains a bit top-heavy, I would expect upticks to be sold rather than downticks bought. So, while jockeying for position ahead of the FOMC unfolds, inter-day momentum will be driven by the DXY which continues to show a robust inverse correlation to Gold. But overall look for Gold to tread water ahead of the FOMC.
The European Central Bank will not renew an agreement with 21 European central banks that limits gold sales. “Signatories of the 4th Central Bank Gold Agreement no longer see the need for a formal agreement as the market has developed and matured,” the European Central Bank said in a statement on Friday. The agreement expires on 26 September and includes the ECB.
Gold investors should take this as a vote of confidence. There is little threat of a widespread sell-off over the next decade so no need to extend the agreement. Gold has become much more of diversified reserve factor with half of the 24 central banks that purchased gold last year had not been in the market for decades, including some Eastern European and Asian central banks. Central banks are unlikely to stop buying gold anytime soon.
Posititionion alone would suggest USD bullish bets could unwind ahead of the FOMC.
Sure the consumption component of US GDP was strong, but with economic drag across everything else, it’s sending off some alarm bells about the trajectory for US growth. And from my current currency markets modelled view the prospect of slower US growth is negative for the USD, signalling to me anyway this is an excellent time to pause for thought about currency markets in general as was we dive headfirst into to the most prominent central bank event of the year.
Then we had Trump and Kudlow seemingly contradict each other about administrations US dollar policy, which is giving even more reason to sit tight.
The ECB dovish pause has not created some newfound value for the Euro, but rather with the market heavily vested for weaker EUR traders is sitting tight ahead of the FOMC. But even though the ECB kicking the can to September, if currency traders are indeed focusing on growth metrics as I endlessly harp on about, the lack of ECB policy action in the wake of the disastrous PMI and IFO prints is an even more compelling reason to sell EURUSD.
Adding to the Euro woes was the dollars fortuitous move when the US GDP print came out better than expected. Consumption contributed a whopping 2.85 % as shoppers opened their purse strings and spent at a feverish pace. They are proving yet again that we should never underestimate the spending power of the US consumer.
The Pound remains under pressure for the same reason as last week as the probability of a no-deal Brexit increase as due to more combative negotiations which could push the situation to the brink of disaster, for the Pound that is. This as news hits the UK is stepping up preparations for a no-Deal Brexit at the October deadline
Overall Currency view
But if I was put on the” spot”, so to speak
But in terms of importance, and accounting for the F.X. market’s mercurial mood swings, the most critical variable in the dollar’s positive expression is growth in the rest of the world, and particularly in China.
Moving in the opposite direction to last year’s economic momentum and interest rate mosaic, the U.S. manufacturing ordinals are converging with the rest of the world. Still, there has been no reversal in the dollar’s fortune, merely a slowing of last year’s momentum suggesting the USD is not about the hand over the King of Hill mantel anytime soon.
It’s a busy week on the central bank front, but it’s the FOMC who will test the upper limits of the markets Central Bank patience and resolve. The market has settled on 25 basis point cut with a nod to additional easing. If the Fed cuts at the upcoming FOMC meeting, which appears highly likely given officials’ statements, it will inaugurate the beginning of a new Fed easing cycle. Anything other will trigger an aggressive symmetrical response across a swath of risk assets.
Inflation concerns aside, the other main reason the market is all in on a July rate cut is the Fed has always eased when the leading indicators have declined over a 6-8 month period. So, the July easing is very much in line with historical patterns considering the US manufacturing ISM has declined for the last nine months and is down from above 60 to 51.7.
So, an argument could be fashioned that the Fed’s are a bit late to the plate on this policy move, and with absentee inflation yet another major concern a 50 bp rate cut is not completely out of the question.
But much of ISM decline is a result of the trade war shock to growth which continues to unravel the global economy, and in the US specifically, the “Trump Bump” to the US manufacturing sector is all but a distant memory.
So, the amplitude of the Fed easing cycle will very much depend on the de-escalation and a resolution around trade concerns which in the absence of a détente could continue to weigh on US manufacturing data and all but force the Feds hands with a follow-up cut in September.
