Twas the week before Christmas and the markets are waiting for bedlam to break out. Old Blighty is in Brexit purgatory, while the Fed remains a multistory. President Trump will be accusatory, while China remains conciliatory. U.S. economic data could prove to be transitory, but I’m sure traders would rather be in the Yukon territory.
But for all intents and purposes, this week is the last for position taking before the holiday thinned-trading conditions take over and year-end flow dominate.
The U.S. markets floundered to the lowest close since April
So far this holiday season, Santa has only delivered a bag of bother: Brexit impasse, European political mess, a global growth sinkhole and Trump legal issues, to name a few.
Global equity markets melted in front of our eyes on Friday. The synchronised global growth slowdown continues to gather weight with China’s weaker consumption data confirming the extent to which it is being felt in China., Poor PMI’s in EUR and horrendous GDP print in Australia amidst a Sydney housing market meltdown, suggest no country is immune to the global economic downturn.
We knew EM, and the rest of the world was struggling, but I think the Fed’s early warning signal a few weeks ago that they are concerned that the benefit of Trumps tax cuts would fade continues to resonate. After all, it was the U.S. market that was carrying the weight of global risk sentiment on its shoulder. If the U.S. economy turns south, we’re in for a world of hurt. Fortunately, however, U.S. retail sales and Industrial production held up their end of the bargain and yet again global risk sentiment is riding on the U.S. market coattails. Even still, investors were unwilling to celebrate the strong U.S. retail sales report Friday. Instead, soft European PMI’s, weaker China data and lower Oil prices were the focus. And all but ignored China announcement to lift retaliatory tariffs on U.S. cars for three months, but completely priced in hence the muted reaction.
Oil Markets
The Baker Hughes U.S. Crude oil drilling rig count is down four as WTI prices continue to slide.
The Horrendous EU PMI’s, weak Chinese consumption data, a dimmer view for Japanese Tankan survey all point towards slower growth in Q 1 2019. These weaker economic data points are hardly a ringing endorsement for commodity prices. It’s the likelihood of protracted slow down in China that continues to stoke fears of demand slowdown.
Besides to the USA, China and Japan are the worlds largest consumers of oil, so when those counties economies go into the tank, it blunts demand for oil and provides an exceedingly bearish backdrop for prompt contracts in the context of a currently oversupplied market.
Oil markets have been struggling for direction post-OPEC with traders reading between the headlines and watching U.S. inventory numbers to gauge shale output. Keeping in mind U.S. shale-oil industry production is being restricted as the construction of pipelines and other infrastructure bottlenecks keep blunting supply from Permian Basin and Bakken formation’s, but new pips are coming in 2019. The more OPEC tries to cut supply and drive prices higher, the bigger the door opens for U.S. shale producers.
But even The International Energy Agency said it’s too early to tell whether oil-supply cuts announced by OPEC and its allies last week will succeed in balancing global markets.
With market struggling for direction, Oil prices are prone to shift in risk aversion. However, when the risk off is triggered by global growth concerns, it is particularly impactful for oil prices.
Gold Markets
A resurgent U.S. dollar is threatening to cut short a developing rally in gold markets, as the stronger dollar continues to offset the positive impact from the sell off in global equity markets.
Currency Markets
USD: Still King of the Hill?
A strong U.S. retail sales report for November – not only did November numbers beat expectations, but there were also significant revisions to the prior statement.
The strength of this data makes a stark contrast to the shocking data overnight in both Europe and China. Once again, it confirms that the U.S. economy continues to outperform its peers by a considerable margin and suggest the USD is still the king of the hill benefiting from the worlds most robust economy and highest G 10 yields.
And while the much-ballyhooed convergence story will eventually happen, it’s looking so far in the distance today after weak EU and China data, that we could see the EUR/USD test 1.1000 and USD/CNH above 7 in Q1 2019. The USD could be further supported by haven demand as the USD appears to be the best currency option to park money for the foreseeable future given that it is the highest yielding G-10 currency
EUR: Trader’s plunder the EURO after EU PMI’s plummet
The EUR/USD tested the critical 1.1275 level on Friday. But fortunately, it was Friday as traders weren’t all that enthusiastic to sell the 1.12 handle ahead of the weekend. Not mention, this week is effectively the last week of the trading year before year-end flow dominate were currency movements tend to adopt a random walk theory.
