January 7, 2019

Daily Observations:

Stocks across Asia kicked off the week with strong gains after dovish comments from Fed Chair Powell and an easing of monetary policy in China stoked a renewed appetite for risk assets. The Bloomberg Dollar Index fell to the lowest in more than 2 months and Treasuries steadied after Friday’s slide. US and Chinese officials will begin trade negotiations on Monday in the hope of reaching a deal during a 90-day truce.

US-China Trade Talks:

US and Chinese officials are set to begin trade negotiations on Monday in the hope of reaching a deal during a 90-day truce between President Donald Trump and his counterpart Xi Jinping. While the mid-level talks probably won’t produce a major breakthrough, the stakes are high as both sides face a resumption of tariffs in March if they don’t strike a deal.

More senior-level discussions are expected later this month, with the South China Morning Post reporting that Trump may hold talks with Chinese Vice President Wang Qishan at the World Economic Forum in Davos, Switzerland. According to Bloomberg news, here are 7 issues that will be key to making headway:

1. Intellectual property
   • The negotiations will focus on “structural changes” in the way China handles technology transfers, intellectual-property protection, cyber-theft and other issues, the US said after Trump and Xi met in Argentina. China has announced an array of punishments that could restrict companies’ access to borrowing and state-funding support over intellectual-property theft, and is drafting a law to prevent forced technology transfer.
2. Huawei and 5G
   • Huawei has long denied accusations by the US and its allies of facilitating state-sponsored espionage. The company is racing to develop 5G technology and owns a tenth of essential patents worldwide. But its efforts have been frustrated by the US, which has banned its products for government procurement and encouraged other nations to do the same.
3. Made in China 2025
   • China’s industrial ambition to transform itself into an advanced manufacturing leader by targeting 10 emerging sectors including robotics, clean-energy vehicles and biotechnology has raised the ire of the US. Trump has argued China’s state-led intervention violates WTO rules and could create an unfair playing field for foreign investors. Tariffs imposed by Trump took aim at many of the industries targeted in the plan.
4. Energy
   • The US is becoming a major oil and natural gas exporter while China has emerged as the world’s biggest buyer of both. While lifting China’s retaliatory tariff on US LNG may revive sales, the bigger, longer-term concern for the industry is restoring enough trust to convince Chinese companies to invest the billions of dollars in future American LNG export projects.
5. Agricultural imports
   • Investors will be watching to see if China removes retaliatory tariffs on US farm products that severely hurt America’s heartland. Lifting the tariffs could encourage private buyers to immediately resume US farm-product purchases. China may also remove its anti-dumping and anti-subsidy tariffs on US distiller’s dried grains, which China is the largest buyer of, as well as allow imports of US poultry after it gave the green light on US rice purchases. If talks fail, China may also cancel some soybean orders that have been placed over the past weeks.
6. Auto tariffs
   • After imposing a 25% retaliatory tariff on vehicles imported from the US, China temporarily scrapped the duty starting Jan. 1 as the world’s 2 largest economies looked for a way to cool trade tensions. The additional tax has hurt all carmakers that sell US-made cars in China, including Tesla Inc., BMW AG and Daimler AG. Auto sales in China have fallen for 6 consecutive months through November, and December data is due this week.
7. Market access for banks
   • China has pledged to increase access for foreign-owned financial firms. In November, UBS Group AG became the first entity to win control of a local securities joint venture under rules that were eased in 2018. JPMorgan Chase & Co. and Nomura Holdings Inc. are still waiting for approval to take 51% stakes in onshore partnerships. Xi says the opening is steadily widening, and Bloomberg Economics estimates that, barring a major economic slowdown or change, foreign banks and securities companies could be raking in profits of more than $32 billion a year in China by 2030.

Powell Hints Fed is Open to Pause Hikes:

Federal Reserve Chairman Jerome Powell signaled the central bank could pause interest-rate increases if the US economy weakened and pledged he will stay at his post even if President Donald Trump presses him to resign. Invoking events of 2016, when the Fed held rates unchanged through most of the year amid financial market turmoil spurred by concerns over slower growth in China, Powell said he’s “listening sensitively to the message that markets are sending” about downside risks.

“With the muted inflation readings that we’ve seen, we will be patient as we watch to see how the economy evolves,” Powell said last Friday on a panel with his predecessors Janet Yellen and Ben Bernanke at the American Economic Association’s annual meeting in Atlanta. “No one knows whether this year will be like 2016,” Powell said in remarks that appeared to be scripted at the start of the event. “But what I do know is that we will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy should that be appropriate to keep the expansion on track.”

The dollar weakened, Treasury yields advanced and the S&P 500 Index closed 3.4% higher Friday as investors bet the Fed chairman would wait and see how the economy performs before raising rates again.

China Liquidity Boost:

The PBOC trimmed banks’ required reserves, seeking to boost liquidity as China’s economy slows . The amount of cash lenders must hold as reserves will be cut by 1 percentage point, dropping by 0.5 percentage point on January 15 and a further 0.5 percentage point on January 25, the central bank said on its website.

