The new tariffs on China delayed

We had two important developments this week making headlines around the globe.

Firstly, bowing to pressure from concerned business leaders (according to Bloomberg), the US President Donald Trump delayed tariffs imposed on certain Chinese imports until December 15th this year. The decision (on Tuesday) sparked a relief rally in global stocks, after heavy selling seen on the previous session.

However, that was short lived as Wednesday, the markets were rattled again when the yield on the benchmark 10 year US Treasury note was at 1.623%, moving below the 2 year yield at 1.634%.

Why is that important? Because it has been a reliable, yet sometimes early, indicator for economic recessions over the past 50 years. Credit Suisse reported that when the inversion occurs a recession follows on average within 22 months. But they also included some positive news. The same report shows the S&P 500 is up, on average, 12% per year, from the time of inversion until the recession kicks in!!! (could the market be the final last gasp upsurge, the last bit of a price rally before collapse?)

Meanwhile, China’s National Bureau of Statistics reported the economy is growing at a stable pace and the reason for a slowdown in retail sales in July was weaker auto sales. It added that consumption has huge potential with employment also as expected. Nonetheless July industrial production was +4.8% year on year, versus expectation of +6.0%, the slowest growth rate since February 2002.

In the UK, there is now speculation that a general election could be on the cards. Britain leaving the European Union on Oct 31, deal or no-deal, does not seem to satisfy the opposition MPs as well as a good chunk of Conservatives. So much so that Prime Minister Boris Johnson accused the rebels from both parties of conspiring with Brussels. The ongoing political uncertainty has kept the GBPUSD under heavy downside pressure touching a low of 1.2014 on Monday.

Meanwhile the German economy, EU’s biggest, saw a slump in the second quarter GDP (albeit small one of 0.1%) which puts increasing pressure on Chancellor Angela Merkel to kickstart fiscal stimulus. It seems the US-China dispute has a heightened negative effect on the nations relying heavily on their manufacturing base. According to European Central Bank exports of goods and services accounted to 28% of the EU GDP in 2017 compared to only 12% for the US.

China’s counterpunching?

Gold prices continue to rally, moving above the psychological $ 1500.00 mark, as Sino-US disputes make the central bankers around the world rather edgy. A case in point, the New Zealand Central Bank cut its benchmark interest rate by 50 basis points from 1.5% to 1% versus expectations of only 25 basis points cut. The Reserve Bank of India and the Bank of Thailand followed suit. The precious metal reached $1510.00 although has since had a minor pullback on Friday morning, back below the $1500.00 mark.

China’s own currency, the onshore yuan fell to an 11year low, now costing more than 7 to buy one US dollar which indicates that the Chinese may not rush to support it any time soon, or at the least support it less than they have recently. The Trump administration was quick to label China ‘a currency manipulator’, leading to People’s Bank of China Governor Yi Gang saying his country ‘will not engage in competitive devaluation’ CNBC reports.

On the other hand, some analysts expressed views that allowing yuan’s freefall, Chinese government has in fact weaponized its currency as the trade war intensifies.

The US stock markets started the week on the back foot as Monday saw a selloff of more than 3% for each of Dow Jones, S&P and Nasdaq. Although a rally back was observed on Wednesday, it seems the US stocks are ending the week under renewed downward pressure.
Back in the UK the second quarter preliminary GDP figures showed a drop of 0.2% versus expectations for a flat result. In reaction to this first quarterly contraction since Q4 2012, the pound sterling fell below 1.21 vs the US Dollar. It seems that every central banker in the developed world is trying to devalue their respective currencies by slashing rates and/or other easing measures. But the Bank of England benefits from that, mainly on the Brexit saga and a slump in the GDP without much effort on their part elsewhere? Not bad.