Predictably, markets short covered into the "witching hour” *(17:00 GMT) and the EUR/USD did close precariously just above 1.1300.level. However Eurozone PMIs have been a particularly important driver EUR/USD sentiment, and when combined with the growing political sinkhole in Europe, it does suggest markets will remain underweight EU assets which should continue to weigh on EUR sentiment.
GBP: Brexit Bedlam
Currency stress around Brexit is at the similar level’s seen weeks before the 2016 referendum, suggesting that we are at a very critical inflexion point for Cable. As the markets are increasingly pricing in more risks, it leaves plenty opportunity for sterling to bounce much higher should more clarity emerge. On the flip side, the longer the debate drags on, the more uncertainty seeps in.
AUD:
Remains driven by China proxy trades, but the focus remains on the Feds.
Asia EM FX
With all the negative economic signals coming out of China, its hard to remain positive on EM FX Asia, but until all the trade war tail risks are priced out, I don’t think investors will ever feel particularly comfortable with EM Asia exposure. With the market not focusing on the broader implication of a global growth slow down, it’s getting difficult to find a convincing counterbalance. While the Feds could signal a dovish hike this week, FX differentials haven’t been that convincing a driver, especially when global risk assets remain under pressure. Strong U.S. economic data makes a stark contrast to comprehensive financial data which suggest the USD will stay in favour
The MYR could feel the pinch this week as the slowdown in global will pressure oil and commodity prices lower, while trade war risk continues to weigh on the domestic growth side of the equation. While the strong USD makes Malaysia bond less attractive.
Three Critical Drivers This Week And Beyond
The Federal Reserve Board
The market widely expects the Fed to raise rates for the fourth time in 2018 at its December meeting this week. However, the more important question will be what signal the Committee sends about its policy path in the coming years. Given the recent equity market meltdown, the Feds are tasked with a delicate balancing act of convincing the markets that the U.S. economy looks upbeat, while delivering a dovish view. Fortunately for the Feds, they can sound very optimistic, the market has done a great deal of the heavy lifting as there isn’t a lot of hawkishness priced into 2019 and beyond. Plus, we’re very close to the end of this rate hike cycle, and all that is left for markets to decide is the pace of normalisation to reach the Fed’s terminal rate. Within this context, the playbook suggests the Fed signals some data-dependent flexibility around the speed of rate hikes which could help to ease financial conditions and ultimately provide some equity market relief heading into 2019.
Trade war, why investors are still nervous and trade détente petered out.
The Trump administration’s position on China has always been beyond tariff and trade. Its always been about global security concerns, the deliberate theft of intellectual property rights and U.S. technology know how. And frankly, global capital markets continue to miscalculate this high stake game of axis and allies, while mostly reacting small positives, while interpreting positive Trump tweets as some sign of a trade truce.
While its fair to say post-G-20, we are nearing “peak” tariff war, although there will probably be one final escalation at the end of the G-20 trade detente. But more significantly, we’re on the cusp, if the recent Huawei (SZ:002502) incident is any indication, of entering the next stage of the Trump administration’s China strategy, where US-China tensions will spill over into both familiar and unfamiliar areas. Of course, the U.S. will continue to clamp down on China tech sectors, but the U.S. policy hawks, John Bolton and Peter Navarro, have made it known Africa looks likely to be the next theatre of engagement for U.S.-China relations where concerns are mounting that poorer African nation will fall prey to China’s “debt trap”.
Recall, Sri Lanka took massive loans from China in sums the small island nation had absolutely no way to service, but when China played hardball over payment delays, the Sri Lankan government handed over the Hambantota port and 15,000 acres of land around it for 99 years. Indeed China is a great student of the U.S. Founding Fathers as it was John Adams who famously stated “ ‘There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt.’
China Central Economic Working Conference (CEWC)
The conference begins Tuesday where the government will set forth a roadmap of economic policy for the upcoming year. The market expects policy markers to reaffirm 6.5% GDP target. Despite Markets' forecast that China’s deficit will go up by 3% next year; the government is expected to give a tax cut that will benefit the majority of the people in the country. The markets will be focussing on any reassessment of mainland’s deleveraging policies and measure to rebalance growth. According to the local media sources, the PBoC tweaks are not going to include additional loosening in monetary policu. Financial regulators will focus more on the medium-to-long term credit supply, rather than short-term next year.