By Stephen Innes
Happy to hear that markets in Hong Kong are expected to start trading on Monday after Mangkhut roared through the City. But more significantly friends and colleagues are all safe!
Now for the nuts and bolts
As many had suspected, despite Treasury Secretary Mnuchin's attempts to broker a trade deal with China, the US may proceed with tariffs against China. Over the weekend, wire reports suggested the Trump administration plans to announce within days new trade tariffs on as much as $200 billion in Chinese goods, quoting people familiar with the matter. Trade issues and their impact on the global economy are likely to dominate investor focus this week.
Now whether this is little more than the President using this leverage as a negotiating tactic or not, China officials will continue to be frustrated. This 'good cop bad cop' routine continues to undermine Mr. Mnuchin's efforts, as it is still not clear if anyone other than Trump himself is commissioned to cut a deal. And not too unexpectedly and quite ominously, China could cancel the meeting.
But assuming the tariffs go through Tuesday, given that this is not so unexpected, I guess the big question is 10% or 25% and I suspect this is where the event tail risk lies. If Trump comes out with 25%, we could get an outsized market reaction.
The market had interpreted Mnuchin meeting favourably and triggered a near 3% short covering rally in Emerging Markets late last week with the Hang Seng Index rallying over 3.5%. But HSI futures dropped over 1% in Friday's trading after President Trump tweeted that he did not feel under pressure to reach a trade deal with China while HSCEI futures also fell. The offshore CNH fell to its lows for the day after the news as not unexpectedly, Chinese leaders have promised retaliation for any US measures. All this noise is contributing to a very bearish setup this week.
Nonetheless, the trade war escalation playbook does suggest EURUSD and USDJPY will move lower, USDJPY on risk aversion but we could see an outsized move on the Australian dollar due to its G-10 China proxy status. And while the XAU-DXY correlation was wobbling a bit on Thursday, but if dollar buying does emerge, as the playbook suggests, gold could trade lower if the stronger USD narrative re-emerges.
But at a minimum, the dollar should remain supported X JPY especially USDCNH, as the offshore RMB provides an excellent hedge to trade war escalations.
Looking for a glimmer of hope, however, remember President Trump and Xi are expected to be offered a roadmap to work with by November and per White House Economic Advisor Kudlow, more US-China trade talks will likely take place on the sidelines of the UN meeting (September 18) and G20 (November 30). This news could take, which will probably lessen the sting of this announcement, hoping that indeed prevails and some progress can be made soon.
But mercifully it is only $200 billion and not closer to $300 billion or more. Otherwise, it could get a bit messy in the markets this week.
Indeed, local equity markets will be in focus as too will both oil and currency markets. But with the ongoing string of solid US economic data, investors will also be concerned about rising US yields after the 10-year US Treasury bond hit 3 per cent on Friday. Even with best-laid plans, this could be a tricky week to navigate.
Despite the likely positive impact from Iran sanction, traders were very much focusing on the adverse economic effects from trade war and how that could weight negatively on oil demand in Asia. And the weekend's tariff headlines will not help that sentiment. So we are seeing some early pressure on WTI in Asia this morning, but frankly, risk sentiment outside of last week's short covering rally has been sour, and as such I'm not expecting a great deal of support on the front.
Also, there has been some backroom discussion again between the US and Russia, with the US offering concessions tempting Russia to cap rising oil prices ahead of what is shaping up to be a contentious US midterm election. While it doesn't necessarily imply lower oil prices, it does support some traders' long-held view that OPEC and non-OPEC producers will try to cap Brent at $80 through the US November elections for no other reason to avoid the "Wrath of Trump."
In India, the weaker rupee profile and higher oil prices were causing State-owned oil marketing companies (OMCs) to increase the rates of sensitive petroleum products like petrol and diesel in the country on Sunday. India imports about 80 per cent of its crude oil, and the falling Indian rupee will make the imports costlier and lead to a rise in fuel prices. So that hard cost impact is hitting consumers.