ECB published the economic bulletin after its July policy meeting expressing concerns that the current climate of “prolonged uncertainty” is “dampening economic sentiment”. The manufacturing sector is one to keep an eye on. Market participants seem to anticipate weaker growth in the coming quarters, therefore leading to a potential restart of Quantitative Easing. Nonetheless, the EURUSD moved higher during the week hovering around 1.12 currently.

So, if the widespread consensus a few months back was that a deal between China and the US could be struck by the end of 2019, now that favourable outcome appears to be becoming increasingly doubtful.

China strikes back

Last week US President Donald Trump announced 10% tariffs on the remaining $300 billion of Chinese imports. The move came after the Federal Reserve was less dovish than Trump’s liking (judging by his tweets).
In reaction, China’s Yuan weakened to a record low against the US dollar, as more than seven yuan are needed now to buy one greenback. As a consequence, the US Treasury was quick to label China a ‘currency manipulator, devaluing the yuan while maintaining foreign exchange reserves, despite using such tools in the past’. Now, it is acknowledged that China’s currency does not float freely but is managed as a matter of policy. By and large it only fluctuates within a predefined channel.

Nonetheless there is a widespread opinion that China has in fact kept the yuan strong, in the past, for two main reasons. Firstly, if China wants to keep growing by exporting to the world (Belt and Road Initiative is testimony to that) they will want to make yuan part of global currency reserves club (up there with the US dollars, euros, yens, pounds and so on). One cannot do that with a shaky currency.
Secondly, China is, and has been, worried for a while about capital flights. At any sign of currency trouble, investors (foreign or domestic) could decide to take their cash out of China. So defending the yuan is a way to discourage capital outflows.

But in order to do that China needs to sell US dollars. Ok, it has a trillion dollars in reserves, but why squandering these reserves to prop up your own currency, in the middle of a trade dispute. Especially when the other side desperately wants a weaker currency themselves. Does that mean the trade dispute might take longer than initially expected? We shall see.
Interesting to note is that a devalued Chinese yuan could export deflation all over the world. And that’s the last thing the West needs amid low growth, low interest rates and ongoing weak inflation.

From the technical analysis point of view, the chart shows the overall trend in USDCNH is bullish.

We saw a sharp rise above psychologically important 7.0 mark recently. That level proved good resistance in December 2016 as well as October last year. It managed to break above the sideways range of 6.68 – 7.0 where it has been fluctuating since March 2018. So the uptrend remains intact.
The price now sits comfortably above the 9 week (red) and 21 week (green)moving averages so a retracement to resistance turned support of 7.0 could be considered. We note that the 9 week moving averages has crossed above the 21 week moving averages in May this year which, in hindsight, proved good buying signal for USDCNH pair. Interestingly these moving average crosses were effective signals, both in January 2019, when they gave an indication of a bearish move, and end of May 2018, a bullish trend (blue circles).

There are a string of lower supports, which proved good levels, at 6.90, 6.85, 6.79 and 6.68 shown by the red stripes. We note that support around 6.68 mark also represents 50% Fibonacci retracement from a high of 7.13 to a low of 6.24 (February 2018) alongside 6.79 as a 61.8% Fibonacci retracement.

Currency wars are back?

US President Donald Trump tweeted that China and Europe are manipulating their currencies to compete with USA and not to be left behind, Bank of England Governor Mark Carney also talked down the pound sterling. Federal Reserve Chair Powell’s testimony to Congress was seen as dovish, suggesting an interest rate cut in the US later this month is a done deal. And that would happen amid full employment, solid economic growth of 3% per year and S&P 500 reaching an all time high above 3000. All leads to the suspicion of a return to a currency war?

Gold remained above $1400 mark as Bloomberg reported that central banks buying in 2019 is on track for 700 tons, which represents an increase of 73% compared with last year. The main reasons were slowdown in economic growth, geopolitical tensions and trade disputes as well as attempts to diversify reserves from fiat currencies.  

China June Inflation data showed CPI at 2.7%, in line with expectations the lowest since August 2016, which could be problematic for industrial profits going forward.

