January 21, 2019

Daily Observations:

Asian stocks built on their January rally as investors demonstrated continued confidence that trade tensions ultimately will subside and policy makers will refrain from growth-damaging monetary tightening. Shares in Tokyo, Hong Kong and Sydney climbed after the S&P 500 Index hit its highest since early December on Friday.

China Posts Weakest Growth Since 2009:

China notched its slowest expansion since the 2009 financial crisis last quarter amid a debt clean-up and trade woes, while signs of stabilization in December suggest government efforts to cushion the deceleration are beginning to take hold. 4Q GDP rose 6.4% from a year earlier, in line with expectations and at the slowest pace since 2009; compared with 6.5% in the previous 3-month period. In December, gauges of consumption and factory output accelerated, while investment held up.

For the full year, the economy expanded 6.6%, in line with estimates. Although it has moderated significantly from the years of double-digit growth, China is still one of the fastest growing large economies and its larger size now means it remains the world’s growth engine.

So far, the government and central bank have tried to stimulate the economy without resorting to a massive credit flood and infrastructure binge like in 2009. The PBOC has been quietly guiding interbank borrowing costs down without actually cutting official interest rates, and the fiscal authorities have pressed on with tax cuts and expedited government bond sales, among other policies.

US-China Trade Talks Still Lacking Progress:

Ever since negotiators from the US and China sat down in Beijing after a Christmas meltdown in global markets, President Donald Trumphas sought to calm investors and claim his trade talks are making great strides. But that glosses over a more uncomfortable reality.

According to people close to the discussions, the 2 sides have so far made little progress on the issue any deal Trump strikes with China may ultimately be judged on: ending what the US has dubbed as decades of state-coordinated Chinese theft of American intellectual property.

China’s alleged IP theft and its related practice of forcing foreign companies to hand over technology to gain access to its market formed a large part of the agenda for the three days of early-January talks. Yet the discussions amounted more to an airing of grievances than constructive negotiations, according to participants and others briefed on the talks.

Deputy US Trade Representative Jeffrey Gerrish spent much of the time citing a US report used to justify the tariffs imposed on some $250 billion in Chinese goods, one person present at the talks said. Chinese officials responded by repeating longstanding denials of any wrongdoing and asked the US for proof. The lack of progress in discussions on structural issues such as IP was confirmed by Robert Lighthizer, the US trade representative, in a meeting with lawmakers last week, according to congressional aides.

EU Split Over Delaying Brexit:

According to a Bloomberg news report, European Union governments are disagreeing over how long they think the UK should delay Brexit, with some pushing for an extension of as much as a year.  While some countries think the EU should offer Britain a generous period to negotiate a deal that will win the backing of Parliament, possibly after a second referendum, others oppose a postponement of any sort and want pressure to be put on the UK to accept a deal as soon as possible, according to four EU diplomats.

It’s up to the UK to request a delay and, so far, UK PM Theresa May has said she doesn’t intend to. But with the deal the government negotiated with the EU suffering the biggest House of Commons defeat in history last week and little sign there’s a majority in favor of any alternative, many officials on both sides believe keeping the UK in the bloc beyond its scheduled March 29 exit date is the only plausible way forward. If May, who is due to set out her next moves in Parliament later today, does make a request for an extension, approval would have to be unanimous from the EU’s remaining 27 countries.

Elections to the European Parliament in May are the biggest obstacle to any extension. Several countries believe the UK should be able to delay Brexit until the start of July when the newly elected assembly sits for the first time. France and the European Commission, the EU’s executive, are among those pushing for a long extension. Germany takes a flexible approach, although it isn’t in the camp pushing for the longest extension.

Other countries believe the UK should be given longer, even as much as a year, to nail down a far more detailed blueprint for the future, meaning Britain may have to take part in the EU-wide vote.

Trump-Kim Summit Likely to be Held in Vietnam:

US officials are planning for President Donald Trump to hold his second summit with North Korean leader Kim Jong Un next month in Vietnam, people familiar with the plans said, suggesting negotiations for the meeting were gathering pace.

The late-February summit would probably take place in the capital Hanoi, but Danang, the site of the 2017 Asia-Pacific Economic Cooperation meeting, and Ho Chi Minh City in the country’s south have also been considered, the people said. The details came to light as nuclear envoys for the US, North Korea and South Korea held talks at a resort outside Stockholm, the Associated Press reported, citing the Swedish foreign ministry.

The White House announced on Friday that Trump would meet Kim in late February, following a 90-minute meeting between the president and Kim Yong Chol, one of the North Korean leader’s top aides. Kim Yong Chol also met Friday with Secretary of State Michael Pompeo.

Neither the administration nor the North Koreans offered much else after Friday’s meetings about what they’d agreed to and what would be gained from the planned summit. That only raised more questions because so little progress has been made toward the US’s ultimate goal – getting North Korea to give up its nuclear weapons, since the first meeting between Trump and Kim in June in Singapore.

