August 20, 2018

Daily Observations:

Asian equities were mixed Monday as traders look for clues from earnings reports, developments in the trade war and a meeting of central bankers in Jackson Hole later in the week to gauge the outlook for markets. Japan’s shares fell, while stocks rose in Hong Kong and were little changed elsewhere in Asia. The dollar steadied and the 10yr Treasury yield was little changed.

Maersk Issues Tariffs Warning:

The US economy will be hit many times harder than the rest of the world by an escalating global trade war, according to Soren Skou, chief executive officer of A.P. Moller-Maersk A/S, the world’s biggest shipping company. Skou said the fallout of the current protectionist wave “could easily end up being bigger in the US.” Tariffs could slow global annual trade growth by 0.1 to 0.3%, though for the US the effect could be “perhaps 3 or 4%,” he said at Maersk’s headquarters on Friday.

The company transports about 20% of the world’s seaborne consumer goods, putting it in a unique position to gauge the fallout of tariffs on trade flows. Maersk has in the past broken with its culture of steering clear of any political debate to criticize the trade policies of US President Donald Trump.

“The first thing the American importers would do if tariffs are put on Chinese consumer goods would be to buy in Vietnam, in Indonesia or elsewhere in Asia,” Skou said. “Big US consumer brands like Nike produce in all of Asia, not just in one country, so there will be a substitution effect.”

The US put duties on $34 billion of Chinese goods last month, citing unfair trade practices by the world’s second-biggest economy. The Trump administration has said it will impose tariffs on a further $16 billion on Aug. 23, and even signaled it won’t shy away from targeting the entire $500 billion in Chinese exports to the US.

Gundlach Wans of Treasury Short Squeeze:

A giant of fixed-income markets is warning that a build-up of speculative short positions in the US Treasuries market is setting those traders up for pain ahead. Net short positions on 10yr Treasuries from hedge funds hit the highest level on record, according to the latest data from the Commodity Futures Trading Commission. For Jeffrey Gundlach of DoubleLine Capital LP, the extreme nature of that positioning has raised the risk of a possible short squeeze, where an increased appetite for US bonds forces bearish investors to cover their bets.

Bond investors have no shortage of catalysts to look forward to this week, with commentary expected from Federal Reserve Chairman Jerome Powell at the Jackson Hole symposium and minutes from the central bank’s Aug. 1 policy meeting.

Turkey’s Credit Rating Cut Further:

Turkey’s credit rating was cut further into junk Friday by S&P Global Ratings and Moody’s Investors Service, which said the volatile lira and wide current-account deficit may undermine the Middle East’s largest economy.

S&P reduced Turkey’s foreign-currency rating to four notches below investment grade at B+ from BB-, on par with Argentina, Greece and Fiji. Moody’s lowered its grade to Ba3 from Ba2, 3 notches below investment grade. The ratings companies said the weak currency, runaway inflation and current-account deficit are Turkey’s key vulnerabilities.

S&P last lowered Turkey’s credit rating by a notch in May, when it said there was a growing risk of a hard landing after the economy expanded by 7.4%. The downgrade by Moody’s followed a prior ratings cut in March. Above-trend growth typically expands the current-account deficit, which is expected to reach 6.4% of gross domestic product by the end of 2018. Most estimates for that gap predate the most recent run on the lira.

“We forecast a recession next year,” S&P said. “Inflation will peak at 22% over the next four months, before subsiding to below 20% by mid-2019.”

Fed Expected to Stay on Hiking Course Despite Tumult Abroad:

According to a Bloomberg news report, global financial markets got uglier while Federal Reserve officials were on their August hiatus, but bond traders are wagering that won’t be enough to deter them from pressing on with monetary-policy tightening in the world’s largest economy. The yield curve has also pushed back to its lows of the cycle and speculators in Treasury futures are holding record short positions.