In the US, FOMC June meeting minutes saw many Fed officials calling for a rate cut as a ‘cushion for shocks’ adding that inflation expectations were inconsistent with the 2% goal.

In UK, the pound fell below 1.25 to the dollar to a low of 1.2440, the weakest level since April 2017. The slump was based on the lingering Brexit uncertainty still weighing on the economy which is expected to contract in Q2, the first time in 7 years. UK Prime Minister contender Boris Johnson maintains that the country must be prepared to leave EU without a deal. On Friday GBPUSD rebounded slightly around 1.2550.

Meanwhile the former International Monetary Fund Chief Christine Lagarde is set to be confirmed as the new ECB President in October. At the same time European Commission warned of rising downside risks and downgraded the euro zone economic outlook in its latest forecast. ECB minutes also indicated a governing council agreeing on the need to prepare for policy easing. Despite that we can see EURUSD holding between 1.1240 to 1.1280 range.

US-China trade talks at G20

Gold’s breakout above levels that held repeatedly since 2013, making a high of $1439, has been described as a perfect storm of technicals and fundamentals. Geopolitics, in the form of US tensions with Iran, Sino-US trade dispute, a Federal Reserve getting ready to ease again constantly bullied by a President who desperately wants a weaker dollar (and higher stock market), all lined up to support the precious metal.
China’s Commerce Ministry said tariffs by certain countries are a threat to the global economy, although they agreed to keep open the communication channels with the US. Meanwhile US Commerce Secretary Wilbur Ross reiterated Trump’s tariffs threats are not a bluff, although his camp is looking for a ‘reasonable deal’ with China over trade.
Presidents Trump and Xi will meet on Saturday in Japan at the G20 summit and the media seems cautiously optimistic, although both sides aren’t giving much away.
Boris Johnson, the front runner to become the UK Prime Minister, said Parliament is now ready to back a no-deal Brexit and repeated his promise to exit by October 31 this year. Fear grows among Brussels politicians that a no-deal Brexit is increasingly becoming unavoidable. After encountering good support at 1.25 to the dollar, the sterling soared to 1.2750 which was good resistance in the past.
ECB President Mario Draghi hinted last week that more stimulus will be needed if the outlook remains concerning, amid lingering uncertainty regarding trade tensions. A string of economists were quick to predict the central banker will emphasize that more and more in the near future and eventually take action, possibly from September onwards. The EURUSD is sitting just below 1.14.
After going south for a good 18 months, Bitcoin more than doubled since early May reaching above $13,800 and the steep surge made everyone remember the booming second half of 2017. It retraced to $10,500 and looks to be stable just below $12,000 on Friday. However Bloomberg reports ‘the pop culture zeitgeist isn’t quite as giddy’ as apparently Google searches for the word bitcoin were five times higher in December 2017. On the other hand, that episode made Bitcoin & co significant enough that a lot more people are now clued up about them. Facebook announced plans to issue their own crypto currency, Libra, in a sign that institutional adoption is gathering pace.

Gold price breaks higher

Gold made a break above the $1350 – $1360 area which has offered solid resistance for the last few years, reaching $1400 level. The move came after the Federal Reserve hinted it will soften its monetary policy thus hurting the greenback.
China has cut its holdings of US Treasury by $7.5 billion in April to $1.11 trillion, the lowest mark in almost two years according to Bloomberg. At the same time People’s Bank of China added 240 billion yuan into the banking system, via a one-year (medium term) lending facility, in an attempt to increase banking liquidity. To further counter the US tariffs and limit the damage on its economy, China has lowered duties on non-US imports.
The US Federal Reserve held interest rates unchanged in a range between 2.25% – 2.5%, as anticipated, but added the economic activity has been rising at a moderate pace (changed from ‘solid pace’ last month). Chair Powell acknowledged that inflation dropped, trade risks have grown but ‘he wanted to see more’ before cutting. Markets have now almost fully priced in a rate cut of 25 basis points in July with further cuts expected to follow. Quite a turnaround over the year..
After dropping to a recent low of 1.25 to the dollar, the pound sterling managed a small rebound following steady inflation data with CPI figures coming in at +2.0%, in line with consensus. However, selling pressure remains with the continues political uncertainty. On Thursday, the Bank of England left its benchmark rate unchanged at 0.75% with overall language also remaining the same.
Meanwhile ECB President Mario Draghi said more rate cuts are part of the central bank’s key tools, joining the US Fed in taking a renewed dovish stance. Ironically, such actions attracted indignation from President Trump who tweeted that ‘ECB chief remarks make it unfairly easier for them to compete against the US’.
Reserve Bank of Australia has released its June 2019 monetary policy board meeting minutes saying further easing would be appropriate. The labour market, in particular, would be expected to bear the most weight, although lower rates are expected to push down the value of Aussie dollar.