Brent crude oil tested decent support level on Friday, following up on Thursday's bearish shift in near-term sentiment, but driven primarily on the build in US oil products but trimmed losses into the close. WTI dips remained supported by the larger-than-expected 5.3 million barrels on the inventory report. But perhaps short covering as options on October WTI crude oil will expire on Monday probably will influence given the market is lean. But with the risk-reward calculus not signalling a bullish setup for energy in general, in the absence of any supply disruption, the markets could struggle ahead of the OPEC meeting as oil producers were making a convincing argument that a likely downturn in the global economy could hurt oil. Of course, this is from a soothsayer's perspective. And while impossible to quantify these unknowns, what we do know is that the weaker EM currency profile would most certainly hurt consumers' appetite at the tertiary level of the demand curve. But Chinese commodity demand has appeared not to be destroyed by the 25% US tariffs on $34bn as China continues to offset trade headwinds by upping fiscal spend.
In the wake of depleting oil inventories, Baker Hughes' US Crude, Oil Drilling Rig Count hit +7 last week.
The string of positive US economic data on Friday supporting the market's base case Fed outlook dented gold's appeal into the close. With US 10s hitting the psychologically significant 3% level on Friday, we could see more traders feasting with the gold bears on Monday. So we could see more pressure on gold prices as we near that critical $1190 level. While traders focus on the USD -Sino trade, the USD becomes an intricate part of the equation as US dollar demand could emerge from investors looking to ride the latest trade war storm under the umbrella of US bond yields.
US Equity Markets
Dow and S&P 500 managed to claw out gains as traders were treating the President's more aggressive tone towards China trade with a grain of salt. However, after weakened headlines surfaced that the US administration's delay in implementing the tariffs was more about the USTR taking into consideration comments for leading US businesses and not indeed as an actual reprieve, I would expect Asia markets could stumble out of the blocks. So far, the US equity market has been relatively insulated to trade war, but further escalation has huge negative implications for global equities.
While everyone thought US yields could begin to rise in September as the markets emerged from holiday, few could have predicted returns to come on as strong as they did with 10Y yield's robust 3% on the back of last week's strong wage growth data, in addition to some hawkish Fed-speak. The most significant shift in my view comes from Fed Governor Lael Brainard, who I dare say is starting to roost with the Hawk, suggesting the sitting Federal Reserve Board is a tad more hawkish than markets have priced in. Last week's lower-than-expected US CPI print does suggest we are nowhere near a reprice higher of the Fed curve. But with the market emerging from its summer slumber and may soon realise it is pricing 2019 rate hike risk far too pessimistically, if the strong run of US economic data continues and even more so on the first glint of inflation.
The strong local employment data print last week was a real positive signal for the Aussie, and when taken in context with the weaker USD CPI than expected, the Aussie was looking good, and market sentiment was shifting positive. But just as the Australian dollar bulls thought it was safe to go back into the water, tariffs and trade war-escalation are again front and centre in dealers' minds.
Trade war does throw some doubt into the EURUSD higher view for no other reason we may see USD demand on haven appeal. But if the latest trade war headlines remain little more than an idle threat given the EURUSD remains undrowned and if the USD does start to weaken again, the euro could be the best way to express USD weakness given Mario Draghi's wonderful, less dovish lean last week. Key levels remain 1.1730 and 1.1560.
Japanese PM Abe is widely expected to win Thursday's LDP leadership vote, which will enable him to continue as leader of the party for the next three years and become Japan's longest-serving premier. The Bank of Japan is expected to keep policy on hold at its meeting this week as inflation continues to remain subdued. But traders will be focused on guidance.
Indian Rupee (New Currency Measures)
INR was supported via FPIs on Friday after catching a tailwind from CBT's aggressive rate hike and oil prices coming off Thursday's boil, this has marginally improved sentiment. This weekend's measures will be viewed in a positive light and should keep Friday's momentum going, but twin deficit currencies will remain in the market's crosshairs.
It is intervention redux 2013 all over again, so a good bit of this is priced in. And while India's macro picture is considerably more improved since then, does it matter with the persistent threat of EM contagion wearing on investors? Not to mention higher US yields and the possibility of oil prices surging after the US Iran sanctions are enforced.
But the overall feeling I am getting from the street is that, provided the rupee stays below 74 there will be no immediate concerns about servicing the debt. But the problem with that level is it does offer a target for the EM bears to focus on. I am still concerned about EM contagion but at this stage, the sell-off remains idiosyncratic mainly, but we could see USD buyers on knee-jerk USDINR dip on Monday's INR open as sentiment remains incredibly sour.
But ultimately trade deficits improve; the weaker links in the EM chain running large trade deficits will continue to face currency speculation scrutiny.