December 5, 2018

Daily Observations:

Asian equities dropped at the start of today in the wake of the biggest slide in stocks on Wall Street since the mid-October downdraft, though US futures advanced after China officially echoed President Donald Trump’s optimism over bilateral trade talks. Losses eased as the trading session wore on for stocks across the region. A cause for concern has been the yield curve, which has further flattened. Adding to the risk aversion overnight was news that UK Prime Minister Theresa May’s push to avoid a so-called “hard Brexit” may be at risk.

Market Switches to Risk-Off Mode:

US stocks plunged, with the Dow Jones Industrial Average tumbling almost 800 points and the S&P 500 dropping more than 3%, as a litany of concerns wiped out Monday’s rally in risk assets.

Trade-sensitive shares sank as uncertainty arose amid speculation that the US and China made no meaningful progress on the trade front last weekend. Financial shares got hammered as the yield curve continued to flatten, even as a Federal Reserve official offered hawkish comment. Adding to the risk aversion was news that UK Prime Minister Theresa May’s push to avoid a so-called “hard Brexit” may be at risk. Traders are even starting to bet that the Fed will cut interest rates as soon as 2020.

The swaps market has moved up the timing for when it sees the hiking cycle peaking, toward the end of 2019 or early 2020, a period when the Fed’s own projections indicate tightening will still be under way.

China Confirms 3-Month US Agreement Deadline:

China said Wednesday the trade meeting with the US was “very successful” and is “confident” of implementing the results agreed upon at the talks, but didn’t provide any further details on the outcome. Beijing will start to quickly implement specific items where there’s consensus with the US, and will push forward on trade negotiations with the US within the 90-day “timetable and road map.”

The Ministry of Commerce’s statement was the first official confirmation from China that there’s a 90-day window for the talks, although there was no mention that the US has threatened to raise tariffs again if a deal isn’t reached at the end of it.

China and the US announced a truce in their trade war after the meeting between Trump and Xi Jinping on Saturday, but that quickly descended into confusion, with both sides announcing different statements on what was agreed. There’s also been confusion just on the US side, with the White House, Trump and his advisers making conflicting statements as to the details of a deal.

China Foreign Minister Wang Yi said China was willing to “expand imports according to the needs of its domestic market and people, including importing marketable products from the US to gradually ease the trade imbalances,” adding that both sides had agreed to open their markets to each other.

China would also “work to gradually resolve the reasonable concerns of the US side,” he said, according to an official translation of his statement. While not directly contradicting the statements from Trump and other officials, the Chinese statement describes both sides reaching a consensus, with little detail on any actual policy changes.

Yield Curve Flattens:

On Monday, the yield on 3-year Treasuries fell below the 5-year rate for the first time in a decade. A more closely watched relationship, the spread between 2- and 10-year yields, remain positive though, although the gap keeps getting slimmer and is now at 11.5 basis points, its lowest since 2007.

An inversion happens when interest rates on shorter-maturity government securities climb above those of longer-dated bonds. That doesn’t usually happen, because investors want to earn more if they’re tying up their money for longer. When it does, it’s bad news and recession has historically followed.

Fed officials are reacting with varying degrees of alarm. Dallas Fed President Robert Kaplan told Reuters Monday that the yield curve is telling him “that it’s wise to be patient here” and suggests markets expect slow global growth. But when asked about the recent flattening on Tuesday, Williams lumped the yield curve in with other risks, including global ones. While he and his colleagues pay attention to warning signs from financial markets, he said financial conditions are still “overall pretty favorable” to growth.

Theresa May Loses 3 Key Brexit Votes:

UK Prime Minister Theresa May is locked in a power struggle with the British Parliament that looks set to determine the final shape of Brexit. May lost 3 key votes on a day of drama in the House of Commons on Tuesday, highlighting the weakness of her position as she tries to ratify the deal she’s struck with the European Union.

