The list of concerns for market citizens remains largely unchanged.
News that China and the U.S. will hold low-level talks on trade later this month served to shore up sentiment a bit last week, but it’s worth noting that U.S. tariffs on $16 billion in Chinese goods (the second tranche of the first round of 301-related duties) take effect on Thursday and public hearings on a proposed second round targeting an additional $200 billion in imports from China are scheduled this week as well. Here’s BNP:
On the trade front, Chinese officials arrive in Washington Wednesday for renewed talks aimed at averting the next USD 200bn of tariffs due to be implemented next month. While the delegation is not viewed as sufficiently senior to reach a full deal this week, we would not rule out non-specific but encouraging headlines, similar to what emerged from President Trump’s meeting with Jean Claude Juncker last month, which could hit USD long positions.
For now, the yuan has stabilized thanks to a three-pronged effort involving the reinstatement of forwards rules (August 3), the chiding of onshore banks for selling RMB (August 7) and a move to squeeze offshore liquidity (August 16). Here’s an updated version of our annotated CNY chart:
The yuan has also been buoyed by lower-than-expected USDCNY fixings. Taken together, Barclays notes that this constitutes “growing evidence that exchange rate management remains important to policy makers.”
According to reports out Friday, the U.S. is planning to ask the Chinese trade delegation to agree to strengthen the currency, an proposition that is laughable on multiple fronts. We described why that effort is so absurd in “You Can’t Fix Stupid: U.S. Treasury Will ‘Pressure’ China To Strengthen The Yuan.”
Emerging markets will remain on the frontburner after a week that saw developing economy assets struggle to digest the turmoil in the Turkish lira. EM equities are in a bear market, have fallen for three consecutive weeks and are coming off their worst week since February.
As detailed on Sunday in “This Is Not A Drill“, developing economy assets could come under renewed pressure this week depending on how markets read the Fed minutes and depending on what kind of tone Jerome Powell strikes on Friday in Jackson Hole.
ZAR looks like it may be the next domino. Last Monday, the rand joined the lira in seemingly succumbing to Mrs. Watanabe-related trading. Through August 7, retail investors in Japan were still running long positions in both EM crosses.
On the whole, MSCI’s gauge of EM FX is sitting near a one-year low and has fallen in 10 of the last 12 weeks.
It’s worth watching BRL here as well. We’re back near 4 there, a level that could cause problems. “The October presidential election takes centre stage this week with at least four election poll results expected to be released (IBOPE, Datafolha, MDA, Ipespe)”, BNP notes, adding that “while TV and radio campaigning starts only on 31 August, internet campaigning has already begun.”
Folks will also be watching for any sign that trade talks between the U.S. and Mexico are making further progress and any good news there could help the peso decouple from the sour sentiment around EM. Trump still seems antagonistic towards Canada though, which means a complete NAFTA deal is likely to be some ways off.
“The Fed has shown little concern about global developments and, in its August meeting, remained committed to gradual rate hikes, seeing monetary conditions as still accommodative”, Barclays wrote on Sunday, adding that despite the Fed’s seemingly steadfast commitment, “the market remains reluctant to price restrictive monetary policy settings, especially after 2018, with just 80bp of hikes implied to the end of next year, vs. our expectation of 150bp and the median FOMC participant forecast of 120bp.”
If short-end rates continue to rise in the U.S., all the worse for EM and all the more bullish for the dollar. In the week through Tuesday, USD net longs jumped another $1.4 billion to a new fresh “since January 2017” high at $24.3 billion overall.
The longer the current dynamic wherein the Fed is pigeonholed into hawkishness remains in place, the stronger the substitution effect, as cash begins to look more and more attractive, especially in light of ongoing turmoil and volatility in various risk assets.
“Whatever your target return level, recent sell-offs are likely to have dented your willingness to run large amounts of risk at precisely the same time as $ cash has gone from offering much less than most assets were returning to significantly more”, Citi’s Matt King wrote last Thursday.
Obviously, commodities will remain in focus as well. Oil has fallen for seven straight weeks, the metals are in a tailspin and the Bloomberg Agriculture subindex is languishing near all-time lows. Needless to say, the commodities malaise isn’t helping EM. Here’s the BCOM:
Notably, hedge funds seem to have nailed it on the metals plunge.
In Europe, expect the euro to remain soggy thanks to (perhaps overblown) concerns about European banks’ exposure to Turkey. There’s a full breakdown of that exposure here, but below, find a handy pocket guide for BBVA, UniCredit, BNP and ING, which have been in the news amid the lira plunge.
On the domestic political front, Trump and his lawyers have become increasingly combative of late as September draws near. Rudy Giuliani continues to insist the Mueller probe should be wrapped up by the first of next month and news over the weekend about Don McGahn clearly unnerved the President. Although investors have become somewhat numb to “Mueller” headlines, the algos likely haven’t.