Market Thoughts: EM, Trade Stand-Off Benefit Safe-Haven Currencies
Ivan Delgado | Sep 03, 2018 06:57AM ET
As markets roll over into September, price action in the forex space remains dominated by trade negotiations and emerging markets’ instability. On the trade front, US President Trump is not bending for no one, with his hard-line stance well embodied via last week’s interview with Bloomberg, renewing his aggressive rhetoric against Canada, China, and the European Union. Besides, a controversial leaked off-the-record conversation toughening up his position on Canada, served as a precursor to anchor risk-off flows last Friday despite a major late Friday recovery, not reflected via weaker Yens or the US Dollars, both ending last week in a pretty strong footing, as woes over emerging markets are far from going away.
With the Mexican-US trade deal agreement now representing an insignificant matter (water under the bridge), market’s attention will continue to be on US-Canada trade talks, set to resume on Wednesday, which keeps hopes still alive after last week’s attempts to find a compromise fell apart. The Canadian Dollar has been under the cosh, with the frustration on a no deal between the US and Canada reflected in the price action. Since the posturing and talks may still drag on for weeks, with a deadline to reach a handshake agreement set by end of Sept, expect the intensity of headlines to slow down a notch until Wed.
Another source of concern and volatility this week is the possible immediacy of tariffs being applied to over $200b Chinese goods and services as soon as Sept 8th, and with the EU-US trade tensions heating up once again, there is no shortage of risks to factor in and it’s hard to see how it can get much better from here before it gets worse. In the grand scheme of things, it means that the breakout lower seen in a prop risk-weighted index we monitor may find further legs lower. Remember,the index tracks the most risk-sensitive assets, all equally-weighted in order to gauge the overall risk sentiment in the market.
But deals or not deals, last Friday’s late yet meritorious recovery in risk reminds us how disconnected and immune US equities are to external factors, with the S&P 500 ending on positive territory just above the 2,900.00 level, as Treasuries got dumped hard, sending the 30-yr yield, as the favorite proxy for risk over 4bp higher, from 2.98% up towards 3.02%, while keeping gold depressed sub $1,200.00. Less compelling is the outlook for emerging markets, as currencies such as the Indonesian rupiah, Indian rupee, South African rand, Argentine peso or the Turkish Lira keep trading at extremely low levels, making it much more troublesome for these economies to get sustained levels of USD-denominated wholesale funding and/or repay its foreign debts.
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We should not forget the volatile nature of Brexit negotiations, with last week’s comments by EU’s Brexit negotiator Barnier over an improved outlook for trade terms to the UK proving to be a fudge, as the ambiguity on subsequent comments suggest the risks of a no-deal Brexit is back on the table. Over the weekend, Barnier said that he strongly opposes UK PM Theresa May’s Chequers proposals on future trade. To make matters worse, May reiterated over the weekend that a 2nd Brexit referendum is completely out of question, adding that she will not surrender to Brussels unless compromises are reached in line with Britain’s interest. As a result, we have a Sterling that is sliding further in early Asian trade as longs liquidate and re-assess their bets.
A currency that is caught between a rock and a hard place is the Aussie, making fresh trend lows as the fluid situation in emerging markets and lack of international trade negotiations between the US and its major counter-parts weighs on the exchange rate, closing for August below the 0.72 level, which now puts a key level of reference acting as support multiple times through 2016 at 0.7150 in sight. The resumption of the downtrend should also be perceived as a more negative stance on Australia’s monetary policy going forward, as markets anticipate higher mortgage rates in Australia to add further pressure into the elevated levels of household debt, which will make the RBA even more cautious. Turning the attention to the Kiwi, while it’s been argued by researchers at BNZ that the currency may be reaching fair levels based on purchasing parity standards, the backdrop is far from conducive, with the RBNZ on the same boat as the RBA in terms of the outlook for monetary policy, with no rate hikes expected until 2020.
Looking at the most liquid pair in the forex arena, the EUR/USD exchange rate had its worst daily performance since August 10th, with key drivers such as risk sentiment, Germany 10 Year vs US 10 Year Spread bond yields, Italian vs German yield premium, all pointing towards further weakness ahead. As a reminder, the latest gesture by the EU to scrap car tariffs found no contentment with Trump, considering the proposal insufficient. In addition, the slight miss in the EU CPI numbers, which adds to the flattish readings seen in Germany earlier last week, should put a dent in the expectations for the ECB to upgrade its outlook for inflation.
On Monday, expect thinner markets on Monday, as both the US and Canada enjoy long weekends. But as long as Trump’s Twitter remains open, spats of volatility can be expected. The Aussie will reflect in today’s price action the latest outlook in the state of consumer spending, with retail sales scheduled, with China’s Manuf PMI also expected to have a minor effect in prices. It’s worth noting that despite the trade tensions with the US, economic data in the big panda has yet to show these concerns feeding through the economy, which also suggests the economic activity is becoming less dependent on international trade. Later on the day, low tier European data (manufacturing reads out of Germany, France, Italy) and the more volatile UK manuf PMI are due, with the American session vacant of any data releases.
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