October 18, 2018

Daily Observations:

Stocks retreated in Asia after benchmark US Treasury yields climbed back toward seven-year highs in wake of minutes of the last night’s hawkish Fed policy meeting minutes. The yuan hit its weakest since the start of last year, as the US Treasury refrained from naming China a currency manipulator, while at the same time escalating scrutiny of the country’s exchange-rate policy. Gold slipped lower while crude oil fell below $70/bbl on supply concerns.

US Refrains from Labeling China an FX Manipulator:

The Treasury Department stopped short of declaring China a currency manipulator in its semi-annual report on foreign-exchange rates, slightly easing tensions while serving notice that the US will be closely watching the Chinese yuan after its recent slide.

“Of particular concern are China’s lack of currency transparency and the recent weakness in its currency,” Treasury Secretary Steven Mnuchin said in a statement. “We will continue to monitor and review China’s currency practices, including through ongoing discussions with the People’s Bank of China.” While Treasury said in the report that direct intervention by China’s central bank has recently been “limited,” it also said the US is “deeply disappointed” that the nation doesn’t disclose those interventions.

No major trade partner was designated a currency manipulator, according to the report, which was released Wednesday by the Treasury. Still, the department dialed up criticism of China’s state-driven economic model.

Trump Plans to Withdraw US from Postal Treaty:

President Donald Trump plans to withdraw the US from a 192-nation treaty that gives Chinese companies discounted shipping rates for small packages sent to American consumers, another escalation of his economic confrontation of Beijing.

US officials said the administration sought to revise the treaty in September and was rebuffed by other nations, prompting the decision to withdraw. The State Department will deliver a notice to the Universal Postal Union in Switzerland Wednesday, White House Press Secretary Sarah Huckabee Sanders said in a statement.

Fed Debates Hiking Rates Past Neutral:

Federal Reserve officials stepped deeper into a debate over how high to push interest rates, as a majority favored an eventual and temporary move above the level they deem neutral for the economy in the long run.

The clearest summary of policy makers’ views, unusually, appeared not in the minutes to the Sept. 25-26 policy meeting, which were released Wednesday in Washington, but in the accompanying notes to officials’ most recent economic projections. “A substantial majority of participants expected that the year-end 2020 and 2021 federal funds rate would be above their estimates of the longer-run rate,” according to the document.

Those long-run estimates typically reflect where officials believe interest rates will neither stimulate nor hold back the economy. In their most recent projections, officials’ median estimate for that neutral level was 3%.

US-Saudi Tensions Escalate:

President Donald Trump and his top diplomat cautioned against putting the relationship between the US and Saudi Arabia at risk over Jamal Khashoggi, who entered the Saudi consulate in Istanbul more than 2 weeks ago and apparently never emerged. But the crisis over the missing journalist and critic of the Saudi government is escalating as fresh accounts of his disappearance, some of which read like a horror movie, increasingly cast doubt on assertions by the Saudis that they don’t know what happened to him.

The US president reiterated to reporters on Wednesday that Crown Prince Mohammed bin Salman’s government agreed to buy $110 billion in US weaponry during Trump’s visit to the country last year, his first trip abroad as president. He has said that canceling those purchases would only push Saudi Arabia toward Russia or China for its arms purchases. “If you look at Saudi Arabia, they are an ally,” Trump said. “They are a tremendous purchaser of not only military equipment but other things.”

Dollar Libor at 10-Year High:

The global dollar benchmark rate that everyone loves to hate and which regulators have marked for extinction approached a 10-year high Wednesday, adding to strains on some emerging economies and US companies alike.

The London interbank offered rate still serves as the basis for trillions of dollars in loans and floating-rate securities globally, even though its replacement is gaining traction. Steeper US interbank borrowing costs risk rippling across developing economies by tightening financial conditions and forcing local-currency benchmarks higher. It’s a development that could heighten investor concern at a time when a rising dollar has sparked worries about emerging-market borrowers’ ability to repay loans in the greenback.

3-month US dollar Libor is now 2.4496%, the highest since November 2008. The main driver is that traders are pricing in further Fed tightening. Officials’ latest quarterly forecasts indicate another rate hike this year followed by 3 more in 2019.

China Equity Market’s Liquidity Crisis:

The recent rout in Chinese equities is throwing the spotlight on $613 billion of shares pledged as collateral for loans. Loans extended to company founders and other major investors who pledged their shareholdings as collateral emerged as a popular financing channel in recent years. However given the recent losses in equities, there has been a growing risk that brokerages will be forced to sell the shares, accelerating the downturn, Bloomberg news reported earlier today.

At least 35 companies have seen pledged shares liquidated by brokerages since the start of June, more than triple the 10 in the first 5 months of the year, according to company filings. At least 2 firms announced after this past Monday’s close that their shares were at risk of forced selling.

About 4.24 trillion yuan of shares have been pledged as collateral for loans, according to Bloomberg calculations using China Securities Depository and Clearing Corp. data, accounting for about 11% of the country’s stock market capitalization.

FX Updates:

USD/SGD:

Spot: 1.3777

USDSGD pared earlier week declines as the pair rose Thursday, on the back of overnight USD strength. A move back above 1.3800 is expected over the coming days on the back of continued greenback strength. To the downside, 1.3600 represents a key support.

AUD/USD

Spot: 0.7136

AUDUSD climbed earlier today on the back of a sharp drop in the Australian jobless rate, to its lowest level since 2012. However, any gains for the FX pair may be short-lived as the jobs report also showed a weaker-than-expected increase in employment last month. The currency pair’s downward trend since the start of the year continues to hold, and looks on track to reach its 9-year low at 0.6828 by year-end.

USD/CAD:

Spot: 1.3039

USDCAD extended overnight gains earlier today, with the pair attempting to break its 100-day moving average, currently at 1.2896, for the third time since end-September. Hawkish FOMC minutes and weakening oil prices were the key drivers of the pair’s move.

The downtrend channel, established since July, continues to hold, although the longer term technical bias points to the upside. The pair broke above its multi-year triangle pattern earlier this June – a breakout above of its current 3-month long downtrend channel would suggest a likely retest of the 1.3382 resistance.

USD/CNH:

Spot: 6.9330

USDCNH flirted with a 2-month high, after the yuan fell to its lowest level since January 2017 after last night’s Treasury report, which stopped short of declaring China a currency manipulator. The PBOC had earlier today weakened its daily fixing by 0.25%.

Investors will continue to keep a close eye on the key 7.000 level. Given the continued monetary policy divergence between China and US, continued weakness of the yuan versus the greenback is likely.

USD/JPY:

Spot: 112.52

USDJPY seems to have found some support at its 112 handle this week, having held above it since last Thursday. It seems probable USDJPY will rebound back to at least 113 over the near term. The key resistance at 114.50 remains the level to break for the pair to resume its uptrend, which began in March this year. A breach of 114.50 is likely to lead to a run up to the pair’s next resistance at 118.66.

GBP/USD:

Spot: 1.3099

GBPUSD declined back to its 100-day moving average at the 1.3100 handle, following Brexit uncertainty and a stronger US dollar courtesy of hawkish Fed minutes. The medium-term uptrend since mid-August continues to hold; a decline below 1.2922 would signal a reversal.

Sources: Bloomberg