“Markets remain in a wait-and-see mode, as significant optimism regarding the ‘Phase One’ US-China trade deal has been priced, but doubts remain about the final touches”, Barclays wrote over the weekend.
“Wait-and-see mode” may seem like an odd characterization for a market that finds equities perched at record highs, but it’s actually pretty apt. Although there’s a sense in which Donald Trump has no choice but to validate market expectations for tariff rollbacks (lest he should risk a December meltdown akin to last year’s harrowing collapse), there are no sure bets with this president. Indeed, it would be foolish to completely rule out a scenario where Trump reverts to standard operating procedure, where that means ratcheting up tensions as US stocks scale new peaks on the assumption he’s “playing with the house’s money”, so to speak.
Bonds, meanwhile, are at the crossroads, with the selloff having stalled, but no clear impetus for a resumption of the furious rally that unfolded through August.
There’s a dearth of obvious catalysts in the new week. Traders will get the October FOMC minutes, which will be parsed for more evidence that the committee intends to stay on hold and also for any indication as to what factors would prompt “a material reassessment” of the outlook.
“We suspect that there will be a discussion in the minutes of whether the Fed has cut too much. Either way it will be clear that the majority of Fed officials think that policy is supportive”, BofA said Friday, adding that “we may get a bit more perspective from the minutes on what constitutes a change of view” sufficient to prompt a move in rates.
“We expect [the minutes] to show that the Fed is through with providing insurance cuts although retains an easing bias owing to residual uncertainties”, Barclays muses. “The balance of risks has improved since the October meeting, and the minutes might look somewhat stale and are likely to provide little new information”, the bank goes on to say.
Any hawkish lean will not be appreciated by Trump, who last week told an audience in New York that Jerome Powell was putting the country at a disadvantage on the global stage. “Gimmie some of that money”, the president said, referencing negative rates abroad. “I want some of that money”.
Over the weekend, China’s Commerce Ministry released a statement documenting the most recent call between Liu He, Steve Mnuchin and Bob Lighthizer. The conversation was described as “constructive” and came at the request of the US, Beijing said. To wit (translated):
The two sides have engaged in constructive discussions around the respective core concerns of the first phase of the agreement and will continue to maintain close communication.
Larry Kudlow’s upbeat comments to reporters on Thursday evening were in part to thank for Friday’s rally. Earlier in the week, the Wall Street Journal, FT and others suggested the talks had hit a “snag“, and Trump continues to insist that China needs a deal more than he does, a debatable contention.
The yuan is coming off its first weekly loss in six, and has moved back above 7.00 after strengthening through the key level for the first time since August earlier this month. “We expect progress towards a ‘Phase One” deal to keep CNH range-bound over the next few weeks, while any market nervousness around the deal is more likely to be priced in the China proxies”, Barclays said Sunday.
The Shanghai Composite fell more than 2% last week amid a string of lackluster data. On Saturday, the PBoC acknowledged the myriad challenges facing the economy in its third quarter policy report.
Also on the docket this week, meeting minutes from the ECB and the RBA, as well as PMIs out of Europe.
The US is widely expected to issue a two-week extension of temporary licenses allowing US firms to keep doing business with Huawei when the previous reprieve expires on Monday. A new, two-week extension would be markedly shorter than the previous 90-day waivers.
“FWIW the bullish trade thesis remains largely centered on ‘rollbacks’ of existing tariffs and / or delays to the December tranche”, Nomura’s Charlie McElligott remarked on Friday. “Secretary Ross’ comments in an interview lend optimism to the idea that the Huawei temporary license which was set to expire will likely be extended as a further conciliatory act from the US to China”.
On the rollbacks, the market still expects the September 1 tariffs to be lifted and the December escalation to be taken off the table. Anything short of that will be a disappointment, and although it’s possible a “sell the news” dynamic will take hold once there’s confirmation, it seems just as likely that the rally in equities would run at least a bit further when the deal is sealed.
As far as the risk of some adverse headline triggering the kind of mechanical, cascading selloff that’s become all too familiar over the past several years, Deutsche Bank notes that “vol control funds are at maximum equity allocations and risk to their exposure remains asymmetric, [but] persistently low vol recently means that a small rise in vol from current levels is unlikely to trigger selling”. On the bank’s estimates, even a 3% rout would trigger “only $7bn in selling by vol control funds, less than half the level estimated back in May”.
For his part, Nomura’s McElligott sees scope for some “unshackling”, if you will. “Despite dealers remaining (still very) ‘Long Gamma’ on the out-of-expiration trade, we are at least in the process now of clearing some of the positioning [and] hedging flows which have helped keep us so ‘pinned’ between 3075 and 3105 the past two weeks”, he says. That, in turn, means US Equities “should have greater ability to move up or down going forward”.