February 20, 2019

Daily Observations:

Asian stocks traded mixed Wednesday, paring earlier earnings-related gains, while Treasuries ticked higher as trade concerns lingered. The yuan climbed amid a report the US is asking China to keep its currency stable as part of the negotiations. With earnings season nearing an end, the latest minutes from both the Fed and ECB due this week and US President Donald Trump weighing an extension of the deadline for a trade deal with China, investors have plenty to ponder with the outlook for global growth at its weakest since the global financial crisis.

US Seeking Stable Yuan Amid Trade Talks: 

The US is asking China to keep the value of the yuan stable as part of trade negotiations between the world’s two largest economies, a move aimed at neutralizing any effort by Beijing to devalue its currency to counter American tariffs, people familiar with the ongoing talks said.

Officials from the 2 countries are discussing how to address currency policy in a “Memorandum of Understanding” that would form the basis of a deal that ultimately will have to be approved by President Donald Trump and his Chinese counterpart Xi Jinping, according to several people involved in and briefed on the discussions.

While the precise wording remains unresolved, a pledge of yuan stability has been discussed in multiple rounds of talks in recent months and both sides have tentatively agreed it will be part of the framework of any final deal. Negotiations resume Tuesday in Washington and are scheduled to continue through Friday as a March 1 deadline for higher US tariffs approaches.

Yield Curve Inversion Worries Resurface:

Tonight’s release of minutes from the Federal Open Market Committee’s January meeting has the potential to send one of the most widely-followed parts of the Treasury yield curve hurtling toward inversion within a matter of weeks.

Some analysts interviewed by Bloomberg have commented that the gap between 2-and 10-year notes, which bottomed out at 9.1 basis points in December and currently stands at about 14.3 basis points, could resume its narrowing trend should the minutes tilt either of 2 ways:

• The Fed signals that another interest-rate increase may be on the horizon even without clear signs of longer-run US economic improvement, or
• If policy makers saw the risks of a recession as greater than they’ve let on while reaffirming a preference for keeping the fed funds target rate unchanged.

According to one analyst, 3 key elements to look out for in the minutes are any explanation for the Fed’s “abrupt dovish U-turn” last month, the manner in which the central bank will incorporate patience and flexibility into its reaction function, and the logistics behind a possible end to the balance-sheet runoff. All those pieces will be “pivotal” for outright yield levels and the shape of the curve.

Growing Rift Between US & European Carriers Over Huawei:

A group representing top US mobile service providers disagreed with European and Asian counterparts over alleged security threats from Chinese equipment maker Huawei Technologies Co. ahead of a conference that will highlight a US-Europe divide on the issue.

A Feb. 14 release from GSMA, a London-based wireless industry group, urged European lawmakers not to ban Huawei as a supplier. But CTIA, a Washington-based group, responded Tuesday with its own statement saying the GSMA “does not represent the views of all wireless operators or all regions.”

The divergent statements underscore a fissure opening between Washington and carriers and regulators around the world, who’re starting to re-evaluate US warnings that China’s largest technology corporation aids Beijing in espionage. This week, New Zealand Prime Minister Jacinda Ardern left the door open for Huawei to play a role in the rollout of next-generation networks, while a senior Italian government official dismissed the issue.

European carriers offered to cooperate with their governments in devising steps to ward off vulnerabilities. CTIA, with members that include US market leaders AT&T Inc. and Verizon Communications Inc., has urged US regulators to go slow in crafting rules on equipment security.

Beyond US-Chinese bickering, economics plays an important role in what gear goes into future 5G networks, the advent of which are expected to galvanize everything from smart cities and self-driving cars to fully automated homes. Huawei’s technology is considered on par with the likes of Ericsson or Nokia’s, but more cost-effective.

China’s Stock Rally Nearing $1 Trillion:

China’s stock rally since January has added more than $893 billion to the value of the country’s equities, lifting Shenzhen’s risky startups and state-backed giants alike. The rebound has been so quick and widespread that it’s already triggered signs of overheating in four of China’s major benchmarks. The CSI 300 Index’s 14 percent rally is its best start to any year in a decade, and turnover across all exchanges is the highest since March.

While valuations have been low for months, Chinese equities really took off only after another set of weak economic data made monetary policy easing almost a certainty. Gains intensified when the new securities watchdog eased restrictions on trading, encouraging an increase in leveraged bets. Ample liquidity and a streak of foreign buying have fueled volumes.

According to Bloomberg news, traders are quickly moving on from last month’s deluge of profit warnings and China’s weaker economic growth, focusing instead on all the reasons why the outlook should improve. An interest-rate cut from the People’s Bank of China is on the cards, while next month’s annual gathering of top-level officials may spawn more supportive policies. Even Chinese state media has chimed in, highlighting the growing bull case for stocks. Next week’s decision by MSCI Inc. on whether to include a broader array of A shares in its indexes may also provide another catalyst.

The concern is that China’s equity rebound is on shaky ground, underpinned mostly by fickle investor sentiment. Evidence of speculative trading has popped up in some of the riskiest parts of the market, and traders are borrowing more cash to chase the rally. Skeptics say only a better-than-expected recovery in profit growth will drive the next leg up.

UK Officials Target Brexit Deal Within Days:

UK Prime Minister Theresa May is making a last-ditch attempt to save her Brexit deal and prevent Parliament seizing control of the UK’s divorce from the European Union. The British government sees May’s meeting on Wednesday with European Commission President Jean-Claude Juncker in Brussels as a crucial chance to get legally binding changes to the so-called Irish border backstop, which has proved the biggest obstacle to getting a deal. But EU officials are playing down the prospects of an imminent breakthrough, saying the meeting is just a staging post in the resumption of talks.