Fortunately for equity markets, global central banks have adopted ” whatever it takes” mentality to buy some time for both parties to reach a trade resolution. Still, uncertainty about whether the next series of tariffs on China will hit or whether the US administration targets the EU remains a huge question mark which at a minimum should keep the Fed on the easing tack and provide growth and risk asset with sufficient breathing room.
But after the FOMC cards are on the table, and the forward-looking indicators like the PMI and ISM are behind us, it is now time focus what firms are doing rather than what they were saying.
A Shanghai Surprise?
Hoping for the best but preparing for the worst best describes my view about this week’s face to face trade meeting in Shanghai. But we are not overly optimistic about a substantial positive Shanghai surprise.
However, our best guess is that the two sides will find agreement on a few modest soft-pedalled concessions including new Chinese purchases of US agricultural products and a pause of further tariff increases on Chinese exports to the US. President Trump and Chinese President Xi already agreed in principle to these two items in Japan a month ago negotiations conclude.
Following another month of escalating tensions, agreement on practically anything will be a positive as the market will relish any sign of progress and investors could respond more emotionally than is warranted to any baby stepped dribs and drabs.
With the US economy doing well and equity markets at record highs the Whitehouse would be less likely to meet China halfway, whereas even President Trump has resigned himself the fact that China might roll the dice on the US 2020 election hoping for a more trade comprising Democrat to be voted into power.
The Hong Kong Factor
The US has been conspicuously quiet commenting on the civil unrest in Hong Kong as to not estrange the mainland further amid these quarrelsome trade negotiations. If China takes any incensing behaviour or the US were to comment resolutely supporting the protesters, this could trigger a severe blow to the trade talks. We think this is certainly worth keeping an eye on.
A slowing Hong Kong economy falling house prices and drop in tourist trade may pale in comparison to the global economic fall out that could occur if the US administration steps into the fracas.
WEEKEND UPDATE (27-7-27)
The Heavy Central Bank Docket Awaits
It’s a busy week on the central bank front, but it’s the FOMC who will test the upper limits of the markets Central Bank patience and fatigue.
The Federal Reserve
The market has settled on 25 basis point cut with a nod to additional easing. If the Fed cuts at the upcoming FOMC meeting, which appears highly likely given officials’ statements, it will inaugurate the beginning of a new Fed easing cycle. Anything other will trigger an aggressive symmetrical response across a swath of risk assets.
The Bank of Japan
The Bank of Japan reaction function has more do with the trajectory of USD rather than anything else. Hamada and others have been toeing the dovish line in recent days in that significant easing by the Fed could strengthen the yen and could trigger a BoJ call to action if a currency race-to-the-bottom unfolds, but certainly not at current USDJPY levels.
The Bank of England
With a weaker Pound and strong wage growth fueling inflation, the Bank of England is facing a bit of a problem as a gloomy global outlook, and the increased chance of no Brexit divorce intensify. So, the markets will likely be more focused on how the BOE navigates their guidance, particularly around UK growth in the context of inflation as the BOE also publishes its quarterly inflation report along the side of its policy statement.
The European Central Bank ( updated view)
The ECB’s regime shift in the face of waning tolerance for sub-target inflation has markets now betting on a 20 bp cut in September and the restart of QE.
But Reuters reported, citing sources, that some policymakers still needed to be convinced about tiering: if QE was restarted then bank bonds and equities are no-go. Bloomberg reported much the same from its sources, who said adjustments to TLTRO terms might be better than tiering. It also said some members expressed doubt as to the efficacy of further, so we need to keep an eye on this development.
Trade meeting in Shanghai
Hoping for the best but preparing for the worst best describes my view about this week’s face to face trade meeting in Shanghai. Not much else to add at this point. But we are not overly optimistic about a positive Shanghai surprise.
Oil prices ended the week where they started as traders are weighing tensions in the Middle East, and the trend of weekly inventory draws against persistent concerns about the global economic downturn.
