Issue#: 537/2019

Spot values at a glance:







Daily Observations:

Asian stocks got off to a mixed stock this week as traders digested the latest trade developments and weighed continued Brexit uncertainty. Shares in Tokyo, Singapore and Hong Kong gained, while indices in Shanghai, Taiwan and Sydney fell. Futures on the S&P 500 edged higher, signalling American stocks may test an all-time high this week. The dollar traded near its lowest level since July and Treasury yields held steady.


BoJo’s Vows to Deliver Oct 31 Brexit:

Boris Johnson will make a fresh attempt to deliver on his pledge to take Britain out of the EU on Oct. 31 as optimism grows that he now has enough support to get his deal through Parliament. Cabinet ministers made clear the prime minister is undeterred after a crunch vote on Saturday forced him to write to the EU asking for a 3-month delay.

Johnson will on Monday ask the House of Commons to back his deal with the EU in a new “meaningful vote”, a test he was denied Saturday after lawmakers voted in favour of an amendment that sough more time for the agreement to be scrutinized.

That puts Johnson on a possible collision course with Commons Speaker John Bercow, who could decide not to allow the vote because it amounts to asking the same question twice in the same session in breach of parliamentary rules. At the same time, the government is preparing to introduce the legislation needed to deliver Brexit in the hope of fast-tracking the bill through both houses of Parliament in time for Oct. 31. The government was defeated in the amendment vote, brought by former Conservative Minister Oliver Letwin, by just 16 votes. Ministers insisted on Sunday that it now has the backing of the 320 members of Parliament needed to win.

That optimism was shared by Michael Gove, the minister in charge of no-deal Brexit preparations, who said the risk of a no-deal Brexit had increased because there was no guarantee the EU would grant Britain’s request for an extension. The government confirmed on Sunday it was triggering Operation Yellowhammer, its contingency plan to make sure Britain can deal with the fallout from a chaotic departure from the EU. Johnson made clear to the EU that he’d rather Britain leave without delay and he refused to sign the letter requesting an extension, one of three sent to Brussels late Saturday. European Council President Donald Tusk is now consulting member states on how to respond.

The Times of London on Sunday, citing unnamed diplomatic sources, said the EU is ready to grant a 3-month extension if Parliament fails to approve the deal, with the U.K. able to leave on the 1st or 15th of November, December or January if an accord is ratified. If Johnson calls a second referendum, or meets other obstacles, governments led by Germany would push for a longer extension, possibly pushing the deadline to June 2020, the Times said.


China’s Risky Pacific Loans:

China should put the brakes on its lending in the South Pacific to avoid lumping economically vulnerable nations with unsustainable debt, according to a report released by an Australian think tank. “The sheer scale of China’s lending and its lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries poses clear risks,” the Lowy Institute said in a report released Monday. “China cannot remain a major lender in the Pacific at the same scale as in the past without fueling significant” dangers, it said.

According to Lowy, 6 South Pacific governments are debtors to China: Cook Islands, Fiji, Papua New Guinea, Samoa, Tonga, and Vanuatu. Between 2011 and 2018, China made official loan commitments to the region totaling about $6 billion, or about 21% of regional GDP. As China spreads its influence beyond the South China Sea to the South Pacific, a region comprised of island nations traditionally under US hegemony and on Australia’s doorstep, officials in Washington and Canberra are increasingly concerned Beijing may use debt through infrastructure loans as leverage to establish military bases in the region.


China Confirms Phase 1 of US Trade Deal:

China’s top trade negotiator offered positive signals that talks with the US are making progress and both sides are working toward a partial trade deal. “China and the US have made substantial progress in many aspects, and laid an important foundation for a phase one agreement,” Vice Premier Liu He said at a technology conference in Nanchang, Jiangxi, on Saturday. He reiterated that China is “willing to work in concert with the US to address each other’s core concerns on the basis of equality and mutual respect.”

The comments come as the US and China work toward getting some sort of agreement ready for presidents Donald Trump and Xi Jinping to sign at the APEC summit next month in Chile. The US has said China will buy as much as $50 billion in US agricultural goods in exchange for the suspension of additional tariffs, though Bloomberg has reported that the Chinese want more talks and would need existing tariffs rolled back in order to reach that amount of imports.

The “phase one” deal described by Washington may not address many of the larger issues that initiated the trade war which has dragged on for more than a year, such as forced technology transfers and industrial subsidies. The White House is also looking at rolling out a previously agreed currency pact with China, people familiar said earlier. The agreement would be similar to commitments China has already made in accordance with IMF standards, they said.

