U.S. politics and trade are likely to dominate the headlines this week, which means market participants will yet again be forced to cope with the psychological overhang from Donald Trump’s ongoing legal trials and tribulations (and “trials” can now be taken quite literally) and the threat of another escalation on the tariff front.
Last week was easily the worst week of Trump’s presidency. In addition to Michael Cohen pleading guilty and implicating the President in open court, Paul Manafort was convicted on eight counts and Trump Organization CFO Allen Weisselberg was granted immunity by federal prosecutors, a development that bodes particularly ill given how much he likely knows. It also seems likely that Trump will move against Jeff Sessions sooner rather than later.
On trade, there’s progress on the NAFTA front as Robert Lighthizer appears to be closing in on a deal with Mexico, but low-level talks between the U.S. and a Chinese delegation went nowhere last week, setting the stage for Trump to move ahead with duties on an additional $200 billion in Chinese imports. Here’s BNP with a bit of color:
Trade negotiations between the US and China are set to continue in the week ahead, but time is running out if the next round of tariffs, scheduled for early September, are to be avoided. Talks with Mexico, however, seem to be closer to achieving results, recent reports suggest. While a NAFTA deal would still need to incorporate Canada, a positive conclusion to Mexico negotiations could support the MXN as well as the CAD and EUR, as markets would view this as a sign that the administration is prepared to make deals with key trading partners even though US-China negotiations remain stalled.
To be clear, if Trump moves ahead with tariffs on $200 billion in additional Chinese goods, it would mark the most serious escalation yet. As a reminder, that would have implications for consumer prices at a time when the Fed is watching for nascent signs of an inflation overshoot.
On Friday, in his speech at Jackson Hole, Jerome Powell played down the idea that the U.S. economy is on the verge of overheating and that inflation is set to spike. Between that and China’s move to bring back the counter-cyclical adjustment factor in the yuan fix, the dollar fell on the week, helping to allay fears of an imminent meltdown in emerging markets.
Don’t ignore the reintroduction of the CCAF. That’s a big deal and it means the PBoC is angling to rein in volatility. It was the fourth step Beijing has taken this month to stabilize the currency and guard against the psychologically important 7-handle.
(Bloomberg w/ annotations)
For their part, SocGen thinks this isn’t the time to test the PBoC. “With policymakers clearly uncomfortable with a 7-handle, the deployment of the CCAF, along with reserve requirements on FX forwards and the squeeze in spot and forward points earlier in the month, risk-reward does not favor testing the PBoC’s resolve”, the bank’s Jason Daw wrote on Sunday.
With any luck, the dollar will remain under pressure and the yuan will be steady, helping to shore up ex-U.S. risk sentiment (as a reminder, from here it would be preferable if risk assets outside the U.S. were allowed to do some catching up to the record highs on Wall Street).
All of that said, Barclays doesn’t think Trump’s jawboning and/or the President’s legal woes are going to be enough to dissuade dollar bulls. “Solid economic fundamentals and the Fed’s commitment to independence will likely shield the USD from political noise, although USD positioning has become extended”, the bank wrote on Sunday.
It seems to me that because the latest CFTC data is current through last Tuesday, the fact that longs weren’t trimmed “bigly” means the market isn’t putting much stock in the notion that Trump can influence Fed policy. The likes of Esther George specifically said they would not be swayed by any tweets last week.
Barclays does caution that “the market will likely continue to assess the legal implications and political repercussions for Trump in weeks to come, potentially bringing volatility to US markets.”
There’s no shortage of data in the U.S. this week with multiple Fed surveys on deck along with trade data, PCE, consumer sentiment and the second read on Q2 GDP. It would be hilarious if Trump holds a press conference for the second vintage like he did for the initial print last month. Remember, this is what “an amazing rate” looks like:
Anyway, solid reads on any or all of that data has the potential to embolden dollar bulls even further and make that crowded long even more crowded.
Speaking of stretched positioning, the record short in TY was extended in the week through last Tuesday, although overall, the duration short was trimmed. Still, this is ripe for a squeeze:
Switching gears, Turkey comes back from an extended holiday this week, which means you can look forward to more shenanigans in the lira and likely more absurd soundbites from Erdogan and Albayrak. The Borsa Istanbul Banks index is a veritable disaster.
Staying in EM, you’ll want to keep an eye on Brazil as it looks like BRL might take the baton when it comes to being the weak link in EM FX ahead of the election. Here’s Barclays:
The BRL has started to react to electoral polls in the early stage of the campaign, underperforming peers as the market-friendly Geraldo Alckmin has shown no improvement in the past weeks, while the left and right poles, PT and Bolsonaro, have increased their voting intention. In FX options markets, implied vol levels are particularly elevated and skews heavily favor USD calls heading into the first round of the presidential elections on October 7, but should moderate after the second round. The multitude of electoral scenarios, the lack of clarity regarding candidates, and scant details on their policy platforms make navigating these risks especially challenging for markets.
Of course ZAR is also in the firing line for EM currencies. Ultimately, it might be left to MXN and CNH to hold things together.
There’s other notable data on deck in DM this week, with CPI in Japan, GDP in Canada and flash inflation in Europe. Markets are still warily eyeing the fiscal outlook in Italy, where the populist government is seemingly destined for a clash with Brussels next month. There’s more on that here, but suffice to say it’s clouding the outlook.
If you’re going by beats and misses, it’s notable that Citi’s economic surprise indexes are converging, with U.S. outperformance fading away in recent months.