October 1, 2018

Daily Observations:

Asian stocks saw a mixed start to the final quarter of the year in holiday-thinned trading. Volumes were below normal in a number of markets, with Labor Day in Australia, Hong Kong shut and China out through Oct. 7.US equity futures, Canada’s dollar and Mexico’s peso all climbed on reports that American and Canadian negotiators have reached a Nafta trade deal. The USD strengthened, while 10yr Treasury yields ticked higher.

US and Canada Reported to Reach Trade Deal:

The US and Canada have agreed on a trade deal that would save the North American Free Trade Agreement as a trilateral bloc, according to 3 people familiar with the matter, Bloomberg news reported earlier. President Donald Trump has approved the developments and the expectation is that an agreement will be announced on Sunday night, according to the people, who spoke on the condition of anonymity. US Trade Representative Robert Lighthizer and Canadian officials are working on the final touU.S. and Canadian negotiators have been negotiating around the clock this weekend to make a Sunday midnight deadline that would allow the countries to sign the deal as the final act before Mexico’s outgoing President Enrique Pena Nieto leaves office at the end of November.

Reaching a pact with Canada allows the 24-year-old pact to remain trilateral and for the US to check another box for its legislative process in the lead up to a congressional vote. Trump has said he wants to rename the deal the US-Mexico-Canada agreement.

China Manufacturing Slump:

Two gauges of activity in China’s manufacturing sector worsened in September, reflecting the nation’s economic slowdown and fallout from the trade war with the US. The official manufacturing purchasing managers index stood at 50.8 in September versus 51.3 in August, lower than the median estimate of 51.2 in a Bloomberg survey of economists. Meanwhile, the Caixin manufacturing PMI, which better reflects sentiment among smaller, private firms, declined to 50 from 50.6, the lowest since May 2017. The gauge for new export orders in the manufacturing PMI report fell to 48, the fourth consecutive month of contraction and the lowest reading since 2016.

The lack of progress in negotiations between Washington and Beijing over their trade rivalry means that there’s a good chance the current roster of tariffs on $250 billion of Chinese goods exported to the US will grow, as President Trump has threatened. With little room for optimism on external demand, the outlook for China’s economy hinges increasingly on the effectiveness of targeted stimulus measures being rolled out this year.

Italy Credit Downgrade Risk Rises:

Italian assets took a beating on Friday after the government set a wider budget deficit than most investors had anticipated, potentially setting the country on a collision course with Brussels. A drop in banking stocks sent the nation’s benchmark stock index tumbling the most in 2 years, and local borrowing costs surged, with yields on bonds maturing in 10 years climbing the most since the end of May.

The government set the deficit target for 2019 at 2.4% of GDP, marking a victory for Italy’s populist leaders. Investor and analyst concerns were centered around the sustainability of the country’s 2.3 trillion euro debt load and the possibility of a sovereign credit rating downgrade.

JPMorgan Chase & Co.’s analysts had identified a 2% deficit as the maximum threshold to avoid a downgrade from rating agencies, and wrote that it would be a surprise if most if not all rating agencies didn’t act in the next few weeks.

Singapore Home Prices Rise Despite Property Curbs:

Singapore private home prices are still inching higher, albeit at the slowest pace in five quarters, even after the government imposed additional property curbs to avoid the risk of a sharp correction that could be destabilizing to the city-state’s economy.

An index tracking private residential prices increased 0.5% in the 3 months ended Sept. 30 compared to a 3.4% advance in the June quarter, according to a flash estimate from the Urban Redevelopment Authority on Monday. That adds to a 9.1% gain in the year through June.

According to Bloomberg news, apartment prices in prime districts rose 1.2% last quarter compared to a 0.9% gain in the 3 months through June 30. Unit prices in suburban areas added 0.1% after climbing 3% in the previous quarter. Prices near prime areas slid 0.8% after gaining 5.6% in the June quarter, the data show.