The result is that Parliament now has the potential to decide on Britain’s “plan B” if, as expected, it rejects May’s divorce agreement with the EU in the biggest vote of all next week. It raises the possibility that members of Parliament could seek to pursue a softer withdrawal, including potentially staying in the bloc’s single market, or even attempt to stop Brexit entirely. One option that could gather momentum over the weeks ahead is for a second referendum to allow the public to overturn the decision of the first.

On Dec. 11, Parliament will vote finally on whether to accept or reject the 585-page withdrawal agreement that May and the EU reached in November. Few officials in May’s government believe they have much chance of winning, with some Tories predicting a heavy defeat. If so, the UK will be on course to crash out of the EU with no deal, an outcome which the BOE and the Treasury warned last week would cause immediate and severe damage to the British economy. According the BOE analysis, house prices would be hit by 30% and the pound would fall by as much as 25% after a no-deal Brexit.

Australia Economy Growth Slows:

Australia’s economy slowed last quarter as commercial construction fell and household spending slowed, casting doubt on the central bank’s outlook and all but ruling out an interest-rate increase next year. GDP rose 0.3%, the weakest gain in 2 years and compared with a forecast 0.6%; the economy grew 2.8% from a year earlier against an expected 3.3%. Household consumption slowed and the savings ratio declined, statistics bureau data showed in Sydney Wednesday.

The data are a blow to the RBA narrative of record-low rates fueling economic growth of around 3.5% this year and next to drive higher wages. It’s now contending with a less robust expansion at a time when house prices just recorded the biggest drop since the global financial crisis. That could prompt consumers to further rein in spending.

Cash-rate futures on Bloomberg priced out any chance of an interest-rate increase through September next year and there’s now a less than 50% chance of a hike in 2020. The RBA has kept interest rates at 1.5% for almost 2-1/2 years to spur the economy and lift inflation. It maintains that the next move is likely to be up, having not hiked since late 2010.

Sources: Bloomberg
    

FX Updates:

USD/SGD:

Spot: 1.3678

USDSGD erased most of its previous day’s decline Wednesday, rebounding off a 2-month low. Recent USD weakness has resulted in the pair retreating back below 1.3700; a failure to hold above 1.3800 last month indicates some technical exhaustion for the FX pair. Hence the momentum bias has shifted towards the downside. A breach below the 1.3600 support will likely result in an accelerated selloff towards the 200-day moving average of 1.3533.

AUD/USD

Spot: 0.7303

AUDUSD slumped earlier today, following poorer than expected Australian GDP data. The Australian dollar slid the most in 2 weeks, falling against all its G-10 peers, amid speculation that the RBA will refrain from hiking rates until 2020. 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 handle of 0.7200 needs to hold; a decline back below it would mean more downside to follow.

USD/CAD:

Spot: 1.3280

USDCAD is threatening to breakout of its longer-term wedge for the third time in a month. A climb above 1.3386 would confirm it. The Canadian dollar has displayed recent weakness, ahead of tonight’s BOC rate decision. No change in rates is expected and will likely stay unchanged at 1.75%. However, continued crude oil weakness, uncertain global trade landscape and recent speculation about the Fed’s policy stance could change the BOC’s expectations for next year.

USD/CNH:

Spot: 6.8655

USDCNH rebounded off a 3-month low earlier today. The yuan on Tuesday had reached its strongest level against the USD since September following a tentative trade truce between the US and China. 6.8000 represents a key support level.

USD/JPY:

Spot: 112.95

USDJPY’s 2018 trend 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: 1.2705

GBPUSD tested its 1.2662 key support level last night, following PM May’s  as expectations remain high the UK PM May will lose a crunch Brexit vote on Dec. 11. If the Prime Minister loses the meaningful vote by a close margin, we could see a limited market reaction, as expectations will shift to the belief that a plan B could be put together.  The market is currently pricing in for this vote to fail. A strong defeat could bear a more adverse reaction to the pound, and could almost certainly lead to a drop closer to the 1.2500 handle.