September 14, 2018

Daily Observations:

Most Asian indices extended rallies after their recent battering drove valuations to a 2-year low, following a technology-supported advance in US equities. The USD held declines after US inflation unexpectedly cooled in August. With the dollar heading for its biggest weekly loss since February, prospects for US-China trade talks and action by Turkey to support its currency, it all made for a largely positive tone Friday.

US Inflation Unexpectedly Cools:

US CPI unexpectedly cooled in August as apparel prices fell by the most in about seven decades and medical-care costs declined, suggesting little urgency for the Federal Reserve to speed up the pace of interest-rate hikes. Excluding food and energy costs, the core consumer price index rose 2.2% in August from a year earlier, compared with the 2.4% median estimate of economists surveyed by Bloomberg News, a Labor Department report showed Thursday. The broader CPI slowed to a 2.7% annual gain from 2.9%.

Fed policy makers are widely expected to raise interest rates later this month and have also penciled in a fourth move this year, though a more persistent slowdown in inflation could affect their outlook. Freight costs and rising wages, along with tariffs and counter-levies, may keep putting upward pressure on inflation. The Fed will publish officials’ updated economic and rate forecasts on Sept. 26.

Trump Tempers Expectations on China Talks:

US President Donald Trump got ahead of a possible new round of tariff talks with China, boasting he has the upper hand in the burgeoning trade war and feels “no pressure” to resolve the feud.

Trump’s Twitter message on Thursday shows he is determined to enter any negotiation showing strength, but risks stoking Chinese fears that he isn’t serious about striking a deal. Chinese officials felt burned by US backtracking in prior talks as the 2 countries’ trade dispute deepened. Trump’s comment tempered the market’s already cautious optimism over the US government’s proposal for another round of talks with Beijing. The disclosure on Wednesday that the US wanted to renew talks had boosted US stocks and emerging-market assets.

Turkish Lira Surges Following Rate Hike:

Turkey’s central bank appeared to defy President Recep Tayyip Erdogan by jacking up rates more than expected to lift the flagging lira, capping a day of chaos that started with a ban on conducting business in dollars and euros.

The country’s Monetary Policy Committee raised the one-week repo rate by 625 basis points to 24%, almost double expectations in a Bloomberg survey. The lira, among the world’s worst performers this year, jumped 2.5% against the dollar.

The move came just hours after Erdogan triggered tumult by repeating demands for lower borrowing costs after issuing a decree curtailing the use of foreign currencies in domestic transactions. The independence of monetary policy has been in doubt since Erdogan pledged in his election campaign this year to exert more control over the central bank.

JPMorgan Predicts 2020 Crisis:

A decade after the collapse of Lehman Brothers sparked a plunge in markets and a raft of emergency measures, strategists at JP Morgan Chase & Co. have created a model aimed at gauging the timing and severity of the next financial crisis. And they reckon investors should pencil it in for 2020.

According to their analysts, the good news is the next one will probably generate a somewhat less painful hit than past episodes. However, the bad news is that diminished financial market liquidity since the 2008 implosion is a “wildcard” that’s tough to game out.

JPMorgan’s Marko Kolanovic has previously concluded that the big shift away from actively managed investing, through the rise of index funds, exchange-traded funds and quantitative-based trading strategies, has escalated the danger of market disruptions. He and his colleagues wrote in a separate note Monday of the potential for a future “Great Liquidity Crisis.”

“The shift from active to passive asset management, and specifically the decline of active value investors, reduces the ability of the market to prevent and recover from large drawdowns,” Joyce Chang and Jan Loeys wrote in the Monday note. Actively managed accounts make up only about one-third of equity assets under management, with active single-name trading responsible for just 10% or so of trading volume, JPMorgan estimates. This change has “eliminated a large pool of assets that would be standing ready to buy cheap public securities and backstop a market disruption.

ECB Holds Rates, Confirms Bond-Buying to be Phased Out:

The European Central Bank confirmed it will cut bond-buying in half next month and anticipates that new purchases will be halted by the end of the year. The central bank also added it will buy 15 billion euros ($17 billion) of assets a month from October to December, and that a decision to halt the program after that continues to be contingent on incoming economic data. Policy makers reiterated that interest rates will remain at their present record lows “at least through the summer” of 2019.