If talks this week go according to plan, May’s team hopes to put a revised Brexit deal to a binding vote in Parliament early next week, and before Feb. 27, UK officials said. That’s the date when members of Parliament opposed to Britain leaving the bloc without an agreement would have the chance to take the process out of May’s hands.

One plan May had been urged to push in Brussels is to use technology to avoid the need for a backstop policy for the Irish border. The so-called backstop effectively ties Britain into the EU’s customs regime indefinitely, in what pro-Brexit campaigners see as a betrayal of the 2016 referendum vote to leave the bloc.

But the government has now concluded that the plan for new technology, known as the “Malthouse Compromise,” is not a serious contender for resolving the current impasse. But it could be revived as part of future negotiations over the long-term trade deal with the EU, according to government officials who asked not to be named. Pro-Brexit Conservatives met May to push their case for the Malthouse plan on Tuesday and insisted afterward that it remains “alive and kicking.”

RBA Concerned Over Consumption Outlook:

Australia’s central bank reaffirmed its mounting concern over the consumption outlook as households are besieged by falling property prices, weak income growth and high debt.

The RBA said while the economy was weathering the property slump, if prices declined much further then consumption could be weaker. That would “result in lower GDP growth, higher unemployment and lower inflation,” the bank said in minutes of its February policy meeting released in Sydney Tuesday.

RBA Governor Philip Lowe dumped a tightening bias in favor of a neutral policy outlook earlier this month amid increasing risks at home and abroad and a downgrade in forecast domestic economic growth. Yet he remains buoyed by resilient hiring and unemployment edging lower, suggesting faster wage growth and an uptick in inflation could still be in the offing.

“Members noted that there were significant uncertainties around the forecasts, with scenarios where an increase in the cash rate would be appropriate at some point and other scenarios where a decrease in the cash rate would be appropriate,” the central bank added.

Goldman Reiterates Short Dollar Call:

Goldman Sachs Group Inc. is sticking to its guns in calling for the dollar to depreciate, despite criticism that its recommendation’s usefulness has come and gone.

Goldman advised shorting the dollar in early January, accounting for the Federal Reserve’s pivot away from steady gradual increases in the benchmark interest rate. While the greenback indeed dropped thereafter, it has rebounded this month as other central banks adopted less hawkish stances of their own. Goldman says the dollar will fall anew.

“One common pushback to this view is that, with the Fed shift now behind us, would it take another dovish surprise to push the dollar down from here?” Michael Cahill, a Goldman economist in London, wrote in a note Wednesday. “We think not.” The Fed’s “dovish shock” is still set to reverberate, because policy maker sensitivities have fundamentally shifted, in Goldman’s view. Chairman Jerome Powell and his colleagues will probably be increasingly responsive to negative news, and be more relaxed about any need to react to positive surprises with tighter policy, the thinking goes.

History shows the currency could still appreciate against this backdrop if the US suffers “pronounced recession concerns” or global growth as a whole falls to “worrying levels,” triggering a haven bid for the greenback, Cahill wrote. A second key scenario is if American growth “significantly outperforms,” making the Fed’s perceived shift short-lived, he wrote. “Ultimately, we think both of those scenarios are unlikely,” Cahill wrote. Goldman continues to recommend shorting the Dollar Index, targeting 93, with a stop-loss of 97.50.

FX Updates:

USD/SGD:

Spot: 1.3524

USDSGD slipped 0.4% to a 2-week low earlier today, and looks poised to retest the 1.3500 support. The momentum for USDSGD remains to the downside, after the pair failed to break above its 50-day moving average last week.  Over the near term, 1.3500 should continue to provide support, while to the upside the 200-day moving average at 1.3646 is a likely resistance.

AUD/USD

Spot: 0.7162

AUDUSD rebounded off the 0.7100 handle last night, following positive US-China trade talk headlines yesterday. The pair rose to a 2-week high of 0.7177, breaching the 50-day moving average in the process. The next resistance level of 0.7200 is likely to be reached before the end of the week. However, the longer-term trend continues to point to the downside as indicated by the chart’s regression analysis trend. The key resistance above is the 200-day moving average, currently at 0.7269.

USD/CAD:

Spot: 1.3198

USDCAD is currently threatening to break below the 1.3200 support, following overnight USD weakness after it was reported that the US was pressing for a stable yuan exchange rate in trade talks with China. The 3-month low at 1.3069 represents the key support; a break below would also signal the break of the pair’s 17-month old uptrend.

USD/CNH:

Spot: 6.7236

USDCNH sank by as much as 0.8% to 6.7192, amid bets the authorities will not devalue the yuan as part of trade talks with the US. The surge came after a report that the US is asking China to keep the currency’s value stable. The key support resides at 6.7000, last tested in end-Jan and a key Fibonacci retracement level between the low in Mar 2018 and high in Nov 2018.

USD/JPY:

Spot: 110.87

USDJPY looks poised to retest its year-to-date high at 111.13, after the yen weakened for a third day as faltering Japanese trade data bolstered the case for further stimulus. Improved global risk appetite damped demand for safe haven assets as well. The 200-day moving average at 111.29 may cap the pair from rallying further over the short-term.

GBP/USD:

Spot: 1.3056

GBPUSD surged past the psychological 1.3000 mark following growing hopes of a possible extension of Article 50, and as UK and EU officials work on a new legal text for the contentious Irish border backstop. The significant level remains at 1.3300

Sources: Bloomberg