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
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Lost Their Zeal

While yesterday Brexit seemed real
As both sides looked close to a deal
This morning we hear
A deal’s not so near
As Ireland’s North lost their zeal

Meanwhile from the Far East, the news
Is that China just might refuse
To buy pork and grain
Unless we refrain
From publicly airing our views

While the same two stories remain atop the leaderboard, the score has clearly changed. This morning, much of yesterday’s Brexit optimism has dissipated as the DUP, Boris Johnson’s key Northern Irish ally in Parliament, explained they could not support the deal that Johnson has been furiously negotiating over the past few days. Remember, DUP stands for Democratic Unionist Party, and the Union of which they speak is that of Northern Ireland and the rest of the UK. As such, they cannot countenance the idea of a soft border in the Irish Sea between Northern Ireland and the rest of the UK. They want to be treated exactly the same. At the same time, they don’t want a hard border between themselves and the Republic of Ireland, so it seems that they are the ones that need to make up their collective mind. As time is very clearly running out, the conversation has reached a very delicate phase. Remember, the Benn Act requires PM Johnson to request an extension by this Saturday if there is no deal agreed, and of course, Boris has said he “would rather be dead in a ditch” than request such an extension.

From what I have read, it appears that the soft border would be time limited, and so in the end, I think the pressure on the DUP will be too great to bear and they will cave in. After all, they also don’t want to be the ones responsible for the failure of reaching a deal. The pound, after having traded as high as 1.2800 yesterday, has been extremely volatile this morning, trading in a more than 1.0% range and having touched both the highs at 1.2790 and the lows near 1.2660 twice each. As I write, the pound is lower by 0.3% on the day, but at this point, it is entirely headline driven. The one thing that is clear is that many of the short positions that had been built up over the past year have been reduced or eliminated completely.

Turning to China, the story is about Beijing’s anger over two bills passed by the House of Representatives in support of the pro-democracy protests in Hong Kong. The Chinese are adamant that anything that happens in Hong Kong is a domestic affair and that everybody else, especially the US, should keep their noses out of the discussion. In fairness, it is a Chinese territory legally, unlike the situation in Taiwan where they claim ‘ownership’ with less of a legal claim. Nonetheless, they are quite serious and are threatening retaliation if any law addressing Hong Kong is passed by the US. Now a bill passing the House is a far cry from enacting a law, but this does seem to be something where there is bipartisan support. Remember, too, that the standoff with China is one of the few things where the Democrats and President Trump see eye to eye.

At the same time, somewhat behind the scenes, the PBOC injected CNY 200 billion into its money markets last night, surprising everyone, as a measure of further policy ease. Thursday night the Chinese will release their Q2 GDP data and while the median forecast is for a 6.1% annualized outcome, there are a number of forecasts with a 5 handle. That would be the slowest GDP growth since at least 1992 when records started to be kept there. At any rate, the cash injection helped weaken the renminbi with CNY falling 0.3% in the overnight session. One thing to remember here is that part of the ostensible trade deal is the currency pact, but if that deal falls apart because of the Hong Kong issue, it opens the door for CNY to weaken a bit more.

It ought not be surprising that the change in tone on those two stories has dampened overall market enthusiasm and this morning can clearly be described as a risk-off session. In the G10, the dollar is stronger against everything except the yen and Swiss franc (both higher by 0.1%). In fact, both NOK (-0.9%) and NZD (-0.7%) lead the way lower with the former responding to oil’s ongoing weakness as well as the potential negative impact of a hard Brexit. Meanwhile, the kiwi has suffered after the RBNZ reiterated that lower rates were likely still in store despite CPI printing a tick higher than expected last night at 1.5%.

In the EMG space, things have been less dramatic with ZAR today’s weakest component, falling 0.5% after news that the troubled utility, Eskom, will be forced to create rolling blackouts, further highlighting its tenuous financial position and putting more pressure on the government to do something (read spend money they don’t have) to fix things. Without a solution to this issue, which has been hanging over the economy for several years, look for the rand to continue its broad move lower. While at 14.97, it is well off the lows seen in August, the trend remains for the rand to continue falling. Otherwise, this space has been far less interesting with KRW dipping just 0.25% overnight after the BOK cut rates by 25bps. The thing is, comments from BOK members indicated a reluctance to cut rates much further, thus limiting the downward movement.

This morning brings us Retail Sales (exp 0.3%; -ex autos 0.2%) and Business Inventories (0.2%). Then, at 2:00 the Fed’s Beige Book is released with analysts set to look for clues about economic activity to drive the Fed’s next activity. We also hear from three Fed speakers, Evans, Kaplan and Brainard, who all lean to the dovish side of the spectrum. With European equities under pressure and US futures pointing lower, it seems that risk will remain out of favor, unless there is a change of heart in the UK. But for now, think risk-off as a guide to today’s activity.

Good luck
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