In ECB President Dragi’s press conference, the key takeaway was his comment that uncertainty around the inflation outlook is receding and the projection for core inflation as “significantly stronger.” He downplayed the risk of EM contagion, saying the spillover hasn’t been substantial. While he touched upon the downside risk of financial market volatility and rising protectionism, he quickly countered by highlighting the upside risk from the region’s less constrained fiscal policy and underlying economic strength from a robust labor market, rising wages, healthy consumption and business investment. As for Italy, his attitude is that watch what they do, not what they say.

China’s Investment Slowdown Worsens as Industry, Retail Hold Up:

China’s economic momentum weakened a notch in August, with a continued slowdown in investment overshadowing solid retail sales and industrial production data.

• Industrial output rose 6.1% in August from a year earlier, versus a projected 6.1% in a Bloomberg survey and 6% the previous month
• Retail sales expanded 9.0% from a year earlier, versus a forecast 8.8%
• Fixed-asset investment rose 5.3% year-on-year in the first 8 months, compared with an estimated 5.6% and 5.5% the previous month
• The surveyed jobless rate in urban areas stood at 5.0%, versus 5.1% in July

Infrastructure investment slowed to 4.2% in the first 8 months, the slowest since the data series started in 2014. That means policies to expedite such spending haven’t fed through to construction yet.

Carney Warns of Rate Hikes if Brexit Deal Fails:

Bank of England Governor Mark Carney told senior government ministers that a no-deal Brexit would probably see interest rates rise rather than fall, according to people familiar with the matter.

Carney, who joined a cabinet meeting Thursday to outline the BOE’s planning for a turbulent exit from the European Union, told those present that crashing out without an agreement would lead to a fall in the pound and higher tariffs, pushing inflation higher. That would make it harder to cut borrowing costs to support the economy as the BOE did in the aftermath of the Brexit vote in 2016, said the people, who asked not to be named because the discussions were private.

Central bank policy makers, who cut rates to a record-low 0.25% in August 2016, have increased borrowing costs twice in the past year to keep inflation in check. Officials have previously said that Brexit could prompt a policy move in either direction.

Carney also said a no-deal outcome could see house prices fall by over 35%, while mortgage rates increase. The BOE has previously said that its stress tests show banks could withstand the worst-case scenario.

FX Updates:

USD/SGD:

Spot: 1.3700

USDSGD declined to a 2-week low earlier today, largely due to a broad decline in the USD amid optimism of easing US-China trade relations. The pair has largely been sideways-bound over the past 2 months, ranging between the 1.3600 and 1.3800 handles. A break above the recent high is likely to lead to further gains to 1.3900.

AUD/USD

Spot: 0.7194

AUDUSD lingered just below its 0.7200 handle, after briefly trading above it to reach a 2-week high overnight. The pair slipped back below 0.7200 after Trump poured cold water on trade talk optimism. The downward trend channel since the start of the year stays intact, while the recent break below the 0.7150 support signals more Aussie weakness. The psychological 0.700 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.

USD/CAD:

Spot: 1.2992

USDCAD maintained near 1.3000 overnight, consolidating the decline of the previous 2 trading days. The pair seems to finding some footing around current levels. Technically, the longer-term bias for USDCAD points to the upside; 1.3386 remains key.

USD/CNH:

Spot: 6.8497

USDCNH bounced off a 2-week low overnight, paring some of Thursday’s sharp decline. The currency pair continues to hold below the key 6.9000 handle, a level many FX traders have their eyes on. A break back above it will probably lead to a retest of the currency pair’s 18-month high of 6.9586.

USD/JPY:

Spot: 111.84

This past week, the USD declined, but it found support above 110 against the yen. USDJPY moved higher this week, culminating at a 1-month high earlier today and briefly breaking above 112. The pair could continue to move higher towards 113 in the near term.

GBP/USD:

Spot: 1.3118

GBPUSD gained to its highest in more than a month, soaring past the 1.3100 handle last night, as the UK pledged to provide information that could help solve a standoff with the EU over the Irish border. The pair was also supported by broad USD weakness as data showed US CPI slowed last month.

Sources: Bloomberg