China’s economic growth slowed further to 6% in the third quarter, according to data released last Friday, increasing pressure on Beijing to put an end to the trade conflict. With a drop-off in exports to the US expected to continue as long as tariffs remain, the economy is likely to keep struggling as deflationary pressures hit company profits.


China’s Weak Economic Showing Persists:

China continued its grind to more moderate growth in the third quarter as investment slowed, providing little upside for a global economy flirting with its first recession since 2009. Gross domestic product rose 6% in the July-September period from a year ago, the slowest pace since the early 1990s and weaker than the consensus forecast of 6.1%. On the upside, factory output improved and retail sales held up, but slowing investment growth remained a concern.

Even with the slowdown, year-to-date growth of 6.2% suggests the government can hit its target of an expansion of 6% to 6.5% for 2019. Until now, officials have focused on limited, targeted measures such as reserve-ratio cuts and credit support, wary of expanding the nation’s already heavy debt load. A meeting of the Communist Party’s top leadership due in the coming days may present an opportunity to review stimulus settings.

Nominal growth, which is un-adjusted for inflation, slowed to 7.6% from a year earlier, according to Bloomberg calculations. That’s the slowest since the third quarter of 2016. The nominal growth rate “tends to capture the cycles in the economy better,” according to a research note from Trivium China. It also gives a better idea of whether growth is fast enough to repay the nation’s growing debt, as lending is denominated in nominal values and isn’t adjusted for inflation.


African Swine Flu Drive Pork Prices Higher:

According to a Bloomberg news report, the deadly pig disease is wiping out hundreds of millions of hogs, mostly in China, driving a global surge in pork and bacon prices from Auckland to Vancouver. In Europe, swine carcasses have soared 31% and piglets 56% in the past year. Pig-meat is poised for the steepest jump since mad cow disease and bird flu outbreaks in 2004 led consumers to eat more pork, according to an index compiled by the Food and Agriculture Organization of the United Nations in Rome.

The pork wholesale spot price jumped 16% to 42.46 yuan a kilogram ($2.72 a pound) in the week ending Oct. 11, the biggest gain in at least 13 years. It’s more than doubled since China reported its first African swine fever cases in early August 2018. Prices are widely expected to remain high for at least the next 3 months in the lead up to the Lunar New Year on Jan. 25, a peak time for pork consumption in China, Vietnam and other countries that celebrate the festival.

By the end of 2020, China’s swine herd will slump to 275 million head, down almost 40% since the beginning of 2018, before the world’s largest animal disease outbreak began, according to the US Department of Agriculture. That will pull down global pork production by 10% in 2020. Reduced domestic supplies will boost China’s demand for foreign pork, resulting in record prices and imports. However, Chinese consumers will “feel the pinch,” with a 32% slump in per-capita pork consumption over two years, the USDA said in an Oct. 10 report.


Fed Leaves October Cut on Table:

Federal Reserve officials have said little to take a third straight interest-rate cut off the table when they meet this month. They also haven’t said much about what they’ll do after that. Fed Vice Chairman Richard Clarida, in remarks Friday on the final day before the central bank goes into a blackout period before its Oct. 29-30 meeting, saw lots to be happy about in the domestic economy. But there’s also risks that weakness from abroad, which has already hit manufacturing, will seep into the wider US economy.

“Global growth estimates continue to be marked down, and global disinflationary pressures cloud the outlook for US inflation,” Clarida said in Boston. Trade disputes have slammed global manufacturing and US growth is expected to slow in the second half of the year. Traders have almost entirely priced in a quarter percentage point cut at the upcoming Fed meeting, which would match its moves in July and September.

The last time the Fed reduced rates three times while the economy was growing was in 1998. After the third cut, it sent a strong signal it was done, announcing that financial conditions following 75 basis points of easing “can reasonably be expected” to sustain the expansion.

Officials probably see enough risks that they will want to maintain the flexibility to cut rates further. But keeping the door wide open could create expectations that the current path is something more like a protracted cycle than a mid-cycle adjustment, as Chairman Jerome Powell has called it. Several officials in September, according to meeting minutes, were eager to push back against that perception.

“I felt very strongly at this stage in July and September that we should be taking action,” Dallas Fed chief Robert Kaplan said last Friday in Washington. “I’m more agnostic as we sit here today as to whether we should take, or I should take, more time, understanding we have the December meeting also.”

The burden of saying what comes next will fall to Powell at his Oct. 30 press conference following the Fed’s meeting. It has been careful to omit forward guidance in recent policy statements, saying that it will “monitor the implications of incoming information’’ and “act as appropriate.’’ Powell will probably push back on talk of recession by noting the economy is in a “good place”, a refrain he and other officials have repeated multiple times this year. But he is unlikely to say much about future action, which carries its own communication challenge.


