The Senate’s Blackball

Near China, an island quite small
Has led to the latest downfall
In equity prices
Because of their crisis
As well as the Senate’s blackball

Risk is decidedly off this morning as equity markets around the world are under pressure and bond markets rally strongly. Adding to the mix is a stronger dollar and Japanese yen as well as an uptick in gold prices. The proximate cause of this angst was the unanimous voice vote in the Senate last night to pass legislation requiring an annual review of Hong Kong’s special trade status with the US, something that was heretofore permanently granted in 1992. The new legislation requires Hong Kong to remain “sufficiently autonomous” in order to maintain that status, which is arguably quite a nebulous phrase. Nonetheless, the Chinese response was immediate, threatening unspecified retaliation if the bill becomes law and calling it illegal and an intrusion in domestic Chinese affairs. While the bill must still be reconciled with a similar House version, that seems likely to be fairly easy. The real question is how the president will manage the situation given the fragility of the ongoing trade talks. Thus far, he has not made his views known, but they would appear to be in sympathy with the legislation. And given the unanimity of voting in both chambers, even a presidential veto would likely be overturned.

Given this turn of events, it should be no surprise that risk is under pressure this morning. After all, the promise of a trade deal has been supporting equity and other risk markets for the past six weeks. This is the first thing that could clearly be seen to cause a complete breakdown in the discussions. And if the trade negotiations go into hibernation, you can be sure that risk assets have much further to fall. You can also be sure that the developing narrative that European weakness is bottoming will also disappear, as any increase in US tariffs, something that is still scheduled for the middle of next month, would deal a devastating blow to any nascent recovery in Europe, especially Germany. The point is, until yesterday, the trade story was seen as a positive catalyst for risk assets. Its potential unwinding will be seen as a clear negative with all the risk-off consequences that one would expect.

Beyond the newly fraught trade situation, other market movers include, as usual, Brexit and the Fed. In the case of the former, last night saw a debate between PM Johnson and Labour’s Jeremy Corbyn where Boris focused on reelection and conclusion of the Brexit deal he renegotiated. Meanwhile, Jeremy asked for support so that he could renegotiate, yet again, the deal and then put the results to a referendum in six months’ time. The snap polls after the debate called it a draw, but the overall polls continue to favor Boris and the Tories. However, the outcome was enough to unnerve Sterling traders who pushed the pound lower all day yesterday and have continued the process today such that we are currently 0.6% below yesterday’s highs at 1.2970. It seems pretty clear that in the event of an upset victory by Corbyn, the pound would take a tumble, at least initially. Investors will definitely run from a country with a government promising a wave of nationalization of private assets. Remember what happened in Brazil when Lula was elected, Mexico with AMLO and Argentina with Fernandez a few months ago. This would be no different, although perhaps not quite as dramatic.

As to the Fed, all eyes today are on the release of the FOMC Minutes from the November meeting where they cut rates by 25bps and essentially told us that was the end of the ‘mid-cycle adjustment’. And, since then, we have heard from a plethora of Fed speakers, all explaining that they were comfortable with the current rate situation relative to the economy’s status, and that while they will respond if necessary to any weakening, they don’t believe that is a concern in the near or medium term. In fact, given how much we have heard from Fed speakers recently, it is hard to believe that the Minutes will matter at all.

So reviewing market activity, G10 currencies are all lower, save the yen, which is basically unchanged. The weakest link is NOK, which is suffering on the combination of risk aversion and weak oil prices (+0.4% today but -4.0% this week). But the weakness is solid elsewhere, between 0.2% and 0.5%. In the EMG bloc, CLP is once again leading the way lower, down 1.0% this morning after a 2.0% decline yesterday, with spot pushing back toward that psychological 800 level (currently 795). But pretty much every other currency in the bloc is lower as well, somewhere between 0.2% and 0.4%, with just a few scattered currencies essentially unchanged on the day.

And that really describes what we have seen thus far today. With only the FOMC Minutes on the docket, and no other Fed speakers, my take is the FX market will take its cues from the broader risk sentiment, and the dollar is in a position to reverse its losses of the past week. Barring a shocking change of view by Congress, look for a test of 1.10 in the euro by the end of the week.

Good luck