This week’s gathering of central bankers at the Kansas City Fed’s annual Jackson Hole symposium could well provide clues as to whether such confidence is warranted, and minutes from the Fed’s Aug. 1 policy meeting also loom large. In recent years, international uncertainty has been more than enough to prompt officials to tap the brakes on tightening. Yet with inflation continuing to run above the central bank’s 2% target and America’s decoupling from the global downtrend continuing, this time may be different.

As it stands, traders are almost fully pricing in a rate hike at the Fed’s next policy meeting just over a month from now, and about 50-50 odds of a second increase by year-end, based on fed funds futures pricing. The spread between December 2018 and 2019 eurodollar contracts suggests they expect an additional one-and-a-half rate hikes next year.

Hedge funds and other large speculators are equally confident in the central bank’s tightening trajectory. They boosted wagers against 10yr Treasury futures to a record 698,194 contracts, according to US Commodity Futures Trading Commission data for the week through Aug. 14. That’s even as ructions in emerging markets fuelled the biggest weekly selloff in developing-nation shares since February.

Canadian Inflation Rises Faster Than Expected:

Canada’s inflation hit the 3% mark for the first time since 2011 in July, an unexpected surge that puts pressure on the Bank of Canada to accelerate interest-rate increases. The consumer price index recorded an annual pace of 3%, quickening from 2.5% a month earlier, Statistics Canada said Friday from Ottawa. Economists expected the inflation rate to remain unchanged.

While there’s evidence the acceleration was led by temporary factors, the faster-than-expected results will test Bank of Canada Governor Stephen Poloz’s efforts to be careful about raising interest rates over the next year to avoid a disruption to the economy. Price gains have now reached the upper end of the central bank’s 1% to 3% inflation range, and Poloz has already raised borrowing costs 4 times since last year to cool the economy.

FX Updates:

USD/SGD:

Spot: 1.3711

USDSGD looks poised to slip for the third consecutive session, and looks likely to sink lower over the next few days. A combination of markets being closed for the week in Turkey and a softer tone for the dollar after China halted the yuan’s slump is expected to lead USDSGD lower in near term.

SGD has been consistently trading in the strong half of its SNEER basket in anticipation of another tightening by the MAS in October. Although Singapore’s economic data has been mixed, it is likely the central bank will look through the figures as the pace of Fed hikes has accelerated this year.

AUD/USD

Spot: 0.7303

AUDUSD bounced off the 0.7200 support strongly last week, although the pair is likely to retest its lows again over the near term. Both the FOMC minutes and RBA’s minutes are due for release on Tuesday, and further widening of interest rate divergence between the 2 countries are expected.

USD/CAD:

Spot: 1.3061

USDCAD was relatively unchanged earlier today after slipping back below the 1.3100 handle last Friday following numbers that indicate faster-than-expected growth in inflation. The key support level comes in at 1.2965, the pair’s 8-week low.

USD/CNH:

Spot: 6.8412

USDCNH maintained near Friday’s lows earlier today, fluctuating largely around 6.8500. The FX pair pulled back below 6.9000 during the latter part of last week, after the PBOC’s intervention. Further retracement to 6.8000 is possible over the coming week.

USD/JPY:

Spot: 110.56

USDJPY was largely unchanged from Friday’s close, opening in Tokyo earlier today with a downside bias, despite the improved risk sentiment on Wall Street. The pair’s weakness is largely due to dollar bearishness, after the Wall Street Journal reported China and the US will try to map out talks in a bid to end their trade standoff.

The uptrend in the second quarter of this year will be confirmed broken should the pair fail to regain back above 112.

GBP/USD:

Spot: 1.2748

GBPUSD has been recently plagued by Brexit woes, which has resulted in the pound being one of the weakest currencies among majors. Sterling is likely to remain under pressure this week, with the government due to publish on Thursday the first in a series of notices designed to prepare the UK for a no-deal Brexit, with  advice for businesses and citizens.

A retest of the pair’s 1-year low at 1.2662 is probably over the near term.  The pair has been on the downtrend since April and shows no signs of relenting soon.

Sources: Bloomberg