Whether you’re a geopolitics buff, a Beltway junkie or a market addict, the week ahead has you covered.
On the geopolitical front, Trump heads to the U.N. this week and he’s bringing John Bolton and his mustache along. That’s pretty amusing for reasons that will be obvious to those with a sense of history. Here’s some color from a pretty good Politico piece out Sunday evening:
Bolton served as a U.S. ambassador to the U.N. during the George W. Bush administration, a perch he used to denounce the institution in which he kept an office. Bolton railed at the U.N. as bloated, inefficient and a potential threat to U.S. sovereignty. He infamously suggested that if the 39-story tower on Manhattan’s East River “lost 10 stories, it wouldn’t make a bit of difference.”
It’s little wonder, then, that Bolton’s return to the U.N. is the subject of chatter among U.N. officials and diplomats already converging in New York. Some diplomats are wary about the mustachioed Trump adviser refreshing his U.N. broadsides, while others are looking to gauge Bolton’s influence on the president and will be listening closely for echoes of his rhetoric in Trump’s own words.
“J.B. is coming home,” quipped one Trump administration official, warning anyone who might wonder whether he’s softened his views toward the world body: “He hasn’t changed.”
Iran will obviously be at the top of the Trump administration’s agenda. The President has engaged in an at times shrill back and forth with Tehran since pulling the U.S. out of the nuclear deal earlier this year. At one point in late July, he went so far as to threaten Hassan Rouhani with “unimaginable suffering” in an all-caps tweet that was absurd even by Trump’s standards.
Speaking of “unimaginable suffering”, the administration’s sanctions push has piled pressure on Iran’s already fragile economy. Oil revenue has fallen a truly harrowing 35% since April.
Trump will address the General Assembly on Tuesday and if that goes anything like it did last year, it will be a spectacle to end all spectacles. He’ll also chair a Security Council meeting on Wednesday and if he decides to make that about Iran, Rouhani may well be in attendance.
On Sunday, Mike Pompeo told NBC that Trump was still open to talking with Rouhani, although I would reiterate that the President doesn’t seem to have a good grasp on the difference between Tehran and Pyongyang when it comes to diplomatic wrangling with hostile regimes.
Read more on Mike Pompeo’s recent criticism of Iran
Watch oil amid the U.N. proceedings. OPEC+ seems to be ignoring the latest calls from Trump for lower prices and the dollar’s recent pullback is helping bolster commodities, which put up a good showing last week.
Meanwhile, in D.C., Republicans will spend the week trying to salvage Brett Kavanaugh’s SCOTUS nomination. His accuser, Dr. Christine Blasey Ford, has agreed to testify on Thursday, and although there are still a number of contentious logistical issues to iron out, it looks as though America is actually going to get front row seats for what is sure to be a complete circus.
“No firm decision has been reached on whether Republicans would use staff attorneys to question Ford about her claim that Kavanaugh tried to force himself on her more than 30 years ago — an approach the GOP is considering in order to avoid the perilous prospect of Ford getting grilled by its all-male Judiciary Committee membership, some of whom are publicly skeptical of her account”, Politico notes, describing one of the more important sticking points ahead of the hearing.
As far as markets are concerned, the new tariffs on $200 billion in Chinese goods go into effect from Monday and with them, China’s retaliatory measures. Beijing is said to have declined Steve Mnuchin’s invitation to hold another round of negotiations and a consensus is forming around the notion that Trump is likely to use China’s retaliation as an excuse to move ahead with a third phase in the war, slapping duties on an additional $267 billion in Chinese imports. That would entail going all in (as it were), with the U.S. taxing everything China ships to America.
Last week, markets shrugged off the latest escalation on the trade front, thanks arguably to stimulus hints from China and a promise from Premier Li Keqiang that the PBoC won’t further weaponize the yuan. It was the best week for Chinese equities relative to the S&P since 2016.
And the risk-on sentiment was readily apparent across developing nation assets, with EM FX putting up its best weekly performance since January.
The dollar will obviously be watched closely again this week. Last week’s greenback weakness was in no small part responsible for buoyant risk sentiment.
After paring bullish dollar bets for three consecutive weeks ($4 billion shaved off the net long in the past month) specs added to dollar longs in the week through Tuesday. $4 billion worth of new long exposure offsets what was trimmed, and now we’re back where we were a month ago:
Here’s Barclays with some color:
A decline in risk aversion and market volatility is driving a reversal of safe-haven flows and short-term USD retracement. There are signs of risk aversion fading and market fatigue towards trade war news. US equity markets took the latest round of US-China trade tariffs in stride with the S&P 500 up ~1% on the week, as strong earnings growth provided a buffer against headwinds. The USD spike in reaction to the latest tariff news was short-lived, with the Bloomberg Dollar Spot Index (BBDXY) ending ~0.5% lower. While incoming US data point to continued economic resilience, the coincidence of higher UST yields alongside USD weakness of late suggests that safe-haven flows might be reversing. EM FX vol has fallen, and data showing a pickup in inflows into local currency EM government bond ETFs as well as dedicated EM bonds funds suggest that investor sentiment towards EM might be recovering (see Figures 1 and 2).
