Different week, same focal point for markets: it’s all about trade.
Last week ended with a broadside from GM which, in comments filed with the Commerce Department, warned that tariffs could lead to U.S. job losses. On Saturday, Peter Navarro dismissed that as “smoke and mirrors.” Let’s see what Trump has to say or, more to the point, let’s see what @realDonaldTrump has to say.
There’s still quite a bit of ambiguity around how the U.S. will approach limiting Chinese investment in U.S. industries. Last week was defined by mixed messages as Mnuchin and Navarro were trotted out on Monday to try and calm nervous markets. Wednesday morning brought what appeared to be a relent from Trump, but Larry Kudlow was quick to dismiss the notion that the decision to prioritize CFIUS (as opposed to leaning on the International Emergency Economic Powers Act of 1977) amounted to a less aggressive stance.
Whatever the case, Chinese assets are on edge. The SHCOMP fell into a bear market last week, as did H-shares and all anyone wants to talk about is the yuan, which is depreciating at a rate unseen since the 2015 deval.
Here’s an annotated chart that shows you how things have played out for the yuan. Note the (successful) attempt to engineer a short squeeze last summer, the (initially) successful attempt to put the brakes on that by relaxing rules on forwards in September, the (not so successful) effort to put the brakes on post-September yuan strength by sidelining the counter-cyclical adjustment factor that was used to start last summer’s short squeeze, and the recent weakness:
It looks like the PBoC wants to sit back and watch this, allowing the market-driven depreciation to cushion the blow from the trade tensions and then, when it runs “too” far, step in and intervene by selling USTs to arrest the slide. That would kill two birds with one stone: they’d get the depreciation and an excuse to sell/weaponize their Treasury holdings.
The pressure on the yuan is exacerbated by looser monetary policy. Remember, the Chinese economy is decelerating and a trade war threatens to exacerbate the downward trend in the activity data. As the economy continues to weaken, Beijing has shown a willingness to deemphasize the deleveraging push that threatens to choke off credit creation. That propensity to lighten up recently manifested itself in the PBoC breaking with recent precedent by not hiking OMO rates following the Fed. Last month’s RRR cut was another dovish measure. Well, the more dovish China is compared to the Fed, the greater the policy divergence and that, in turn, puts pressure on the yuan.
Here’s what Barclays had to say over the weekend:
CNY depreciation reflects fundamental developments but is being tolerated by the PBoC. Intensification in trade tensions and slower growth prospects have combined with a broad USD rally to fuel CNY depreciation, with the PBoC tolerating CNY weakness even as they try to moderate the retreat. We do not think the PBoC is actively depreciating the currency to retaliate against the US or stimulate the economy.
Continued USD strength implies upside risks to our forecast for USDCNY at 6.60. We think the PBoC will continue to let fundamentals drive the CNY’s exchange value, allowing the currency to broadly track USD movements. At the same time, the central bank will likely curb volatility to ensure relative stability to avoid triggering capital outflows.
Speaking of yuan volatility, the curve is inverted:
In Europe, trade is of course on the frontburner as well. On Saturday, Germany’s Welt am Sonntag reported that BMW has now written a letter to Wilbur Ross imploring him not to slap tariffs on auto imports.
“It seems that the threat to impose these sanctions is designed to achieve certain economic goals,” BMW said, adding that some 120,000 American jobs have been created by BMW’s investment of nearly $9 billion in a Spartanburg, South Carolina, plant.
The SXAP has fallen in every session since the Draghi rally except one and as you can see, recent losses are egregious:
One test for Europe will be whether the relief rally catalyzed by the immigration deal has any staying power. On Sunday evening, we got the following headlines which could be interpreted a number of ways when it comes to what the future holds for Merkel:
Germanyâ€™s Seehofer to Quit as Interior Minister, DPA Reports
Seehofer will also resign as CSU leader, DPA said that Seehofer told the meeting
— Heisenberg Report (@heisenbergrpt) July 1, 2018
In the U.S., we’ll get the holiday on Wednesday, when Americans will eat hamburgers and drink alcoholic horse piss to commemorate that time a bunch of colonists took up arms against a king in order to ensure future generations were free to be ruled by a treasonous real estate mogul with dictatorial tendencies. Or something.
But it’s not all about drinking cheap beer and eating horrible food in the U.S. this week. We’ll get payrolls on Friday, which should be particularly interesting in light of Trump’s newfound penchant for tweeting out the data an hour ahead of the official release.
Remember: if that were anyone but Trump, the SEC would have been knocking.
