Mixed messages ahead of the G20 sees FX markets now on the sidelines

Mixed messages ahead of the G20 sees FX markets now on the sidelines     

• There is early optimism yesterday from a South China Morning Post story, citing sources that the US and China have tentatively agreed to a trade deal, which will bring the suspension of new tariffs. The source adds that the announcement of the deal will likely come in two separate statements.

• However, optimism soon fades when China’s Ministry of Commerce spokesman follows up saying that it will still consider putting firms on the unreliable list if they implement discriminatory measures on Chinese entities, adding any further tariffs will not intimidate China. Additionally, Hu Xijin, the editor of China's state-owned Global Times newspaper, tweets “two days before meeting President Xi, @realDonaldTrump claims to have Plan B and threatens new tariffs. This is a very unfriendly move and will have a negative impact for sure.” The latest Global Times op-ed from China is also not particularly accommodative, saying "China wants a trade deal, but will always reject an unfair deal. It has nothing to do with how much pressure the US applies...Both China and the US have enough room to maneuver if the two leaders' meeting fails to reach a desirable outcome."

• WSJ also suggests that China has lines in the sand ready. According to the report, Beijing is insisting the US remove its ban on the sale of US technology to Chinese telecom giant Huawei. China also reportedly wants the US to lift all punitive tariffs and drop efforts to get China to buy even more US exports than Beijing says it would when the two leaders last met in December.

• Finally, White House economic advisor Larry Kudlow weighs in when he says “ US may move ahead on additional tariffs on Chinese products…………and that the US is still insisting on structural changes on intellectual property, enforcement mechanisms to any trade deal”. More importantly, according to him, nothing has been agreed upon before the Trump – Xi meeting.  

• Bottom Line – Citi analysts expect the G20 outcome to delay further US tariffs on China and agree to further negotiations.  However, there are two-way risks going into such a major risk event and investors having already de-risked their FX portfolios to a large degree by reducing directional trades and buying safe haven currencies (JPY, CHF and Gold) and now stand on the sidelines. Taking Gold as an example, prices have peaked just shy of $1,440/oz, accompanied by a sharp reversal lower in volatility. Safe havens (JPY, CHF & Gold): A stream of G20 headlines ranging in tone overnight with the less optimistic.      

Stronger euro inflation but weaker activity data a headache for ECB; Brexit: Anti 'No Deal' plans launched to counter Boris Johnson             

• German CPI inflation unexpectedly jumps from 1.4% YY in May to 1.6% YY in June (consensus and Citi 1.4%) with Citi analysts calculating that core CPI (ex-energy and food) has risen back to 1.8% YY. The upside surprise in German CPI seems to come from a smaller decline in energy inflation than expected and a bigger increase in package holiday inflation. Interestingly, German HICP is unchanged at 1.3% YY but the data does set markets up for an upside surprise to euro zone June HICP due to be released tonight (consensus for headline is 1.2% YoY; core 1.0% YoY).

• An eleventh monthly drop in 12 months in the euro zone euro zone economic confidence (ESI - falls 1.9pt to a 34-month low of 103.3 versus consensus for 104.8, Citi 104.3) with broad-based declines, particularly acute in the manufacturing sector and across all major EA member states. This continues to build a strong focus towards the July 25th ECB meeting.      

• UK Conservative MPs resolutely opposing a 'No-Deal' Brexit will try to amend government legislation as early as next week as a way of binding the hands of the future PM. A cross party group, led by Conservative MPs Dominic Grieve and Margaret Beckett have tabled an amendment which seeks to stop UK leaving the EU in October without a deal unless approved by MPs. They hope that as the amendment is not under Labor’s Jeremy Corbyn, it will likely make Tory rebels willing to support it.              

• The Guardian reports that the first showdown could come as early as Tuesday (July 2) - "Under one plan, they will try to change the parliamentary estimates bill [...] t would stop the government being able to consume resources and spend cash if it pursued a no-deal Brexit policy". Another plan would see emergency government legislation on Northern Ireland power-sharing (slated for Wednesday, July 3) hijacked by a similar amendment. The danger with this plan is that a no-deal amendment might be ruled outside the scope of the original legislation... but they would hope to leverage the Speaker's apparent support.                   

Citi’s revised USDCNH scenarios for Trump-Xi meeting at G20        

• Base case (60%) - a benign outcome, in which the US delays additional tariff on China and both sides restart negotiations. In this scenario, USDCNH is likely to retrace modestly lower towards 6.80.

• Modest escalation (30%) - tariffs to still increase after the Trump-Xi meeting, but both sides keep the doors open for negotiation. In this scenario, USDCNH could trade towards recent highs of 6.95, though the PBoC may prefer to keep a stronger fixing to avoid excessive RMB depreciation. In this scenario, the likelihood of USDCNY breaking 7.0 remains below 50%.

• Extreme scenarios: A low likelihood of a deal soon (5%) and complete breakdown in talks (5%) - in a full escalation scenario, chance of USDCNY breaking 7 is much higher, which may be viewed as retaliation by the US. In the very bullish scenario, USDCNH could trade back to pre-May levels of 6.70.      

• This is an extract from the Daily Currency Update, dated June 28, 2019. Please approach a Citigold Relationship Manager if you would like more information.