As developer stocks sink, investors are turning toward real estate investment trusts, or the businesses that hold the real-estate assets rather than the ones that sell them. The FTSE Straits Times Real REIT Index is outperforming a benchmark that tracks home builders.

Rising Commodities to Break Great Divergence Trade:

According to Bloomberg news report last week, analysts around the globe are anticipating the convergence of US markets with the rest world, with higher commodity prices expected to make it happen. With OPEC signaling it won’t boost output to cap oil prices, Brent crude surged to a 4-year high. Copper also rebounded, putting Bloomberg’s commodity index on a 6-day tear that comes at the same time American equities are losing their edge against overseas counterparts. Dollar weakness may follow, a growing chorus of analysts say, further boosting emerging markets that benefit from rising commodity prices and closing the gap with the US.

Morgan Stanley strategists have recently  highlighted how a rising greenback and domestic inflation had already left real returns across many asset classes in negative territory for the year. Meanwhile, JPMorgan’s Marko Kolanovic is doubling down on his call to cut holdings in US equities and add exposure to emerging markets. “The tables are turning as a stronger USD, higher yields, and trade tariffs start impacting US profit growth, and YoY earnings comparisons soften,” Kolanovic wrote in a note Sept. 26. “While we think that US equities will drift higher, the days of rampant outperformance vs. the rest of the world are likely over.”

Much of the call for convergence comes down to the currency impact. Typically the dollar moves in the opposite direction from commodities, so if raw materials continue their upward trajectory, emerging market assets could benefit from a weaker greenback. Then there’s the effect of inflation: Consumer sentiment, which just hit an 18-year high, could falter on more expensive prices for things like gasoline.

FX Updates:

USD/SGD:

Spot: 1.3687

USDSGD gained to a 1-week high on a stronger greenback over the weekend. The pair has largely been sideways-bound over the past 2 months, ranging between the 1.3600 and 1.3800 handles. A break above 1.3819 is likely to lead to further gains to 1.3900. Conversely, the 200-day moving average around 1.3400 acts as the next support to the downside.

AUD/USD

Spot: 0.7223

AUDUSD briefly reached a 3-week high last week but has since pared gains back towards 0.7200. The currency pair’s downward trend since the start of the year continues to hold. A break above last week’s high would signal a potential reversal in trend. To the downside, the psychological 0.7000 handle is likely to be a short covering target for Aussie bears. The 9-year low at 0.6828 is the long-term support level.

The RBA will give its October interest rate decision on Tuesday. It is expected to keep the target rate unchanged at a 1.50% record-low once again.

USD/CAD:

Spot: 1.2833

USDCAD declined to its lowest in 4 months as the US and Canada were said to be close to agreeing on a trade deal that would save the Nafta as a 3-country bloc. The pair declined below the 200-day moving average of 1.2870 in the process. Momentum towards the downside has accelerated; the next support lies at 1.2750, which is likely to be tested soon over the near term.

USD/CNH:

Spot: 6.8841

USDCNH gained for a sixth consecutive month in September, its longest streak since 1992, amid the ongoing US-China trade war. The pair was higher earlier today, looking poised to make another push to test the 6.9000 resistance which has held firmly over the past 6 weeks. With little prospect of a resolution in the near future, various analysts expect an escalation in tensions and a continued slide in the yuan against the dollar.

USD/JPY:

Spot: 113.90

USDJPY finished the quarter strongly last Friday, registering a strong close above the 113 handle. All signs point to more upside for the pair, with the next resistance to be tested resign at 114.50.

GBP/USD:

Spot: 1.3031

GBPUSD was little changed earlier today, after declining on Friday to close out the quarter at a 2-week low. Softer-than-expected GDP data and continued political uncertainty contributed to sterling’s recent weakness. The short-term support at 1.3000 (50-day moving average) may buoy the currency pair for the time being, but continued USD strength and Brexit uncertainty may lead the pair past below it.

Sources: Bloomberg