USD Strengthens, Euro, Sterling Weaken; China’s Elements Of Surprise

Stocks and sovereign bond yields tumbled overnight as markets fretted that China may choke off the supply of rare earth elements to U.S. industry. As a retaliatory trade measure, it’s a no-brainer on the surface, and China has previous “form” on this front. It took a WTO ruling to bring them to heel last time. As ever though, the answer is not as simple as stopping supplies to the U.S.

For a start, global supply chains are so intertwined that it’s likely components containing rare earths (just about anything electronic), would have gone via South Korea, Singapore, Europe and Japan etc., before ever arriving in the Land of the Free. Secondly, a blanket restriction would hurt companies elsewhere in the world that are not on the front lines of the U.S.-China trade frictions. Most annoyingly for China, it would send a terrible message to the rest of the world that they are prepared to weaponize a monopoly as a lever of state (aka Russia with oil and gas) if they don’t get their way. It would, in effect, vindicate the U.S. position on China in the first place. As such, I suspect the chances of China pulling this trigger are very low, despite the rhetoric.

Of course, the rest of the world is not without blame. Rare earth elements aren’t rare at all – they are abundant across the globe. It’s a dirty, expensive and polluting business to refine them, however, and global NIMBY-ism (not in my back yard) is rife when it comes to having refineries built. Much like everyone would like a new airport nearby, just not next door to them. The world has reaped what it has sown by handing the keys to China in this respect.

Investors clearly didn’t like what they saw overnight, stampeding into U.S. Treasuries, out to the 10-year with yields plunging across the curve. Yields move inversely to prices in the bond market. The eternal optimists of the stock market finally took note, and Wall Street did an abrupt U-turn late in the session with the S&P 500 falling 0.85%, the NASDAQ dropping 0.40% and the industrial-heavy Dow Jones plunging 0.95%.

Unsurprisingly, Asian stock markets are a sea of red this morning, following very poor consumer confidence prints from South Korea and Taiwan yesterday. Countries with a high beta to China are clearly getting nervous, and it may be that the repricing of equities to express reality may not be too far away.

Of course, having just left Japan, any pronouncements from President Trump – officially or via social media – could be either a ray of hope to markets or a death ray.

FX

The U.S. dollar is stronger this morning, although not markedly so. This follows on from a modestly stronger performance overnight, notably against the euro (EUR) and sterling (GBP), both of which are suffering in the aftermath of the European elections and Italian budget woes.

Regional currencies are holding their own for now, but the sentiment remains fragile, and it will not take a lot for investors to hit the exit button on emerging markets and therefore many of the Asian regional currencies.

In Japan, the USD/JPY fell as investors bought yen on safe-haven flows, leaving the cross at 109.40. Strong technical support lies at 109.00 with any negative pronouncements from Trump or escalations on the trade front possibly setting off a test of this level. A daily close below 109.00 implies a deeper correction to USD/JPY is imminent.

Equities

Asian and Pacific stock markets are a sea of red this morning following the overnight sovereign bond rally, and the U.S. adding many regional markets to the currency manipulator watch list. The U.S. cleared China of being a currency manipulator overnight illustrating that although it is easy to get onto the watch list, it is quite hard thankfully, to get upgraded to a full manipulator.

That will be cold comfort to markets in Asia as its timing comes as equity markets face the repricing to a global slowdown norm with trade tensions in full swing. Regional markets are likely to stay red today unless President Trump surprises us with one of his missives.

Oil

Oil markets took a breather overnight with Brent Crude almost unchanged at USD70.00 a barrel and WTI rising slightly by 0.35% to U.S.D58.85 a barrel on weather-related supply disruptions.

The picture is not so cheery in Asia today with Brent and WTI slightly lower at USD69.80 and USD58.65 respectively. With the flight to safety in bonds, weaker equities and global growth concerns in full flight, the dark clouds hanging over oil are unlikely to clear during today’s session. This implies oil will struggle to maintain any rally in the near-term today and may be vulnerable to a deeper pullback if the Asian stock market sell-off accelerates.

Gold

Gold fell six dollars to USD1,279.60 an ounce overnight despite a flight to safety from equities to sovereign bonds, and an only modestly stronger dollar. Sovereign bonds are clearly investors’ haven of choice in 2019 so far, leaving gold’s traditional role aground on the reef outside the safe harbor.

To say that gold’s price action is underwhelming in the present macro environment would be an understatement. The longer this state of affairs continues, the more likely we’ll see a severe test of long-term technical support between USD1,265.00 and USD1,270.00 an ounce with an ensuing much-deeper correction.

Gold may pick up some short-term support from Asian buyers today on global economic fears, but in the bigger picture, it needs to do a lot more and sooner if it’s going to stop the wolves circling.

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