October 26, 2018

Daily Observations:

Asian shares slipped again on Friday morning, deepening this week’s markets rout, after disappointing results from Alphabet Inc. and Amazon.com heightened concerns over the outlook for US corporate earnings, global trade and economic growth. The US dollar held near 2-month highs, while the 10yr Treasury yield held near 3.10%. The yuan and Australian dollar approached multi-month lows.

Tech Giants’ Earnings Miss:

Amazon.com sales and operating-income forecasts fell short of analyst estimates, sending its shares 6% lower in after-market trading. Third-quarter operating income exceeded forecasts, though sales were below estimates. The web-services division saw sales rise 46% year-on-year, while ad sales soared 123%. Google parent Alphabet reported third-quarter revenue that missed Wall Street projections, squeezed by payouts to partners for distributing its money-making search engine and web browser. The positive standout was Intel, which gave a positive forecast for revenue in the current quarter, boosted by a surprising surge in demand for chips used in personal computers.

Government-Linked Chinese Funds Liquidate:

Two funds linked to the Chinese government sold all their holdings of stocks and bonds in the third quarter without explaining why, leaving investors to guess at the implications for the country’s turbulent financial markets, Bloomberg news reported Thursday.

Withdrawals from the CM Fengqing Flexible Allocation Fund and E Fund Ruihui Flexible Fund caused their combined assets to shrink to 296 million yuan at the end of September, from the equivalent of $4.5 billion in June, according to quarterly statements dated Wednesday. What remains are bank deposits and other unspecified assets. Both funds, described by state media as vehicles for China’s 2015 stock-market rescue, said that 99% of their units were redeemed during the quarter. They didn’t provide details on who pulled the money and why.

The sparse disclosures prompted a flurry of speculation about the government’s response to this year’s $3 trillion selloff in Chinese shares. Did the redemptions represent a net reduction of state support for the market? Analysts couldn’t say with any certainty. Some or all of the money could have been moved to other investment vehicles. One sign that the government hasn’t retreated: people familiar with the matter told Bloomberg on Thursday that China’s “National Team” of state investors has been buying stocks in a targeted fashion over the past week.

Most Asset Classes in the Red This Year:

The October stock rout has delivered a wake-up call to money managers searching for shelter this year. Swelling dollar funding costs, equity volatility and fissures in the synchronized growth story are punishing assets across the globe.

Before last night’s relief rally, US stocks had erased its 2018 gains, following the market’s selloff which commenced earlier this month, wiping off $2 trillion in value. European shares are in worse shape. The Stoxx Europe 600 Index has shed over 10% this year in dollar terms. Meanwhile, cash has dethroned risk assets, with an index of U.S. Treasury bills returning 1.4%.

On the current trajectory, investors will be left with just the dollar and crude oil as the few major asset classes to eke out a decent gain for the year. Treasuries and a few pockets of the credit world are still in the green.

Bank of Canada Hikes Rates, Adopts Hawkish Stance:

The Bank of Canada pressed ahead with a fresh interest rate increase and acknowledged for the first time in more than a decade it expects to completely remove monetary stimulus from the economy. The central bank raised its overnight benchmark rate by a quarter point to 1.75% on Wednesday, the third hike this year and fifth since it began tightening in 2017. More importantly, it dropped references to taking a “gradual approach” and added language about the need to bring rates to levels that are “neutral,” or no longer expansionary.

Policy makers, buoyed by the country’s new trade deal with the US and Mexico, are increasingly determined to return borrowing costs to more normal levels, as recent data suggests the economy is strong enough to cope with tighter policy. Officials may be indicating they expect the current cycle will include at least 3 more increases after Wednesday’s move, given the central bank estimates the neutral rate,  a level that’s neither stimulative nor contractionary, is between 2.5% and 3.5%.

Trump “Maybe” Regrets Hiring Powell:

President Donald Trump stepped up his attacks on Federal Reserve Chairman Jerome Powell, saying he “maybe” regrets appointing him and demurring when asked under what circumstances he would fire the central bank chief. Almost a year since nominating Powell to the post, Trump told the Wall Street Journal in an interview Tuesday that he was intentionally sending a direct message that he wanted lower interest rates, even as he acknowledged that the central bank is an independent entity.