Analysis: Uncertain Outlook Makes it Harder for Central Banks to Tighten Policy

According to a Bloomberg news piece released today, the window to restock monetary ammunition is closing for the world’s major central banks. With economic growth slowing and inflation lagging in big economies like the US and euro area, a push to escape crisis-era policy settings that include rock bottom interest rates appears at risk of stalling. That will leave less firepower to fight off the next economic downdraft, threatening a prolonged downturn.

The outlook for the global economy and its policy makers will be front and center at this week’s meeting of the World Economic Forum in Davos, Switzerland. The IMF is set to update its forecasts there on Monday, while BOE Governor Mark Carney and BOJ Governor Haruhiko Kuroda are among the delegates. Both the BOJ and ECB will hold policy meetings this week. Neither is expected to change its stance.

JPMorgan Chase & Co. economists illustrate the limited scope to re-arm. They estimate the average benchmark of developed-world central banks remains almost 2 percentage points below the pre-crisis level, and recent economic weakness and quiescent inflation has forced them to rein in forecasts for how much that gap will close.

They now expect the Fed to raise rates just 2 times this year, not the 4 they thought previously; they’ve pushed back the ECB’s first rate increase to December from September and cut their anticipated hikes next year to 2 from 3; and they no longer see the BOJ lifting its 10yr yield target in 2020.

Some analysts maintain central banks need to move quickly to normalize policy so that they’re better positioned to deal with the next downturn. But policy makers have generally rejected such a strategy, arguing that an economically unwarranted move to a tighter stance could bring about the very economic contraction they’re seeking to avoid. The upshot is there’ll be less ammo for next time, something likely to worry investors.

To understand how much ammunition was spent in the wake of the global financial crisis, consider this: Analysts at Bank of America Corp. calculate central banks cut rates more than 700 times and bought $12 trillion of financial assets since the September 2008 collapse of Lehman Brothers. Global government debt surged close to 75% to $66.5 trillion, they estimate. Only the Fed has made any real progress in moving away from crisis settings, with 9 rate hikes since late 2015 and by slowly reducing its holdings of securities bought during the crisis and its aftermath. The ECB and the BOJ are in a tougher spot. Their main policy rates are in negative territory.

That could lead to instability in FX markets during the next global slump as the Fed cuts rates to counter the downturn while the ECB and BOJ are constrained from acting. Investors in that case would be torn between wanting to offload dollars because they yield less and coveting them as a safe haven at a time of economic trouble.

FX Updates:

USD/SGD:

Spot: 1.3594

USDSGD extended its recent rebound off the 1.3500 handle Wednesday, amid continued USD strength as the Dollar Index maintained above 96. A rebound to 1.3617, the pair’s 200-day moving average, is expected over the near term. Over the longer-term, the bias remains to the downside, after the pair broke below its 1.3600-1.3875 range earlier this month.

AUD/USD

Spot: 0.7169

AUDUSD remains supported above its 0.7160 level Monday, following the release of key Chinese economic data earlier, which reported the slowest 4Q growth rate since 2009. From a longer-term perspective, AUDUSD’s 2018 downtrend remains intact; a break above the 200-day moving average of 0.7324 could change that.

USD/CAD:

Spot: 1.3266

USDCAD continues its sideways fluctuation between the 1.3200-1.3300 range early this week. The effect of a stronger USD has been offset by a stronger loonie, supported by crude oil’s recovery to back above the $54/bbl handle. Despite oil’s resurgence, the longer-term trend of USDCAD remains higher. A retest of the 50-day moving average at 1.3361 is likely.

USD/CNH:

Spot: 6.8015

USDCNH rebounded Friday, after reaching a 6-month low last Monday and shrugging off poor economic data in China. The yuan has rallied 1.8% this year and is the third-best performer out of 11 Asian exchange rates tracked by Bloomberg. With the previous support at 6.8260 recently breached, the next support region to be tested lies at the pair’s 200-day moving average at 6.7351.

USD/JPY:

Spot: 109.58

USDJPY pared some of Friday’s gain, retreating away from the 110 handle as the pair looks set to snap a 4-day streak. Risk aversion sentiment has begun to creep back into investors’ mindsets as global risks, including a lack of progress on the key US-China trade issue of intellectual property, underpinned demand for haven assets. The path of least resistance remains to the downside; a break below 108 is likely to trigger a wave down to the 106 handle.

GBP/USD:

Spot: 1.2870

GBPUSD was little changed over the weekend, amid news that EU governments are disagreeing over how long they think Brexit should be delayed. Hopes of an Article 50 extension are currently buoying the pound. Should an extension take place, May will need to decide what course to take in the coming months – either a Norway style model or a permanent customs union or relent to a second referendum – all of which should be positive for GBP. A retest of the 1.3000 is possible this week.  

Sources: Bloomberg