The cut will release a net 800 billion yuan of liquidity and will offset a funding squeeze ahead of the Chinese New Year, it said in a separate statement. Data last week showed a worsening picture for the world’s second-largest economy, with a manufacturing gauge falling into contraction, further depressing investor sentiment after a rough 2018.

Brexit Uncertainty Persists:

Theresa May stepped up her battle to persuade her opponents in Parliament to back her Brexit deal, warning the UK will be in “uncharted territory” if they reject her plan in a key vote this month. The prime minister on Sunday outlined a three-pronged campaign to win support for the agreement she’s struck with the EU, proposing to give Parliament a bigger say over the future trade terms with the bloc, promising to say how the deal will work in Northern Ireland and seeking fresh assurances from the EU.

With less than 3 months to go until Britain’s scheduled departure from the EU, there’s still no clarity on what will happen. May’s deal, brokered over 18 months of painstaking negotiations with the bloc’s envoys, looks almost certain to fall in parliament. That would put the country on track to tumble out of the bloc without a deal, putting jobs and the economy at risk as new tariffs and bureaucratic barriers strangle trade with the continent.

If she fails to secure the support of the House of Commons in the vote this month, May suggested Brexit without a deal would be in the cards, something analysis by the Treasury and the Bank of England suggests could be economically devastating. She even left open the dramatic option of a second referendum while insisting she doesn’t want one.

Goldman Cuts Oil Price Forecasts:

Goldman Sachs Group Inc. cut its oil price forecasts for 2019, citing a re-emerging surplus of oil and resilient US shale production. Global benchmark Brent crude will average $62.50/bbl this year, analysts including Damien Courvalin said in a Jan. 6 note, down from a previous estimate of $70/bbl. US marker West Texas Intermediate will average $55.50/bbl, down from a prior forecast of $64.50/bbl. With current prices below those levels, Goldman sees them as undervalued at the moment.

A surge in OPEC production in late 2018 means the market started this year better supplied than the last, and pipeline constraints in the US Permian Basin will clear up faster than expected, according to Goldman. Big projects in the works for years in Brazil and Canada will also ramp up output in 2019. Combined, those increases mean fewer high-cost marginal barrels will be needed to meet global demand growth this year, Courvalin said.

Blackrock Backs Gold:

Gold may extend gains as global growth slows, equity market volatility remains elevated and the Federal Reserve is expected to ease back on the pace of policy tightening this year, according to a BlackRock Inc. money manager, who says the precious metal offers an effective hedge.

“Recession fears are probably overblown, but I do think we’re experiencing a slowdown,” Russ Koesterich, portfolio manager at the $60 billion BlackRock Global Allocation Fund, said in an interview, citing decelerations in the US, China and Europe. While BlackRock doesn’t have a price target, it’s been raising bullion holdings since the third quarter through exchange-traded funds.

Bullion surged in December as global stocks capped their worst annual performance since the financial crisis. Investors took fright at signs of economic weakness in the world’s largest economies, with China grappling against the US trade war. Other political uncertainties, such as Brexit and the partial US government shutdown, have also buttressed demand for havens.

FX Updates:

USD/SGD:

Spot: 1.3574

USDSGD slipped earlier this morning to its lowest since last July, falling below the 1.3600 support, on the back of a broadly weaker USD. Prior to last Friday, USDSGD has largely maintained within the 1.3600-1.3875 range over the past 6 months. Its recent breakout to the downside could signal more downside to come; the next support lies at the 1.3500 handle.

AUD/USD

Spot: 0.7135

AUDUSD extended its sharp rebound from a 10-year low last week, amid growing optimism in US-China trade talks. AUDUSD climbed 0.3% earlier, adding to Friday’s 2.1% jump. The pair’s recovery could find some pause at 0.7160. From a longer-term perspective, AUDUSD’s 2018 downtrend remains intact; a break above the 200-day moving average of 0.7342 could change that.

USD/CAD:

Spot: 1.3361

USDCAD broke to the downside and extended daily losses. The pair extended its fall below 1.3400, slipping 0.1% lower today to register a 3-week low following a weaker dollar as well as firmer oil prices. A strong rejection of the 1.3600 handle indicates that USDCAD’s rise from 1.2788 since last October could be in for a reversal

USD/CNH:

Spot: 6.8524

USDCNH slipped 0.2% earlier today, following modest yuan strength amid optimism the US-China trade talks this week would yield a positive outcome. The recent significant support bellows lies at 6.8260; likely to be tested soon over the near term. The  pair’s upside is likely to be capped around its 50-day moving average at 6.9121

USD/JPY:

Spot: 108.06

USDJPY pared some of Friday’s gains earlier this morning, retreating back to the 108 handle. USD weakness has weighed on the currency, with the market discounting the dollar on the back of the perceived dovishness in the Fed following some weeks where sentiment for Fed rate hikes have been deteriorating. Fed Chair Powell made further dovish comments on Friday as well.

GBP/USD:

Spot: 1.2749

GBPUSD added to Friday’s gains despite the risks ahead associated with the Brexit vote this month. The pair is currently trading near its 50-day moving average of 1.2774, after rebounding off a 20-month low reached last Thursday. Resistance resides at 1.2815, although continued Brexit uncertainty is likely to limit further upside moves.

Sources: Bloomberg