Given that market participants are still long USD, and that asset managers have had a challenging year so far, a continuation in the downward USD momentum would drive a further unwind of USD longs to either lock in profits or when (trailing) stop-losses are triggered.
In bond land, last week saw a notable selloff (more here) and the spec short in TY is still sitting in record territory (so much for the short squeeze).
Here’s a look at what developed market yields have done so far this month:
It’ll be interesting to see if the steepening bias has any legs after last week.
Needless to say, all eyes will be on the Fed for hints as to what comes next for the dollar and bonds. It’s starting to feel like the committee is on the fast track to creating restrictive policy. Beyond that point, the market might start to try and anticipate the end of the tightening cycle.
As far as the meeting is concerned, we’re going to have a ton on this throughout the week, so for now, we’ll just give you a couple of quick bullet points from Goldman to set the stage. To wit:
Inflation is at target, the unemployment rate is below target and falling, and yet the funds rate remains 100bp below the Fed’s estimate of its neutral level. Most FOMC participants now agree that this makes little sense—the Fed has some catching up to do. A rate hike is widely expected at the September FOMC meeting, and barring a significant shock the path up to neutral seems likely to prove fairly uncontroversial as well.
We do not expect any substantive changes to the FOMC statement, with the description of the policy stance as “accommodative” a touch more likely than not to remain. While the FOMC seems to have anticipated removing it in August, an increase in the Fed’s lowest r* estimate might have shifted the goalposts: even after the hike next week, the funds rate will remain below the entire range of r* estimates published by the Fed. In any case, we see the issue as fairly unimportant since the dots already reveal the Committee’s neutral rate estimates.
Changes to the economic projections should be minimal, with 2018 growth bumped up a bit. The median interest rate path is likely to remain unchanged, but we expect a firmer consensus around 4 hikes in 2018, 3 in 2019, and 1 in 2020. The new 2021 projections will offer insight into the Fed’s plan to manage the overshoot of its labor market target. We expect a flat terminal funds rate of 3.25-3.5% and a slight uptick in the unemployment rate as the restrictive policy stance does its work. Finally, we expect the median neutral rate dot to move up slightly to 3%, although this is uncertain and partly driven by changes in the composition of the committee.
In Europe, all eyes will be on Italy and the budget. Over the weekend, Salvini was characteristically defiant. Just a day after Ignazio Visco warned the League leader to be careful, Salvini said this, in an interview with Corriere della Sera:
We’ll do a courageous budget, the deficit isn’t a problem. [I spoke to foreign investors] and all of them, and I underline all, told me the same thing: do a courageous, expansionary budget.
If that sounds like a lie, that’s because it probably is. I cannot imagine that “all” investors are encouraging Italy to flout E.U. budget guidelines in the interest of delivering on a series of far-fetched populist campaign promises.
For their part, Five Star is reportedly looking for a deficit of 2.6% of GDP in order to make sure they can pay for that damn “citizen’s income”. Finance Minister Giovanni Tria is probably pulling his hair out by now. Here’s what Barclays had to offer on Sunday with regard to Italy:
We believe that risk-reward favors EURUSD upside, given limited risks from the Italian and French budgets, and expected improvements in inflation prints. Italy is due to release an update to its medium-term economic and fiscal targets this week (by 27 September), and draft the 2019 budget by 15 October. We continue to expect no significant fiscal deteriorations in the near term, and forecast Italy to revise up its budget deficit target to 1.9% of GDP in 2018 and 1.7% in 2019, from the respective 1.6% and 0.8% agreed on with the EC last year. Given the government lacks the political capital needed to survive internal (Parliament and President of the Republic) and external (financial markets and European Commission) pressures should it decide to implement the pledged EUR100bn fiscal easing, we expect 5SM and L will take a pragmatic approach to public finance management and institutional relationships. As such, any surprises to the upside could send EURUSD higher.
Fingers crossed. For what it’s worth “lo spread” is still well wider than it was before the May BTP bloodbath, signaling that investors are still cautious about how this will ultimately play out.
The U.S. will talk trade with both Canada and Japan this week and it will also be worth watching sterling following Theresa May’s sad Brexit address. The Labor party conference is on deck as well.
In EM, watch Bank Indonesia. They’ll probably hike (again). This is an important story. Multiple hikes from BI since May have failed to arrest the slide in the rupiah, which fell to its lowest since 1998 earlier this month (blue line is policy rate below).
Another hike would be the latest pre-emptive strike from EM policymakers who are desperate to stay out ahead of things as the Fed’s tightening cycle drags on.