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An Awkward Combination.

To the extent there are any good vibes, they aren't likely to last.

An awkward combination of mostly idiosyncratic factors conspired to stabilize risk sentiment in overseas trading Monday, but to the extent there are any good vibes, they aren’t likely to last.

Political developments in Australia helped buoy the Aussie, which surged as much as 1% before trimming gains. News that Scott Morrison’s center-right government will secure a parliamentary majority added fuel to the fire for local equities, which had their second-best day of 2019, leaping 1.7% to the highest since December 2007.

More than a few folks expressed skepticism about the move in the currency. Shorts were covered and offshore funds bought the Aussie and stocks, but focus will quickly shift to a key speech from Lowe. 3-year yields rose, the curve bear flattened and rate cut bets were pared. All of that may reverse once the post-election adrenaline rush gives way to a sober assessment of the RBA’s next move and the reality of the worsening trade war (Australia is obviously susceptible to the vagaries of China’s economy).

Meanwhile, the Sensex surged the most in, well, the most in a very long time following exit polls favorable to Modi. The rupee rallied sharply too.

This is yet another move that could ultimately be faded, although the assumption of political stability is a powerful thing when it comes to stoking bullish sentiment for EMs.

In China, officials are working hard to quell expectations for excessive yuan weakness. SAFE chief Pan Gongsheng on Sunday reminded markets that Beijing has plenty of tools to deploy when it comes to curtailing volatility in the currency and a former central bank official said a breach of the ostensibly important 7-handle would “do more harm than good”. A stronger-than-expected fix helped the onshore yuan strengthen against the dollar for the first day in four.

It’s still not clear whether “7” actually is a magic number. Bloomberg’s Ye Xie had a great little piece out overnight on the subject. Here are a couple of key passages:

The argument for the PBOC to defend 7 is that breaking it would have a large psychological impact on the Chinese people, cementing depreciation expectations and encouraging capital outflows. That perspective doesn’t hold up under scrutiny. For starters, China has tightened capital controls, limiting the ability for money to be moved offshore. For instance, the errors and omissions in China’s balance of payments data, a proxy for undocumented capital flows, improved last year even when the yuan was approaching 7. The psychological impact of 7 may be greatly exaggerated, even if it would constitute a record level for USD/CNH. One could even argue that the longer the PBOC holds the line, the more devastating the impact will be once it breaks because policy makers would appear impotent. A better strategy would be to let the yuan break that level when market conditions require it, and then rein it in to demonstrate two-way movements in the currency

Those arguments are good ones. Especially the bit about how efforts to defend 7 could ultimately prove counterproductive. A staunch defense of a meaningless line in the sand raises questions about why it’s being defended. Those questions could become part of a self-fulfilling prophecy.

For whatever it’s worth, Morgan Stanley said anything above 6.85 “appears excessive” and could be faded as Beijing attempts to keep things calm – for now, anyway.

“The Yuan has reached our near-term target of 6.95 amidst ongoing trade tensions between the US and China [and while] we see risks of further depreciation—possibly through 7.00—we expect any move to be gradual and orderly”, Goldman wrote Friday, citing the following three factors:

First, Chinese policymakers have signaled their desire for broad stability, including through fairly aggressive use of the daily fixing mechanism and comments through media outlets. Second, capital controls tightened after 2015-2016 have meant that achieving Yuan stability has lately required minimal use of official reserves. Third, the PBOC maintains a large stock of reserves, so could likely accommodate market demand for Dollars even if outflow pressures intensify.

You can write your own script. Watch for spot market intervention, rising offshore funding costs and, of course, the daily fix.

Finally, Japan managed to pull a rabbit out of a hat with a much better than forecast Q1 GDP print, driven by net exports (i.e., falling  imports). “At least at the surface, growth accelerated over the previous quarter and sharply exceeded potential”, Barclays wrote Monday, before immediately throwing cold water on the situation. “The contents revealed deterioration, with headline growth supported by a decrease in imports (a deducted item) and unintentional inventory accumulation, while exports and private capex, the drivers of the expansion to date, weighed on growth.”

(Barclays)

Oh, and oil rose as the OPEC+ JMMC pow wow in Jeddah suggested a continuation of the cuts is likely. Donald Trump helped support crude with absurd threats to destroy Iran if the country “wants to fight”.

You can think about all of this as a kind of artificial fillip to sentiment. The Aussie’s strength and reasonably buoyant oil weighed on the dollar, while political stability in Australia and India was cheered. Beijing seems like they want to avoid rapid devaluation (at least in the near-term) and while a quick look under the hood tells a different story, Japan’s GDP beat makes for a nice headline.

Speaking of headlines, those with the word “Huawei” in them all sound ominous. And that’s really all you need to know to start the week.


 

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1 comment on “An Awkward Combination.

  1. You gave us good explanations about the risks that might cause renewed weakness in Australia, China and Japan. But I don’t think I understand the basis for your comment with respect to India. Is it just the size of yesterday’s rally, or that focus will return to valuation, trade and other long term issues?

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