Data released by China’s General Administration of Customs indicate that China’s monthly oil imports from Iran fell in June to the lowest level since May 2010 in a sign that US sanctions are continuing to raise the pressure on Iran, helping to tighten global oil markets and placing a small bid under oil prices on Friday.
But I worry that this week’s trade talks could be a negative catalyst for oil market sentiment in this delicately balanced supply and demand equation.
Gold prices steadied in Asian and European trading and began moving higher before the US opening. In the aftermath of the ECB meeting on Thursday, gold seemed little impacted as the EUR did not sustain a move in either direction. Brexit-related concerns may have sparked some modest geopolitical risk buying. In US trading, there was an initial focus on the US Q2 GDP release. The release showed growth slowed from Q1 but came in better than expected Gold’s wings were clipped by the stronger dollar response likely sending some investors to the sidelines ahead of FOMC.
Global economic data remains disappointing, but equity markets are little affected as unusually the relationship between hard data and equity markets have completely broken down. And sure, the thought central banks are riding into the rescue has been very helpful, but still, the markets remain unusually hardy. But a few compelling arguments are suggesting a pullback is coming. With growth, the primary driver of earnings, we note that the global PMIs, especially in manufacturing, have been declining uninterruptedly since early2018. In the US, the manufacturing ISM has been falling for the last months and is down from above 60 to 51.7. It’s a tall ask for central bank easing alone.
The Week Ahead (a busy one)
Monday: It’s a light start to the week with the critical releases of note being Japan’s June retail sales overnight. After that, we will get Spain’s preliminary July CPI, Italy’s June PPI and the UK’s June consumer credit, mortgage approvals and money supply data. In the US the only release of note is July’s Dallas Fed manufacturing activity index.
Tuesday: The main highlight of the day is going to be the outcome of the BoJ’s monetary policy meeting while in the US June core PCE is also due. In terms of data, we will get the Euro Area’s June unemployment rate, preliminary Q2 GDP in France along with June consumer spending, preliminary July CPI in Germany along with August GfK consumer confidence and July confidence indicators for the Euro Area. In the US, we will get June personal income and spending data, May S&P Corelogic house price index and July Conference Board consumer confidence indicator. Trade talks between the US and China will resume, and it’s the first of two nights of Democratic primary debates. Earnings releases include Apple, BP, Procter & Gamble, Mastercard and Pfizer.
Wednesday: The outcome of the FOMC meeting followed by Chair Powell’s press conference (07:30 pm London Time) will be the main event of the day. Overnight China’s official July PMIs are also due. In terms of data, we’ll get the UK’s July GfK consumer confidence, the Euro Area, France and Italy’s preliminary July CPI, Euro Area, Spain and Italy’s preliminary Q2 GDP, and Germany’s July unemployment report. In the US, we will get July’s ADP employment change and MNI Chicago PMI. It’s also the second night of Democratic primary debates while earnings releases include General Electric, Airbus and Lloyds Banking Group.
Thursday: The main highlight of the day is going to be the outcome of the BoE’s monetary policy meeting followed by Governor Carney’s press conference, while the release of final July manufacturing PMIs is also due in Japan, China, the Euro Area, UK, Germany, France, Spain, Italy and the US. In the US, we will also get July Challenger job cuts, ISM manufacturing data and total vehicle sales along with the latest weekly initial and continuing claims, and June construction spending. Away from data, BoJ’s Amamiya is also due to speak, while the UK has a parliamentary by-election. Earnings releases include Royal Dutch Shell, Barclays, Verizon Communications, General Motors, Rio Tinto and Siemens.
Friday: It’s a payroll Friday with July’s nonfarm payrolls report due in the US (1:30 pm London Time). Before that, we will get the BoJ’s June Monetary Policy Meeting Minutes, the UK’s July construction PMI and the Euro Area’s June PPI and retail sales. In the US, we’ll get the June trade balance, factory orders, and final durable and capital goods orders along with the final University of Michigan survey results. Earnings releases include Exxon Mobil, Chevron and RBS.