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Dog Days: Full Week Ahead Preview

Trade, Japan, Turkey, rubles and so much more.

If Donald Trump’s weekend tweets and campaign trail rhetoric are any indication, trade will be front and center this week in terms of market drivers as the dog days of summer hit.

Over the weekend, the President made all manner of claims about tariffs and presented a long list of anecdotal “evidence” to support his contention that the U.S. is “winning” the trade war which, if you date it to the residential washing machine tariffs implemented in late January, is now entering its eighth calendar month.

On Saturday evening, just prior to a campaign stop in Ohio, Trump made a series of dubious assertions about tariffs and what they mean for the U.S. economy. On Sunday, he picked up where he left off the previous evening, at one point suggesting that the “vast sums of money” other countries will pay thanks to his protectionist push will somehow wipe away the national debt.

“Because of Tariffs we will be able to start paying down large amounts of the $21 Trillion in debt that has been accumulated, much by the Obama Administration, while at the same time reducing taxes for our people”, Trump tweeted. Speaking of debt and taxes, the deluge of Treasury issuance necessitated by the GOP tax cuts and subsequent spending bills are set to balloon the deficit to $1 trillion by 2020, according to the CBO – that’s two years ahead of previous estimates.

This weekend was hardly the first time Trump (the self-styled “king of debt”) has seemingly betrayed a rudimentary understanding of basic economics. In October, while speaking to Sean Hannity, the President famously claimed that stock market gains offset the national debt.

 

Trump’s weekend tweets came on the heels of China’s Friday move to reimpose rules on FX forwards in an effort to arrest the slide in the yuan, which has depreciated enough over the past two months to zero out the effects of Trump’s 301-related tariffs before they were even fully implemented. Apparently, Beijing is drawing the line at 6.90 though, presumably to head off potential capital flight. At virtually the same time that the PBoC reinstated the rules on forwards, the Chinese Finance Ministry warned that if Trump moves ahead with tariffs on an additional $200 billion in Chinese imports, Beijing will fire back with retaliatory tariffs ranging from 5% to 25% on more than 5,000 types of items.

The reinstatement of the forwards rule will likely take some pressure off the yuan, but it remains to be seen how effective that will be. There’s a lot of liquidity sloshing around over there, which is just another way of saying that making it more expensive to short the currency doesn’t change the policy divergence story that led to the depreciation. We’ll get a look at reserves this week which should be interesting in light of recent events. “We expect data on China’s FX reserves to indicate PBoC intervention in July,” Barclays said on Sunday, before stating the obvious, which is this: “Higher-than-expected reserves will suggest PBoC complacency/inaction, as July experienced rapid CNY depreciation.”

As a reminder, if the USTR does decide to go ahead with levies on more Chinese goods once duties on $16 billion go into effect (the final act of the first 301-related tranche), it’s likely that U.S. consumers will start to feel the squeeze in the form of higher prices. There’s more on that here, but as SocGen’s Omair Sharif noted last month, “the proposed $200 billion tally includes a slew of finished consumer items.” The read-through for domestic inflation is not benign, especially in the event Trump decides to go through with last week’s threat to raise the rate from 10% to 25% in the prospective next round of tariffs.

Speaking of inflation, the headline data print in the U.S. is CPI this week. “We forecast headline CPI to increase 0.1% MoM and 2.9% on a YoY basis,” Barclays wrote over the weekend, adding that “as the economy grows above capacity, inflation is expected to mildly overshoot the Fed target.” Last week, the Fed delivered an upbeat take on the economy setting the stage for a September hike and Friday’s jobs report continued to support the narrative, although the headline did miss.

Expectations are for core CPI to register a 0.2% MoM gain, leaving the YoY rate at 2.3%. “Risks are to the upside though, especially if we see pricing behavior front-run possible tariffs”, BNP says. For their part, Goldman doesn’t “expect a significant boost from the tariffs on $34 billion of Chinese goods, reflecting their incidence (industrial inputs and capital goods as opposed to consumer products).” Do note (again), that no one expected the initial round of tariffs to have a demonstrable impact on domestic prices. It’s the prospective duties on $200 billion in additional goods that has folks concerned.

When it comes to the headline CPI print, maybe ask Maria Bartiromo to do the math on that before she goes bragging about wage growth under Trump.