Trump said in the interview that Powell “almost looks like he’s happy raising interest rates” and that it’s “too early to tell, but maybe” he regrets appointing him. He also sidestepped a question on what circumstances would lead him to remove Powell. “I don’t know,” the president said. That contrasted with his response to a similar question on Oct. 11, when he answered, “I’m not going to fire him.”

Powell has so far brushed off the attacks, noting the Fed is independent and arguing by raising rates gradually it’s just seeking to normalize monetary policy in an “extraordinary” economy. He’s also suggested that the central bank needs to keep its eye on possible financial froth, the trigger for the last 2 recessions, as well as inflation for signs of overheating.

China $640 Billion Share-Pledge Risk:

China’s brokers and banks account for more than half the exposure to loans backed by company shares, a key source of risk as the country’s stock market keeps sliding.

About 4.45 trillion yuan (or $640 billion) of shares were pledged as collateral in China’s $5.4 trillion equity market as of Oct. 18, according to Chengdu-based research firm PY Standard. Banks and securities firms have extended more than half of that debt. If stock values continue falling, lenders may be forced to offload more shares, perpetuating a vicious spiral.

Forced selling is adding to the list of issues facing investors in China, from worsening trade ties with the U.S. to concerns about slowing domestic demand and a slumping yuan. The Shanghai Composite Index is among the world’s worst-performing benchmarks this year, and at least 38 companies have seen pledged shares liquidated by brokerages since the start of June, according to filings.

As China’s stock rout has worsened in October, attention has turned to companies that have a high proportion of shares pledged for loans, as well as their creditors. Denied credit by mainstream banks amid a deleveraging campaign, private companies were forced to find other ways to obtain capital; S&P Global Ratings estimates about 87% of stock-backed loans were issued to non-state firms.

Equity at risk of forced selling has swelled to more than 10% of total market value from what Moody’s Investors Service estimates was 2% in 2015. The ratio could increase in 2019, CLSA analysts Alexious Lee and Cara Liu predict. Yet, they don’t see a “crisis” next year as CLSA predicts authorities’ steps will ease debt default risks and improve liquidity. Given that the private sector accounts for the majority of Chinese output, CLSA says the government will announce “real concrete measures” in November to support the economy and financial sector, before top leadership meets the following month and parliament convenes in March.

FX Updates:

USD/SGD:

Spot: 1.3827

USDSGD gained to its highest in 2 weeks, rising strongly back above 1.3800 on the back of pared earlier week declines as the pair rose Thursday, on the back of overnight USD strength. The Dollar Index had earlier climbed to a 2-month high. A retest of the 15 month high at 1.3873 is expected over the near future.

AUD/USD

Spot: 0.7036

AUDUSD earlier declined to a fresh 2-year low as the currency pair resumed its fall towards the 0.7000 handle. The Australian dollar remains fully exposed to broader market sentiment, and is expected to weaken further given a recent spike in risk-off sentiment. 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: 1.3110

USDCAD current surge seems to be the product of broad-based USD strength. Despite a rather hawkish BOC statement earlier this week, which briefly saw the FX pair trade below 1.3000, the continued strengthening in the USD dollar has boosted the pair back to 6-week highs. Crude oil’s decline this month has led to Canadian dollar weakness as well.

A point of inflection seems to be coming up for USDCAD. A break above 1.3326 would confirm the breakout the upside of the 33-month old wedge triangle pattern.

USD/CNH:

Spot: 6.9720

USDCNH rose to a fresh 21-month high earlier today, following broad greenback strength and as the PBOC increased its daily reference rate earlier to the highest since Jan 2017, bringing it closer to the key 7.0000 mark. A break above that level may lead to another broad-based rally in the USD and risk aversion in the global equities.

USD/JPY:

Spot: 112.16

USDJPY’s uptrend since March this year continues to be holding, but only just, as market participants await preliminary US Q3 GDP numbers due for release tonight. A break below 112 is likely to lead to decline back to the pair’s 200-day moving average near the 110 handle. To the upside, the key resistance remains at 114.55, a level that has held 3 times since July last year.

GBP/USD:

Spot: 1.2812

GBPUSD declined back below 1.2800 earlier today, following broad greenback strength and reports on Bloomberg that Brexit talks are on hold, increasing the odds of a no-deal Brexit outcome. More downside is likely; the first support level resides at 1.2662, the pair’s lowest since June last year.

Sources: Bloomberg