Last month’s report was of course a blockbuster and all eyes will now turn to the June report to see if the latest read continues to support the U.S.-centric growth narrative. Here’s Goldman’s prediction:
We estimate nonfarm payrolls increased 200k in June. Our forecast reflects the continued strength of jobless claims and our services employment tracker reapproaching its cycle high. After a one tenth decline in May, we expect the unemployment rate to fall another tenth to 3.7%, reflecting the further decline in continuing claims over the payroll month. Finally, we expect average hourly earnings to increase 0.3% month over month and 2.8% year over year, reflecting favorable calendar effects.
And here’s BofAML:
We forecast that nonfarm payrolls increased by 205k and private payrolls increased by 200k in June, in line with the six-month moving average of payrolls, which currently stands at 202k, suggesting that job growth remains steady at elevated levels.
We look for wage growth to continue to trend higher and expect average hourly earnings to grow by 0.3% mom in June, which should lead the year-over-year growth rate to move up to 2.8% from 2.7%. Our forecast is supported by further evidence of labor market tightening in the data. For example, according to the latest reading of the JOLTS data, job openings currently outpace the number of unemployed in the labor market. Also, the Conference Board’s labor market differential index currently stands at 25.1, suggesting that consumers, on balance, believe that labor market conditions favor the job seeker.
BNP’s take is similar and here are the visuals, for anyone who might find them useful:
The jobs report will come hot on the heels of the June Fed minutes, which should be interesting in light of the characteristically vociferous debate about exactly what the June statement and the updated SEP and dots hold for the future.
“We expect a positive tone from the June FOMC minutes (Thursday) and look for them to explain members’ rationale for hiking rates and signaling further steepening of the rate path. Of particular attention is the discussion of risks to the outlook in light of Chairman Powell’s confidence against the rising threat of protectionism,” Barclays writes.
Ah, yes – “Chairman Powell’s confidence against the rising threat of protectionism”. You might recall that his comments at Sintra last month indicated that he might be getting a bit less “confident.” But don’t tell that to Wilbur Ross (or his proprietary soup can index).
Here’s BofAML’s take on the Minutes:
We will look for further discussions around the amount of further policy firming necessary in the current hiking cycle as the May minutes noted that there were a “range of views” but didn’t expound further. Dovish participants will likely support slowing when reaching “neutral” while more hawkish participants will argue that the stance of policy could turn restrictive as growth remains above trend and inflation above the Fed’s symmetric target. Also, we will look to see how concerned participants are regarding the rising trade tensions and discussions around the potential impact to their economic outlook and the path of policy. In this regard, the details of the Summary of Economic Projections which reveal how the uncertainty and risks to the outlook have evolved since the March projections will be noteworthy.
Also watch for any market fallout from the elections in Mexico.
— Heisenberg Report (@heisenbergrpt) July 2, 2018
As a reminder, the peso rallied more than 2% against the dollar on Thursday, which Bloomberg noted was a 2.5 standard deviation move measured against 30-day historical vol.” Through Tuesday, EWW (the Mexico ETF) saw seven straight days of inflows. Apparently, folks are excited about Obrador now. The vehicle is was up 5% for June, after diving more than 13% in May:
Here’s Bloomberg’s Wes Goodman drawing a parallel with the lira and flagging ongoing concerns about NAFTA, the Fed and trade in general:
The Mexican peso will probably rally further if AMLO wins the election as expected, but economic reality will catch up with the currency soon. Using Turkey as a guide, the lira has rallied since President Erdogan won that nation’s June 24 ballot. The vote removed a level of uncertainty and brought a break in this year’s lira selloff. A similar story is playing out in Mexico as Andres Manuel Lopez Obrador appears headed for victory. But, both currencies remain at risk longer-term because the things that sent them down in the second quarter are still in place in the third. The Fed’s rate hikes are helping the dollar, which will pressure the countries’ external debt. President Trump’s tariffs threaten to crimp trade — and Trump says he’s still not happy with Nafta. All reasons that an AMLO honeymoon probably won’t last long in the currency market.
Traders will naturally be on guard for any further turmoil in the rest of the EM complex following the worst quarter since 2015 for EM equities and FX.
Oh, and don’t forget about oil. Over the weekend, Trump kicked off a firestorm by suggesting (on Twitter, no less), that Saudi Arabia is prepared to increase production unilaterally by 2 million b/d in an effort to help out American consumers. I won’t recount the details (you can read all about it here), but suffice to say Iran was not amused.
Full calendar from BofAML: