Trade tensions widen, remain in safe havens; Decline in US ISM services further raises Fed easing expectations
- USDCNY/ CNH’s break through 7.00 (currently 7.05 and 7.126 respectively) sees a sharp escalation in risk aversion as the VIX Index hits 24.0 (a 10 big figure rally since July 31), Asian equity indices fall in the red and the Dow Jones loses more than 700 points overnight. In FX, risk currencies (commodity and Asia EM FX) make new lows while the key beneficiaries remain safe havens (JPY, CHF & Gold) and EUR and in FI, sovereign debt (US Treasuries, Bunds, Aussie bonds etc) finding new low in yields (UST 10Yrs currently 1.71%).
- PBoC blames US unilateralism and tariffs for CNY/ CNH’s break above 7.00 while overnight, USTR formally declares China as a Currency Manipulator. This leaves little room for negotiations between US and China and sees the current financial market set up (elevated risk asset prices, remaining longs in risk and carry assets, low liquidity during summer, US-China trade tensions, maturing central bank trades) favoring defensive positioning in FX.
- What next? Following USTR’s labelling of China as a currency manipulator, US Treasury Secretary Mnuchin “will now engage with IMF to eliminate “unfair competitive advantage” created by China’s latest actions”. Traders are also focused on state-run newspapers, which suggest President Xi would likely reject any deal that keeps US tariffs or forces China to make concessions on key issues like state-run enterprises. Nevertheless, talks between the US and China are still scheduled to proceed in September. Possible FX intervention talk by US is also on the radar with a Citi analyst survey of FX clients seeing 20% of respondents expecting intervention (since then, White House has explicitly discussed intervention so share may be higher). Any coordinated US Treasury – Fed intervention is most likely seen against EUR and JPY.
- US ISM non-manufacturing falls to 53.7 in July, the weakest print since 2016, with new orders and business activity declining substantially to 54.1 and 53.1, respectively. Responses in the survey cite trade uncertainties and increased costs due to tariffs. Citi analysts expect the Fed to likely lower rates by 25bp in September but a more prolonged cutting cycle is not the base case. However, a deterioration in hard data (or a sharp escalation in US – China trade tensions) could cause the Fed to pursue more aggressive easing measures that could further undermine USD sentiment against the safe havens (JPY, CHF and Gold) and EUR.
Euro area composite PMI points to sub – 1% GDP growth; Brexit - Will UK get an early election?
- Euro zone composite output PMI declines 0.7pts MM to a 3-month low of 51.5 in July vs. 52.2 in June and consistent with only modest GDP growth of sub-1% annualized. However, with markets now fully discounting more than 20bp of ECB rate cuts as well as prospects of resumption of QE, the impact on EUR is limited with EM outflows (as a result of the sharp escalation in US – China tensions) now putting a solid bid back into EUR.
- GBPUSD chops around 1.2140 as UK Labor leader Jeremy Corbyn confirms that he will seek to call an "early" confidence vote in PM Johnson. Citi analysts expect a “No Confidence” motion to be launched in the first week the UK parliament returns from recess (week of September 3). A successful “No Confidence” vote looks to be the best chance to avoid PM Johnson’s “No Deal” Brexit.
Week Ahead – RBA & RBNZ, solid Canadian jobs
- No RBA rate today - RBA Board’s 50bps of policy easing has yet to be captured in activity data, which also has yet to show the impact of the Federal Government’s tax cuts. At the same time, the housing market has started to improve. It is therefore likely the RBA Board will keep the cash rate target unchanged at today’s meeting though Citi analysts still expect the RBA to cut 25bp in November.
- No RBNZ rate cut this week either – Citi analysts expect the RBNZ to keep the OCR stable at 1.50%, but policy guidance should remain dovish. In looking at the economic outlook, the RBNZ MPC is likely to continue to focus on the balance between the downside risks to global growth from geopolitical tensions and ongoing weak domestic business sentiment versus likelihood of stronger government spending and better starting point for 2019 of Q1 GDP growth being stronger than expected.
- Canadian July employment should be indicative of a still-healthy labor market with 19.5k jobs likely added, steady unemployment rate of 5.5% and an above-consensus call for average hourly earnings of 4.0%YoY. Citi analysts base case is for the to continue to keep rates on hold.
USDCNY past 7 - Asia EM FX loses an important anchor
- USDCNY’s push past 7.00 yesterday represents a key psychological impact and raises anxiety over further complicating US-China talks while weighing on broader risk sentiment. It also opens up room for further weakness of the CNY CFETS basket… since disruption of US-China trade talks in early May, CNY has weakened vs. it trading-partner currencies with the CFETS basket dropping about 3% from year’s highs between May-June.
- Well behaved and stable price action of CNY/CNH for most of this year has served as an important anchor for EM Asia FX during times of risk-aversion and USD strength. With this break higher in USDCNY however, EM Asia FX has lost this anchor, and subsequent risk aversion may see Asian (and commodity) currencies weaken further. Moreover, policy makers in several Asian countries may also be wary to committing too many resources to intervention in a broad risk aversion move, driving the local currencies weaker across the board.
This is an extract from the Daily Currency Update, dated August 6, 2019. Please approach a Citigold Relationship Manager if you would like more information.