If the trade headlines out late Friday and over the weekend are any indication, markets will be held hostage in the week ahead by concerns about the fallout from the Trump administration’s intention to move ahead with tariffs on an additional $200 billion in Chinese goods.
According to multiple reports (and according to Trump’s own tweets), an announcement on the next round of tariffs will come as soon as Monday. China has already promised to respond with differentiated duties on $60 billion in U.S. goods, a move that appears likely to trigger yet another escalation from Trump in the form of tariffs on $267 billion more in Chinese imports. If that happens, the President will have made good on his threat to “go to $500 billion”.
On Sunday, reports suggested China may decide to decline Steve Mnuchin’s invitation to convene further negotiations in light of the new escalation.
Dollar In Focus (As Ever)
Trade escalations have played dollar positive since April and there’s little reason to believe that dynamic will change in the absence of a convincing deceleration in the U.S. economy or a clear sign from the Fed that the committee is inclined to adopt a more cautious approach to further rate hikes. The dollar came off a bit last week, but trimmed its weekly decline on Friday, extending gains after reports tipped Trump’s instructions to move ahead with more tariffs.
In the week through Tuesday, the spec long in the dollar was trimmed for a third consecutive week, perhaps suggesting waning enthusiasm for the trade, although again, reasons to be long seem to outweigh speculation that the U.S. economy may roll over in the near-term or that the Fed will be inclined to adopt a dovish lean out of the blue. Here’s the latest update on the dollar long that Jeff Gundlach sees as a contrarian indicator:
For Emerging Markets, Out Of The Frying Pan, Into The Fire
Of course a resumption of dollar strength would weigh on EM FX at a delicate time. Recently, the elevated (and that’s an understatement) ratio of EM FX vol. to G7 FX vol. retreated a bit from the highs in lockstep with the dollar’s breather. It would not be good news if that ratio were to start climbing anew.
Last week, the combination of a cooler-than-expected August CPI print in the U.S. (Thursday), a larger-than-expected rate hike from the Turkish central bank (Thursday) and a surprise rate hike from Russia (Friday), helped stabilize EM sentiment and this week, we’ll get two more key EM central bank meetings in Brazil and South Africa.
Brazil is of course in the throes of electoral turmoil while South Africa just sank into its first recession since 2009. Both BRL and ZAR are on the firing line amid the ongoing malaise in EM FX. Here’s Barclays on the BCB:
We expect the BCB to keep the Selic rate unchanged (Wednesday), in line with consensus. The board has repeated that its next steps will depend on the evolution of economic activity, the balance of risks and the outlook for inflation. Economic activity remains soft in Q3, with inflation expectations well anchored. The balance of risks crucially depends on the outcome of presidential elections, and we do not see the bank reacting to electoral polls. Even though we do not rule out the possibility of rate hikes later in the year depending on the elections’ results, our base case is for stability in the Selic rate at 6.50% until year-end. The DI futures imply around 18bp for the meeting, as recent past depreciation could bring about concerns about FX pass-through. The BCB on hold will bring minor disappointment to the rates markets, but we do not expect a major revision to the market-implied path of policy (about two hikes of 50bp priced for the rest of the year), given the political risks ahead. Similarly, we expect little effect on BRL, as politics are the main driver now.
As far as South Africa is concerned, here’s what Goldman is thinking for Thursday:
We expect the SARB to keep its key two-week repo rate unchanged at +6.50%, in line with median survey expectations, but with forward market pricing implying a 30% probability of a rate hike. The SARB’s inflation view is considerably less benign than our own, and given that risks stemming from a weaker Rand and higher oil have materialised, upward revisions to the MPC’s 2019 inflation profile are likely. Despite the likely inflation target overshoot, Governor Kganyago has expressed that the MPC only sees it appropriate to react to temporarily higher headline inflation from ‘supply shocks’ and FX depreciation insofar as it has adverse second-round effects. Thus, in the first instance at least, we see little reason for the SARB to tighten policy in response to the current shocks. Furthermore, we think that the output contraction in Q2 will contribute to the MPC’s reluctance to consider policy tightening. Going forward, as we argued this week, we continue to think that the bar for rate hikes remains quite high. In our view, a larger or more disorderly FX depreciation and/or indications of fiscal loosening could prompt a pre-emptive monetary policy tightening.
That highlights the dilemma for EM central banks in an environment where the Fed is hiking and global growth is under fire from trade concerns. Policymakers in developing economies can hike to protect their currencies, but that risks contributing to the very same global tightening of financial conditions that caused the problems in the first place and also risks undermining domestic growth at a critical juncture.
MSCI’s gauge of EM currencies posted its first three-day win streak since July to close last week:
In DM, we’ll get the Norges Bank and the BoJ.
In Norway, Lift-Off
Norway will probably hike – a watershed moment of sorts, as it would be the first hike in seven years. “Emphasis will center on the bank’s rhetoric and projected rate path”, Barclays writes, adding that they “expect Norges to continue projecting one hike this year but a path indicating some likelihood of a second hike, in December, would be a hawkish signal and send NOK higher.”
“After more than seven years since the last hike, and a little more than two years since the last cut, Norges Bank seems ready for lift-off”, Goldman said Sunday, on the way to delivering the following color:
Our long-held view is that Norges Bank will hike in Q3 this year. This seems likely to come to play next week. Once initiated, we expect a moderate pace of hikes, of around 75bp per year. This reflects our expectation of a continued low level of policy rates in the Euro area and higher household sensitivity to rates. That said, our current pace of hikes is still higher than Norges Bank (around 45bp-50bp per year).
BoJ Ponders Efficacy Of Tweaks, Abe Looks For Win
As far as the BoJ goes, the September meeting comes on the heels of recent policy tweaks ostensibly designed to mitigate some of the deleterious side effects of Kuroda’s “very powerful easing”. That characterization (a favorite of Kuroda’s) is amusing to the extent the bank’s efforts have actually been “very impotent” when it comes to breaking the deflationary mindset in Japan.
That said, Kuroda’s policies have indeed been “very powerful” when it comes to compressing bank NIMs and sapping liquidity from the JGB market. Although the tweaks delivered in late July tipped a tolerance for larger moves in 10Y yields, the JGB market remains hopelessly moribund. Here’s the JGB VIX:
That spike you see coincided with a fleeting week of activity during which speculation about the forthcoming policy changes pushed yields sharply higher, forcing the BoJ to step in with three fixed-rate purchase ops in the space of week. Since then, things have gotten back to “normal” where “normal” actually means “abnormal” in the sense that virtually no trading ever happens.
“While ‘on hold for long’ is now the market consensus on the BoJ, the possibility of further tweaks should not be ruled out”, Barclays wrote over the weekend, before noting that “any discussions around policy side-effects on regional bank profitability, either at this meeting or Financial System Report to be released in October, will be the key focus in the meantime [while] August nationwide core CPI (Friday) will also be important in assessing BoJ policy outlook.”
“Focus will be on the press conference, where we anticipate questions on market moves after the widening of the 10yr target yield corridor”, BofAML said on Sunday, chiming in.
A day after the BoJ, we’ll get the LDP party presidential election. Abe will likely prevail, giving him a third term and cementing the continuation of ultra-accommodative BoJ policy.
Again, all of this will likely play second fiddle to trade concerns. On the domestic political front stateside, expect more bickering as questions swirl around Brett Kavanaugh and the White House ponders Trump’s fate should Democrats take back the House in November.
Speaking of the midterms, we’ll leave you with a message of hope and unity from the President on Sunday…
Full calendar from BofAML