December 17, 2018

Daily Observations:

Stocks in Asia traded mixed, following 2 weeks of losses driven by a backdrop of uncertain trade conditions and signs that some key economies are slowing. Treasury yields steadied just below 2.90%, while the dollar maintained near recent highs. Crude oil futures continue to languish below $52/bbl. Investors will look ahead to this week’s Fed policy meeting for more clues on its future interest rate hike path.

May Rejects Second Referendum:

Theresa May’s team pushed back against reports they are warming to a second referendum on Brexit as the UK prime minister prepares to face Parliament on Monday. David Lidington, May’s effective deputy, and Chief-of-Staff Gavin Barwell said they don’t favor another plebiscite after newspapers reported they’d held talks on the issue. May herself launched a broadside at former Prime Minister Tony Blair for championing a “People’s Vote.”

“For Tony Blair to go to Brussels and seek to undermine our negotiations by advocating for a second referendum is an insult to the office he once held and the people he once served,” May said in comments released by her office. “We cannot, as he would, abdicate responsibility for this decision.”

Speculation has intensified about a second referendum on leaving the European Union since May withdrew a House of Common vote on her divorce deal with Brussels when it became clear it was headed for defeat. May then survived a bid by her own lawmakers to unseat her as leader of the Conservative Party. She is running out of options as time runs short for clinching a deal with the EU.

All Eyes on the Fed This Week:

Bond traders are all but certain the Federal Reserve will tighten policy this week. The suspense centers on officials’ latest forecasts for interest rates and the economy, which have implications for one of the biggest debates in the Treasury market.

The updated projections come as investors are losing confidence that the Fed will keep hiking amid tame inflation and doubts about global growth. Strategists say a key focus is the Fed’s outlook for 2019, which could dictate whether the inversion seen in some parts of the yield curve becomes more pervasive. The spread between 2- and 10-year yields is already close to going negative for the first time since 2007.

Markets have undergone a sea change since the Fed last laid out its projections in September. The S&P 500 Index set a record high that month, but has since erased its 2018 gains. And the first inversions of the yield curve in over a decade kicked in this month, with the spread from 3 to 5 years dropping below zero.

Amid the carnage in equities, the spread between December 2018 and December 2019 eurodollar futures – a measure of how much tightening traders expect next year, has shriveled to 10 basis points. That implies less than one-quarter point hike.

China Steps Up Debt Clean-up:

China’s effort to cut the burden of insolvent companies weighing on its slowing economy has kicked into higher gear, with a slew of bankruptcy filings that’s set to enrich the case history of debt resolutions for bond investors.

Local courts have accepted or plan to accept at least 5 bankruptcy applications from firms that defaulted on publicly issued bonds since early November. That’s roughly on par with the number seen over the previous4 years. The new pace may continue, with China’s top planning body called on Dec. 4 for local officials to clean up the debt of firms with excess production capacity or insolvent balance sheets by 2020.

The bad news is that some bondholders may find they’re going to get less back from defaulted issuers than they anticipated. The good news: there’s likely to be swifter resolution once court procedures take over from ad-hoc work-out negotiations. And the process will give both creditors and debtors the chance to gain experience in restructuring obligations, little more than four years after China began embracing the concept of defaults in the world’s third-largest bond market.

China Holds Key to Metals Revival:

Following a tumultuous 2018, when Trump trade tensions, Federal Reserve rate hikes, a strong dollar and an economic slowdown in China all combined to push the London Metal Exchange Index to its first annual loss since 2015, investors are hoping shrinking supplies will spark a recovery next year. Five metals fell by 13% or more this year, led by zinc, which lost more than 20%.

Bulls are hopeful the metals market will be supported by China stimulus measures early next year, though others are more bearish following weak import data from China in November.  According to Goldman Sachs, the best bet for 2019 is copper. The pace of decline of visible copper reserves in China this year, suggests the Asian country’s demand for the red metal has risen 5-6% in 2018, according to estimates by JPMorgan Chase Bank NA. That’s above a consensus earlier in the year for 2-3% gains.

