We close out the week with this now maturing theme, trade tensions, yet again front and centre. Yet, while we have a close eye on U.S. relations with China, U.S.-Mexico relations have temporarily stolen the limelight, with Trump imposing 5% tariffs on all Mexican exports, on what is effectively a crackdown on migrants seeking asylum in the U.S. The fact Trump has detailed this can go to 25% by 1 October suggests this could well escalate.
In a U.S. session devoid of any real volatility, well outside of the energy complex, Asia has been jolted into life on the Mexico Tariff news, with USD/MXN spiking 2.1%, with AUD/USD falling just shy of the 69-handle. We’ve seen sellers of S&P 500 and NASDAQ futures (both 0.7%), with S&P 500 futures trading through the 200-day MA and one suspects the cash index will do too later. The bid is in the JPY, with CAD/JPY the big move mover in G10 FX, with my AUD/JPY short idea – a hedge on exactly these sorts of headlines - now slightly in the money and where a break of the 75.35/25 zone would suggest adding to shorts here. Out of G10 FX, we see good sellers of TRY and ZAR.
There has been a knock-on effect into the CAD too, and the USD/CAD daily looks interesting here, with price currently above the 25 April highs. We saw a fake-out on Wednesday, with sellers fading the breakout, but could today be different? One to watch, but a firm close through 1.3520 would be one for the breakout traders, but as always when trading breakouts, how price reacts is just so incredibly important to assess the probability of a continuation move.
China's manufacturing PMI will feed bearish sentiment
Sentiment has not really been too negatively affected by China’s May manufacturing PMI print, which came in at 49.4 and a decent miss to the 49.9 consensus. The finer details of the report made quite concerning reading, with new orders in contraction, while new exports orders came in at 46.5 and will worry about external demand. We have seen buyers of USD/CNH, but the flows have been light in this cross, and Chinese equities are flat on the day.
The bid has fallen out of the oil market
In energy markets, sellers are building on yesterday’s 3.9% and 4.2% decline in WTI and Brent crude respectively, and while the overnight move predominantly stemmed from a lower-than-forecast 282,000 draw in crude inventories, the 0.8% drawdown in WTI crude today is aimed squarely at US-Mex news and price has lifted off the earlier low of $55.66. From a momentum perspective, WTI crude has closed firmly through the 38.2% fibo of the December to April rally, and with the trend now defined by the 5-day EMA, and we see WTI now trending lower from here with rallies into $57.00 likely to be sold.
Let’s also not forget the comments from U.S. VP Mike Pence overnight, that the U.S. can “more than double” tariffs on China, and it seems that the bid has largely wholly come out of the crude market. Rallies are selling opportunities.
Mr Trump will be pleased with moves in crude, and he’ll be a really happy camper if the Fed makes increased noise of meeting the
market and cutting the fed funds rate, where we now see fed funds futures pricing in 33bp of cuts this year. US 5-year inflation expectations sit at 1.89% and incredibly havent moved at all despite the falls in crude, although we saw some further punchy bids in the US bond market yet again, with US 2YR Treasuries now at 2.01%, with the 1-handle is a mere whisker away.
Duration buyers cant be stopped
The bond market is screaming out here, with a relentless hunt for yield (duration) underway. The further out the curve we go the greater the outperformance and move lower in yield, and we now see US5s trading at a 5bp discount to 2s, and as portrayed in recent reports has been a great pre-cursor to future Fed rate cuts over the last few decades.
We heard from Fed vice chair Richard Clarida overnight (at 2am), who detailed “if the incoming data were to show a persistent shortfall in inflation below our 2 percent objective or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook, then these are developments that the Committee would take into account in assessing the appropriate stance for monetary policy.” While most will say we really didn’t hear anything new, the door is now firmly ajar for easing, and that is supporting equities and suppressing volatility from ramping up to an extent. Consider we saw Q1 core PCE (the Fed’s preferred measure of inflation) coming in at 1% (vs expectations of 1.3%), suggesting that perhaps tonight’s (22:30aest) year-on-year core PCE print may come in below expectations of 1.6%. If the data point comes in below 1.50%, we may well see economists moving towards the market pricing and calling for cuts this year – something which seems incredible when so many were calling for four hikes at the start of the year.
If we look at the USD index (DXY - see below), once again, price tried to rally past 98, but the sellers have waded in, and there is just no conviction at this stage to see price close above the April and May highs. It does feel that a critical break is a matter of time though, and long USD positions are still the higher probability trade here. As said in prior notes, if I am going to be short USD it's vs the JPY, and specifically on a closing break through support at 109.20 to 109, and while there is a carry charge, if price can close through 109, then the capital move should be enough to carry concerns.