It’s worth noting that dollar longs came off a bit for the first time in six weeks in the week through last Tuesday. Specifically, net USD length fell by around $0.6 billion, perhaps reflecting concerns that Trump will begin to pile more pressure on the Fed ahead of September.

USD

(Goldman)

Traders will likely stay at least semi-focused on JGB yields following days of volatility surrounding the BoJ’s policy “tweaks” – if that’s what you want to call them.

In the lead up to the July meeting, speculation about what Kuroda and co. would or wouldn’t do in order to try and alleviate some of the distortions created by the bank’s various easing programs was running high. In the week prior to the meeting, the BoJ was forced to conduct three fixed-rate operations to cap 10Y yields. Ultimately, the bank decided to add forward guidance on rates and tip a willingness to let 10Y yields fluctuate a bit more. The market seems pretty keen on testing the waters there.

Japan10

Here’s Barclays summarizing things with an interesting juxtaposition between rates and FX vol. (remember, fear of yen strength is one of the main impediments to BoJ normalization):

Substantial volatility remained in JGB markets with 10y testing post-YCC highs to assess the BoJ’s tolerance level whereas USDJPY already seems to have settled around 111. Factors behind such volatility divergence may have arisen from pure technicals (ie, USDJPY is still well within the recent range whereas JGBs have broken its multi-year range) and different degree of influence that the BoJ exerts (much stronger in JGB via “yield curve control,” which got loosened somewhat). In FX, while higher JGB yields may have exerted some upward pressures on JPY, short-covering of pre-BoJ shorts, as well as broad USD strength, have likely outweighed and boosted USDJPY. The BoJ’s unexpected JGB purchase last Thursday just after 10y auction have provided some support and 10y yields appear to be settling at 10-15bp. Markets will remain vigilant on where long-end JGB yields will settle in the coming days/weeks. We do not expect significant upward pressures on JPY coming from JGB in the near term, but the BoJ’s tolerance for higher yields should lead to gradual JPY appreciation pressures over the medium term.

Traders will also be watching Turkey closely. Over the weekend, President Recep Tayyip Erdogan suggested he’ll strike back at Washington after the Trump administration imposed sanctions on Turkey’s Minister of Justice Abdulhamit Gul and Minister of Interior Suleyman Soylu in an effort to secure the release of North Carolina evangelical Christian pastor Andrew Craig Brunson. Specifically, Erdogan said this on Saturday:

We were patient until last night but I gave instruction to freeze all assets of the U.S. justice and interior ministers, if they have any.

You can read the full story on that here, but suffice to say the lira plunged to a new record low against the dollar last week (10Y yields in Turkey surged above 19%) and the market will be watching for any signs that Erdogan will be willing to negotiate for Brunson or perhaps allow an out-of-cycle rate hike to arrest the currency slide (amusingly, I’m not even sure which of those is less realistic).

USDTRY

Also, watch for any news on the Russia sanctions front. Last week, Lindsey Graham and Democratic Senator Bob Menendez introduced legislation that seeks to turn the screws on the Kremlin for what a bipartisan group of lawmakers describe as “Russia’s continued interference in elections, malign influence in Syria, aggression in Crimea, and other activities.” In the cross-hairs: the OFZ market. If that bill gets any traction on Capitol Hill, it will likely weigh heavily on the ruble. For their part, Citi thinks USDRUB would likely hit 70 in the event the Treasury goes the so-called “nuclear route”.

USDRUBProjection

The RBA and the RBNZ are on deck this week and will do nothing, in contrast to their G10 counterparts, who are, generally speaking, taking some halting steps down the road to normalization.

U.K. GDP is up on Friday – the print follows the BoE hike last week. As noted previously, BofAML wasn’t (and still isn’t) on board with that hike. “We see the hike as a mistake albeit one the BoE minimized by playing down future hikes, but we think the BoE’s growth forecasts are optimistic”, the bank wrote, in a note dated Friday, before asking “Why would growth stay at 0.4% when the 2Q performance was boosted by one-offs?”

Finally, it looks like the domestic political situation in the U.S. is deteriorating pretty rapidly, so you’ll want to be aware of Mueller headline risk.

Full calendar via BofAML

Calendar

 

 

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