Still, if the Fed boosts rates every quarter in 2019, that could lead the bond yield curve to invert and risky assets could have a difficult time appreciating in that environment. Money managers are cautious. Since early March when the trade war got underway, they’ve cut net-bullish bets across a spectrum of 18 commodities by about 68% from the year’s high, according to US government data. In copper they have been net bearish for most of the past 5 months.

Druckenmiller Urges Fed to Pause Rate Hikes:

Billionaire investor Stan Druckenmiller urged the Federal Reserve to pause its “double-barreled blitz” of higher interest rates and tighter liquidity when economies are slowing and markets are falling, in an opinion piece in Sunday’s Wall Street Journal. “We believe the US economy can sustain strong performance next year, but it can ill afford a major policy error, either from the Fed or the rest of the administration,” wrote Druckenmiller and Kevin Warsh, a former member of the Federal Reserve Board.

The Fed at its meeting this week should note developments including global central-bank liquidity reversing from around Oct. 1 and stocks beginning their descent, wrote Druckenmiller, who heads Duquesne Family Office, and Warsh, a visiting fellow in economics at Stanford University’s Hoover Institution. Expectations of more Fed tightening next year come at a dangerous time, with economic growth outside the US slowing in recent months along with trade, Druckenmiller and Warsh said. “No ocean is large enough to insulate the US economy from slowdowns abroad,” the duo wrote.

Druckenmiller and Warsh argue that policy makers could have avoided today’s predicament to some degree. If the Fed had stopped quantitative easing in 2010, it might have mitigated asset-price inflation and a government-debt explosion. When Chair Jerome Powell arrived at the Fed this year, policy makers could have shrunk the balance sheet quickly before hiking rates, they wrote.

Other money managers have issued warnings about rate hikes too. Hedge fund founder Paul Tudor Jones said this month that the Fed is unlikely to move in 2019 as falling commodities prices threaten a slowdown of the economy.

FX Updates:

USD/SGD:

Spot: 1.3750

USDSGD seems to have found decent footing around the 1.3700 handle, holding above it comfortably last week. The pair has recently recovered by as much as 1% since last week. USDSGD has largely maintained within the 1.3600-1.3875 range over the past 6 months. A breach below the 1.3600 support will likely result in an accelerated selloff towards the 200-day moving average of 1.3534.

AUD/USD

Spot: 0.7177

AUDUSD was little changed earlier today after it declined to a fresh 1-month low Frida, following worries regarding a China economic slowdown and a US-China trade dispute. From a technical perspective, the AUDUSD’s shorter-term trend remains to the upside, having broken out of its 2018 downtrend channel last month. The important support of 0.7161 needs to hold; a decline back below it would signal more downside to follow.

USD/CAD:

Spot: 1.3380

USDCAD is continues to hover just below its 1.3400 handle. Volatility in the looks set to pick up this week, ahead of policy decisions from both the Bank of Canada and the Federal Reserve.  A convincing break above last week’s high of 1.3444 is likely to lead to a rise higher to 1.3600 over the near term.

USD/CNH:

Spot: 6.8971

USDCNH was little changed last week, as the pair continued to fluctuate around the 6.9000 handle. The FX pair’s upside could be capped around its 50-day moving average at 6.9274. In recent weeks, there have been signs of a shift from, or at least a slowdown in, USDCNH’s gain since June.

USD/JPY:

Spot: 113.46

USDJPY maintained near its 1-week high, ahead of the highly-anticipated Fed policy decision due later this week. From a longer-term perspective, the pair’s 2018 uptrend seems to be tapering out; the pair has failed to hold above the 114 handle each time it was tested since October. A decline below 112.31, which could happen should investors flock to the yen as a safe haven asset, will confirm the breakdown of the trendline.

GBP/USD:

Spot: 1.2583

GBPUSD extended its decline for a sixth consecutive week, with Brexit chaos continuing to be the main drag on sterling. Multiple backs and forth haven’t changed the fact that the Brexit deal won’t be approved by the UK Parliament, neither revised by EU leaders. The pair’s momentum remains firmly rooted to the downside, with a retest of the 1.2500 handle expected again soon. A break below it could lead a fall further to the next support target at 1.2351.

Sources: Bloomberg