September 27, 2018

Daily Observations:

Asian stocks fluctuated Thursday as investors assessed commentary from the Federal Reserve that reaffirmed the US economy is strong enough to warrant another interest-rate increase by the end of this year. The dollar ticked higher as Treasuries steadied.

Fed Hikes Again:

Fed officials raised interest rates for a third time this year and affirmed their outlook for further gradual hikes well into 2019. The quarter-point increase boosted the benchmark rate to a target range of 2.00% to 2.25%, reflecting an upbeat assessment of the economy identical to the last policy statement 8 weeks ago, despite concerns over Trump’s escalating trade war.

Updated “dot plot” forecasts made a December rate hike almost certain, as the number of FOMC officials expecting another increase by year-end grew to 12, from 8 in the previous projections in June. Stocks fell and Treasuries rose. The Fed is taking off the training wheels, as some of the forward guidance that markets needed after the financial crisis is no longer constructive, according to a Bloomberg columnist.

In their statement, Fed officials dropped a reference to “accommodative” policy. Practically, that doesn’t matter much, because policy remains in easy territory,  Powell acknowledged as much. But it is symbolically relevant as the Fed has maintained the phrase to reassure markets since starting on the path toward normalization in 2015. With the tweak, officials see the end of an era of economic hand-holding. “This change does not signal any change in the likely path of policy,” he said. “We still expect, as our statement says, further gradual increases in the target range for the fed funds rate.”

The hike didn’t over well with President Donald Trump. At a press conference hours after Powell spoke, Trump said that he wasn’t happy the central bank raised rates, calling himself “a low interest-rate person.”

US-Japan Trade Talks:

President Donald Trump announced Wednesday he had reached an agreement with Japanese Prime Minister Shinzo Abe to open trade talks between the 2 nations. Trump said he expected the talks will come to a “satisfactory conclusion” as he spoke to reporters at the beginning of a meeting with Abe in New York. “It can only be better for the United States” because the trade relationship couldn’t get worse, Trump added.

Separately, the administration will publish the text for its bilateral trade deal with Mexico on Friday, which will likely exclude Canada but leave open the possibility for the country to join the agreement later, three people familiar with the matter said.

China Deleveraging Is Going Into Reverse:

Chinese non-financial corporate debt is rising again as a percentage of gross domestic product following a year and a half of deleveraging from its mid-2016 record, according to new data from the Bank for International Settlements.

The ratio jumped to 164.1% in the first quarter of 2018 from 160.3% in the final 3 months of 2017, erasing more than half of the progress Chinese companies had made in reducing debt loads since the ratio topped out at 166.9% in the second quarter of 2016, the BIS data, published September 23, show.

China’s government is looking at ways to counter the effects of an ongoing trade dispute with the US, which is set to knock half a percentage point off of Chinese GDP growth, according to Bloomberg Intelligence estimates. That may mean postponing its deleveraging ambitions, which now appear to have derailed even before the 2 countries began imposing tariffs on each other’s exports earlier this year.

The re-leveraging of the Chinese economy this year is being driven both by an acceleration in the pace of debt accumulation and a slowdown in economic growth, which will cause the debt ratio to rise. In 2017, “faster GDP growth allowed the authorities space to operate tight monetary policy. As a result, debt growth slowed,” economists at the independent research firm Pantheon Macroeconomics Ltd, wrote in a report published Wednesday.

Trump Accuses China of Mid-Terms Meddling:

Donald Trump said he and Chinese President Xi Jinping might not be friends anymore after he accused Beijing on Wednesday of trying to interfere in US congressional elections in November. “Maybe he’s not anymore,” Trump answered when asked how he could remain friends with Xi at a news conference on Wednesday after the United Nations General Assembly in New York.

Trump’s trade feud with the world’s most populous nation escalated during his visit to the UN as the president accused China of attempting to meddle in the US midterm election. He provided no evidence at a UN Security Council meeting where he first leveled the allegation, with a Chinese official sitting nearby. “We have evidence,” Trump said at his news conference. The charge “didn’t come out of nowhere, I’ll tell you.”

Trump said during the Security Council meeting he hosted that Beijing sought to help his political opponents in the midterms. His remarks came 3 days after China placed an advertising supplement in Iowa’s largest newspaper attacking Trump’s trade war.

“We do not and will not interfere in any country’s domestic affairs,” Chinese Foreign Minister Wang Yi said at the Security Council meeting, through a translator. “We refuse to accept any unwarranted accusations against China.”

Rising Commodities to Break Great Divergence Trade:

According to Bloomberg news report, 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.

Argentina Receives $57 Billion Bailout from IMF:

Argentina won a promise of extra cash and faster delivery from the International Monetary Fund, which expanded a record bailout to help the country defend its currency and pull the economy out of recession. Argentina’s credit line will increase to about $57 billion over 3 years, from the $50 billion announced in June. The Fund will also deliver more of that cash up front. Argentina has already received $15 billion and will have access to another $35 billion by the end of 2019.

In return, President Mauricio Macri and his new central bank chief will have to tighten policy. Argentina pledged to accelerate budget savings and freeze the supply of money to the economy in an effort to stamp out inflation. It will also stop burning through foreign currency reserves to defend the peso.

The stakes are high for both sides. Macri is up for re-election next year and risks having to campaign amid a shrinking economy. He sought IMF help even though the Fund is politically toxic in Argentina, after the collapse of a loan program in 2001 led to default and a deep recession. For the IMF, there’s an opportunity to rebuild its reputation in a country where it’s associated with poverty and unemployment.

FX Updates:

USD/SGD:

Spot: 1.3652

USDSGD maintained above 1.3600 following the Fed’s policy decision last night. 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. Conversely, the 200-day moving average at the 1.3400 acts as the next support to the downside.

AUD/USD

Spot: 0.7263

AUDUSD briefly reached a 3-week high overnight peak at 0.7315 on reaction to the Fed’s rate hike, but the broader market faded the action quickly and the Aussie is back into 0.7250, a level that has kept the pair under wraps since late last week. The currency pair’s downward trend since the start of the year continues to hold, but only just. A break above last night’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.

USD/CAD:

Spot: 1.3036

USDCAD rose back above 1.3000, its highest in a week, following news that Trump had rejected a one-on-one meeting with Canadian PM Justin Trudeau at the UN General Assembly  because he’s dissatisfied with trade negotiations with Ottawa. Technically, the longer-term bias for USDCAD points to the upside; 1.3386 remains key. A break below 1.2888 would be a bearish signal.

USD/CNH:

Spot: 6.8681

USDCNH maintained below the 6.9000 resistance, even after news emerged earlier today that China probably will refrain from following the Fed in hiking rates. The currency pair has largely fluctuated between 6.8000 and 6.9000 over the past month.

USD/JPY:

Spot: 112.70

USDJPY pulled back from a key resistance level at 113 and looks poised to register its first declining session in five. The yen is headed for a second quarterly loss as its central bank maintains its record stimulus while the Fed has tightened 8 times since December 2015.

GBP/USD:

Spot: 1.3153

GBPUSD was little changed earlier today despite an eventful session overnight. The pair erased overnight gains as uncertainty about Brexit kept investors on their toes.  The pair peaked at 1.3216 right after the Fed monetary policy announcement but trimmed gains after some second toughs to what the removal of “accommodative” to the statement meant. Sterling pound, however, is still struggling for direction, hovering around its 100-day moving average.

Sources: Bloomberg