Real Yields Approach Zero in China:

According to Bloomberg news, soaring pork prices in China are walloping the country’s inflation-adjusted bond yields, now in danger of turning negative for the first time in 7 years.

Home to half of the world’s hogs, China’s been hit hard by African swine fever, more than 200 million pigs have been culled this year. That’s sent the price of pork, a key element in Chinese cuisine, soaring and in turn drove the consumer price index to breach 3% gains in September. Given the 3.19% yield on 10yr government bonds Monday, that means less than a 0.2% return for bondholders after accounting for inflation.

While extraordinarily low yields, adjusting for inflation or not, have become the norm across the developed world, it’s rare in emerging markets. By contrast with China, South Korea’s 10yr bonds offer almost 2% real yields. Bondholders in India are getting more than 2.5% yields after accounting for inflation running at almost 4%.

And unlike the US, Japan and other issuers, China’s government doesn’t sell inflation-linked bonds, which boost returns to investors in lockstep with a gauge of consumer prices. That leaves domestic investors bearing the full brunt of the loss in purchasing power from the latest surge in inflation. And they’re likely to take the pain without demanding greater compensation, market participants say.

National Bureau of Statistics spokesman Mao Shengyong said Friday that pork prices should gradually return to a “normal range,” and played down concerns about inflation. China has worked to restart domestic production by increasing subsidies and loans to help hog breeding. But it may take time to pull down costs; Bloomberg Economics estimated last month that inflation may surpass 3.5% by December.

A decade ago, trends in China’s bond yields tended to coincide with those for inflation, but that link diminished around 2012-13, when the economy decisively put the years of double-digit expansion behind. Investors strengthened their focus on policy makers’ intentions. Now, the assumption is that the PBOC will look past the pork-induced inflation.



Sources: Bloomberg



FX Updates:


Spot: 1.3625

USDSGD capped its biggest 5-day decline since June last week after the MAS eased less aggressively than expected, reducing only the rate of appreciation for its policy band while keeping the width and level at which it is centered unchanged. The pair further declined this morning, falling 0.1% to 1.3625, its lowest since July. Some support could be found around the 1.3600 region; expect some consolidation between 1.3600-1.3700 in the coming week.



Spot: 0.6861

AUDUSD gained to a fresh month-to-date high, amid hopes of a looming US-China trade deal ahead of next month’s APEC meeting as China’s Ministry of Commerce earlier today pledged to “make joint efforts to achieve the final agreement”. Headlines surrounding the negotiation may continue to influence AUDUSD as it encourages the RBA to revert to a wait-and-see approach, but it remains to be seen if the trade talk will bear fruit as Chinese officials pledge to retaliate to the US blacklist. In turn, the RBA may keep the official cash rate on hold at the meeting on November 5 as the US and China, Australia’s largest trading partner, plan to finalize ‘phase one’ of the trade deal over the coming days.



Spot: 1.3134

USDCAD’s downside risk remains high as the pair’s uptrend line since Sep 2017 is in threat of being breached. A break below 1.3000 would confirm the break down below. The Canadian dollar is the best performing major currency this year, however this week’s federal election will be the next big event to test its resilience.

Liberal Party Prime Minister Justin Trudeau is in a neck-and-neck race with Conservatives leader Andrew Scheer, and while the most likely scenario is a government that doesn’t command an absolute majority in its own right, some strategists say that a minority administration led by Scheer could be better for the loonie in the near term than one under Trudeau.



Spot: 7.0653

China’s offshore yuan is looking to strengthen against the greenback, after the PBOC kept the 1-year loan prime rate at 4.2% earlier today, disappointing expectations for a cut to 4.15%. USDCNH should find some support around the 7.0300 level – last tested in September.



Spot: 108.48

USDJPY stopped short of testing the key 109 resistance level last Friday and continues to fluctuate near last week’s close earlier today, as uncertainty over Brexit drags on. A break above 109, which happens to be the pair’s 200-day moving average as well, is likely to lead to a run up back to the next resistance level at 110.63.



Spot: 1.2915

GBPUSD retreated from the 1.3000 psychological level today, after UK politicians failed to deliver the decisive Brexit vote that had been promised at the weekend. The decline brought to a halt a 4-day winning streak fuelled by speculation PM Johnson could win parliamentary backing for his divorce deal. Strategists say the drop may prove short-lived, with Goldman Sachs among those arguing that a vote will be carried this week.



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