Ten More Percent!

Said Trump in his latest lament
That his tariffs, he soon would augment
If China reacted
So they then enacted
Their own. Trump said ‘ten more percent!’

Clearly the biggest story overnight was the announcement by the Trump administration that they would seek to enact a 10% tariff on a further $200 billion of Chinese goods. The president remains adamant that China does not play by the rules and that the US is bearing the brunt of their mercantilist policies. This is not the venue for that discussion, but certainly the numbers show that US companies have been unable to expand their market share in any meaningful way on the mainland, hence the $376 billion trade deficit in 2017.

Market reaction to the announcement was immediate. Asian markets saw equities fall sharply (Nikkei -1.9%, Shanghai -3.8%), Treasuries rally (US 10yr yields -6bps to 2.87%) and the dollar move higher (EUR -0.65%, CNY – 0.4%) against virtually all currencies except the yen (+0.6%), which benefitted from safe haven flows. US equity futures are pointing lower as both Dow and S&P futures are down more than 1.2%. Commodity prices have also suffered, with energy and base metals lower and only gold holding its own this morning. If you didn’t remember what a risk-off scenario looked like, this is it. My observation is that the market reaction appears to be in the right direction, but I wonder just how much further things can move at this time. It strikes me that we have seen quite an exaggerated move thus a retracement seems more likely in the short run than an extension. Granted, if the latest set of tariffs are actually enacted markets are likely to suffer more, but for now, I kind of think we have seen the worst.

The Lords said a “meaningful vote”
Is a must as they seek to promote
A Brexit that’s gentle
And not detrimental
To constituent interests of note

The other story that has impacted markets was a successful vote in the House of Lords requiring that Parliament have a “meaningful vote” in any Brexit outcome. The intent is to prevent the UK from exiting the EU with no deal, but the May government claims it will hinder their negotiating leverage. The bill in question now heads back to the House of Commons where the vote is expected to be extremely close. In the meantime, the pound has taken it on the chin, down 0.5% and now trading at its lowest level since November. Interest rate futures in the UK have now reduced the probability of an August rate hike by the BOE to less than 50%, which given the increased uncertainty over the Brexit situation makes a great deal of sense. I have maintained that the BOE would not be raising rates because of Brexit, and now that the UK data seems to be showing a slowdown in the economy, and reduced inflationary pressures, I expect to be proven correct. There is just no way that Governor Carney can raise rates with Brexit hovering over the UK economy like the Sword of Damocles. The pound has further to fall, count on it.

Beyond that, I need to catch up on one thing, USDBRL, which fell sharply during last Friday’s session after the central bank, once again, aggressively intervened in the market adding dollar liquidity. Yesterday saw limited movement, but ultimately, the issue remains that the combination of underlying economic weakness and the uncertainty caused by the upcoming presidential election is encouraging international investors to withdraw funds. At some point, the central bank will realize that wasting reserves to protect the currency is a bad idea, but for now, they are clearly keen to prevent too much further weakness. If I had BRL receivables or assets to hedge, I think I would take advantage of the current levels as I expect that a move in spot to 4.00 and beyond is inevitable.

Also, I would be remiss if I didn’t mention a speech by Mario Draghi at the Sintra conference, explaining that the ECB would be patient as they determine the timing of the first rate hikes. That was an even more dovish spin to his press conference last week, and traders did sell the euro further when the comment hit the tape. But really, those are the key stories. Other than the yen, the dollar is stronger vs. all its major counterparts. And while some have seen larger moves than others, there was very little other news of note. So oil-linked currencies (RUB, MXN) have fallen more than those with less exposure to that sector, but really, that is all part of the same story.

This morning brings US housing data with Housing Starts (exp 1.31M) and Building Permits (1.35M) both released at 8:30. But that’s really it. St Louis Fed president Bullard speaks early and there are a few ECB speakers, but with Draghi out of the way and Powell not until tomorrow, I actually expect that today’s price action will be consolidative.

Good luck