In the week ahead, the narrative will revolve around trade tensions, and in that respect, it will be just like every other week markets have meandered through over the past three months.
Friday of course brought the imposition of tariffs on $34 billion of Chinese goods and the expected retaliation from Beijing. All eyes (and ears) will now turn to Trump, to see how he reacts to the growing backlash from America’s farmers, who stand to suffer mightily from China’s countermeasures. He’s also embroiled in an ongoing (if one-sided) war of words with Harley-Davidson and members of his administration have been quick to dismiss the suggestion that the trade war threatens to derail the U.S. economy (see Peter Navarro’s harsh words for General Motors and Wilbur Ross’s implicit criticism of Jerome Powell’s comments at Sintra).
On the surface, at least, it looks like Xi has been successful when it comes to sowing doubt in the minds of at least some Trump voters, but make no mistake, China’s efforts to engineer a soft landing by executing a carefully managed deleveraging have been complicated immeasurably by the trade tension. Authorities have been forced to deemphasize tightening measures and the PBoC has loosened monetary policy. That relaxation has opened up a policy divergence with the Fed, and that disparity is piling still more pressure on the yuan. Last week, Yi Gang himself verbally intervened and policy banks were seen selling dollars at ~6.70. But according to sources, the central bank is waiting for the 6.85-6.90 range before embarking on a more concerted effort to stem the yuan’s decline by either bringing back the counter-cyclical adjustment factor or slowly selling reserves.
Meanwhile, Chinese equities have fallen for seven consecutive weeks and everyone is watching for evidence that the vaunted “national team” is set to step in.
Here’s Barclays, weighing in on what’s ahead for Chinese policymakers:
China economic data take on greater importance amid higher CNY volatility and easing bias of the PBoC. Recall that the surge in USDCNY in mid-June had occurred after the PBoC chose not to follow the Fed in hiking rates (14 June) and after a surprise 50bp RRR cut (25 June), moves that we believe signaled the central bank’s easing bias amid a growing “credit crunch”. Greater evidence of moderating credit and export growth this week will likely reinforce the PBoC’s easing bias characterized by targeted liquidity and growth support. However, we continue to think that “active” exchange rate depreciation will not be used as a policy tool to support the economy, given limited stimulus impact and risk of sparking capital outflows. That said, we also think the PBoC is unlikely to stand in the way of an orderly depreciation driven by market forces, and is likely to intervene during times of extreme volatility. For instance, in response to the CNY freefall last week, the PBoC staged a “coordinated” verbal intervention. While this has helped alleviate market concerns of China using the exchange rate as retaliation against the US, we see upside risk to our year-end USDCNY forecast of 6.60, especially if China’s growth moderation accelerates.
And here’s Goldman:
With the escalation of trade tensions and the implementation of tariffs on China, we have seen a pullback in a number of trade- and China-exposed currencies (including in CNY, AUD, CLP and NJA FX more broadly) over the past month. We find it hard to reconcile the US administration’s ambition to correct trade imbalances with such broad-based Dollar strength, but it also now seems likely that these tensions get worse before they get better. An eventual agreement between the US and its trading partners may still reverse some of the negative market sentiment, but the hits to confidence are real, and it is now easier to envisage miscalculation that inflicts real damage on the global economy and markets. Reflecting this, we are marking down our forecasts for a number of currencies to show a more flattish profile over the next 3 months, and slower appreciation over the next 12 months (or outright depreciation in some of the most trade sensitive economies of Non-Japan Asia).
On the data front for China, PPI, CPI, reserves, trade, money supply, and credit growth are all due this week.
Speaking of CPI, inflation data will be front and center in the U.S. with the latest read due on Thursday.
“After experiencing unexpected weakness last year, consumer price inflation has picked up in 2018, increasing 1.0% through the first five months of the year [and] we expect more of the same in June, projecting both core and headline CPI to have increased by 0.2% m/m, which should push the former up 0.1pp to 2.3% year-on-year and the latter up 0.1pp to 2.9% year-on-year,” BNP writes, in their week ahead outlook.
This comes on the heels of the weaker-than-expected AHE print that accompanied the June jobs report on Friday and it will also be viewed in the context of the June Fed minutes which betrayed a committee that, while characterizing the U.S. economy as “very strong” and while expressing concern about the prospect of overheating in light of fiscal stimulus, also described the trade tensions as “intensifying.”
“Our sentiment score of the minutes also showed a less hawkish Fed in the latest meeting,” BofAML wrote on Friday, adding that “sentiment has edged down over the last two meetings as trade tensions have continued to escalate since the announcement of steel and aluminum tariffs in late March.” Here’s the chart on that:
We’ll get key data releases out of Europe as well. It would be really nice to get some good news on the IP front to build on last week’s upbeat release from Germany (much more on that here).
In the U.K., Theresa May is facing another crisis after David Davis resigned, along with his deputy Steve Baker. That, just as the country is attempting to sort out another poisoning linked to a Russian nerve agent.
Also on the political front across the pond, Angela Merkel appears to have dodged a bullet after resolving a bitter dispute with Horst Seehofer, but the immigration issue is far from “solved” at the EU level. There’s still a ton of headline risk around that.
This is a BoC week and as Barclays detailed on Sunday, a hike could well reinforce the DM-EM policy divergence theme. Here’s the bank’s take:
Events and data this week could strengthen DM central banks’ hawkish tilt, reinforcing the DM-EM FX divergence. The US CPI report (Thursday), which posts after the recent robust payrolls and ISM outcomes, is likely to reinforce the Fed’s steady normalization path. In Canada, we expect the BoC to hike its policy rate by 25bp and maintain a gradual tightening and data-dependent stance (Wednesday), although the CAD is vulnerable to any unexpected tone change given aggressive market pricing (+70bp of rate hikes in one year). If Sweden’s June CPIF (Thursday) surprises positively, the EURSEK retracement could extend, given that the Riksbank has unexpectedly maintained its rate path with a rate hike by year-end predicated on a significant pick-up in CPIF inflation. This is not our base case, however, and we see risks the EURSEK squeezes higher. In Japan, the rhetoric of senior BoJ officials (eg, Kuroda, Harada, Amamiya and Masai) has been subtly turning less dovish since the changes to the Board in April. We look to Kuroda’s speech (Monday) for more evidence of this delicate shift in preparation for normalization, which we anticipate to begin in April 2019. The ECB and RBNZ are the notable exceptions to the group, with the ECB June minutes likely to shed light on discussions on the degree of support within the Governing Council for forward guidance and on reinvesting maturing debt assets.
Oh, and oil will be watched closely to see who has the upper hand in the ongoing battle between Donald Trump’s hardline stance on Iran (bullish for crude) and Donald Trump’s desire to see lower prices at the pump (bearish for crude).
This is a hilarious tug-of-war and Trump seems to be getting increasingly frustrated with the situation, as evidenced by last week’s all-caps, 4th of July Twitter demand that the Saudis do something immediately to bring down prices.
Finally, watch for continuing signs of divergence between the Russell and everything else. U.S. small caps have taken on safe haven status as trade tensions rise, but some folks seem to think the rally in the Russell lacks fundamental support.
“Small cap issues haven’t been resolved,” SocGen recently wrote, before reminding you that while they’ve outperformed “on the back of accruing benefits from the tax reform and relative safety amid trade war fears, the Fed is still raising rates, which is likely to increase pressure on the bottom lines of highly levered negative-cash-flow-generating companies.”
One more thing: the NATO Summit is this week. For a preview of how that’s likely to go, see “Trump Sends Irritated Letters To Freeloading Deadbeats Ahead Of NATO Summit“.
Full calendar from BofAML