Little Trust

Investors and traders believe
The trade talks will shortly achieve
Solutions robust
Despite little trust
Since both sides are known to deceive

Risk is definitely back on this morning as equity markets around the world continue their recent rebound, Treasury and bund prices slide, and commodities climb higher. As to the dollar, it is modestly softer, except against the yen, which is the worst performer in the G10 today.

The primary driver of these moves remains the US-China trade talks, which seem to be going pretty well. If you recall, Monday, Chinese Vice-Premier Liu He made an appearance to demonstrate the importance of the talks to both sides’ negotiators, and the fact that they were extended an extra day, only ending today in Beijing, implies that positive momentum was building and neither side wanted to give that up. While the first reports are that there are still some areas of wide disagreement, there seems to be no doubt that progress has been made.

In addition to the trade story, the market continues to hear soothing words from various Fed speakers regarding the pace of further potential rate hikes. Yesterday, St. Louis Fed President Bullard was quite clear that he thought there was no reason to raise rates further at this time given the lack of measured inflation, although he remains comfortable with the continuing unwinding of the balance sheet. And Bullard is a voter this year, so market participants tend to give voters just a little more credence in their comments. Later this afternoon the Fed will release the Minutes of their December meeting, although I don’t expect them to be that useful. You may recall that it was that meeting’s statement and the ensuing press conference that kicked off the last leg of the equity market rout. Investors kept seeing signs of slowing growth while the Fed seemed oblivious, especially to activity elsewhere in the world. In fact, it was that meeting that convinced many (myself included) that the Fed was no longer in the put writing business.

How wrong we all were on that score. We have heard from a half dozen Fed speakers in the past two weeks, including some of the most hawkish (Mester), and to a (wo)man they all indicated that there was no urgency to raise rates, with some, like Bullard, questioning if there was even a need to do so at all. Clearly, the market has become far more comfortable that the Fed is not out to destroy the equity market, and recent price action is the result of that change of view. Given the change of tone since the meeting, it seems unlikely to me that the Minutes will teach us very much about the current state of Fed thinking. Instead, we still have another eight Fed speeches (including another Powell speech) between today and Friday, which will give us all much better information than three-week old data.

Other news of note includes the announcement overnight by the PBOC that they would be instituting a new bank lending program, the Medium Term Lending Facility (MTLF) which is designed to offer cheap bank funding for loans to SME’s without overly expanding the liquidity in the market. Remember, the Chinese are still trying to wring excess leverage out of some sectors of the economy, but are also feeling the effects of overall slowing economic growth so feel the need to address that. These loans appear quite similar to the ECB’s TLTRO’s, which were deemed a big success when they were being issued. Of course, the key concern there is now that those loans are coming up to maturity, banks need to replace that funding and that is not so easy in a market where global liquidity is drying up. Will the same thing happen in China? Quite possibly. My observation on extraordinary monetary policy is that it has proven much harder to remove than to implement.

At any rate, the market was cheered by that news, as well as the trade talks, and the renminbi continues to behave quite well, actually rallying a further 0.2% this morning. I still foresee a weaker currency over time, but thus far, the PBOC has prevented any substantive movement.

Brexit continues to fester in the background with PM May losing another vote in Parliament. This new bill now prevents Her Majesty’s Treasury from adjusting tax rates in the event of a no-deal Brexit. And yet, there is no indication that the deal on the table is going to pass, so it remains unclear just how that will work. Given the magnitude of the issue, waiting to the 11th hour to achieve agreement may be the only way to get it done. And so, I continue to expect a very late acceptance of the deal, although it is by no means clear that will be the case. One other noteworthy Brexit item is the potential impact it will have on Japanese companies, who have used the UK as their beachhead into the EU. PM Abe will be visiting PM May tomorrow to make sure she understands how important a trade deal is to those Japanese firms, and how important those Japanese firms are to the UK economy.

And otherwise, the currency market remains fairly dull for right now. Even EMG currencies are only showing modest movement overall, albeit generally stronger today. The thing is, market participants are so focused on the major issues, and by extension the major currencies, that there has been reduced activity elsewhere. As long as risk appetite remains robust, the dollar should remain under pressure along with the yen. And for today, that seems like the best bet.

Good luck
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