Rising chance of Fed rate cut?

 The US dollar started the week on the back foot following growing speculation that a rate cut is back on the table at Federal Reserve. There is no end in sight for the trade dispute with China and its increasing impact on global markets is definitely making investors nervous. The week ended with disappointing non- farm payroll figures of 75K versus the expectation of 175k, which leads to the US dollar expected to lose value further. 

Replying to repetitive accusations against his country’s policies, China’s foreign ministry said that every setback in trade talks is ‘due to US breaking consensus’. Amid stalling negotiations, it is unclear if China will devalue its currency in retaliation to US tariffs or employ a more targeted approach i.e. restrict exports of rare earths to the US (China accounts for more than 70% of global output). 

Back in the UK on the Brexit front, Tory leadership contender Boris Johnson said if he gets in ‘we’ll come out of Europe with a deal or no deal by 31 October’. The no deal option is causing a lot of uncertainties within UK, which could possibly cause sterling to drop across the board. 

European Commission reportedly has sent a letter to Italy blaming it for a violation of debt reduction rules and is preparing to apply a $4 billion fine. Responding to this, Italian deputy prime minister Luigi Di Maio commented the EU made ‘absurd’ requests on investments. Away from domestic squabbles, economic fears spread as the European Central Bank signalled its readiness to embark on a fresh round of bond purchases. So we have a dovish signals from both the ECB and the Fed, but the euro is the currency currently coming out stronger breaking above 1.13 against the greenback. 

In a move that was widely anticipated, the Reserve Bank of Australia’ cut cash rates by 25 basis points from 1.5% to 1.25% at its latest monetary policy meeting on 4 June. That represents a record low for Australia and is the first slash by the central bank since August 2016. The decision was taken to support jobs growth, achieve inflation target as well as to deal with a weakening housing market. 

US June payrolls up by 224k vs 160k expected

 Gold tumbled to $1383 on the back of a stronger USD, following a positive meeting between Chinese and US Presidents over the weekend. Nonetheless the sell-off was rather short lived and a rebound soon followed with the precious metal pushing back above $1430 within two days. Hitting perfect technical retracement levels. 

The highlight of the Trump-Xi meeting at G20 summit is that both sides have agreed to restart trade talks and there will be no new levies on Chinese goods. Meanwhile the focus shifted with and the US proposing to add more tariffs to $4 bln worth of EU goods. 

China’s June Caixin Manufacturing PMI came in at 49.4 vs 50.1 anticipated. It is the second lowest reading since June 2016 showing a contraction in manufacturing as the overall economy slips further into the red. However Premier Li Keqiang was adamant earlier in the week that China will not resort to yuan devaluation. 

ECB policymakers seemed confident they don’t need to add monetary stimulus in July preferring instead to wait for more data on the economy (no mention of QE). EURUSD was on the downside for the whole week testing lows of 1.12 at the time of writing. Meanwhile EU leaders agreed to appoint Christine Lagarde (the current IMF chief) as the next ECB President 

OPEC agreed to extend the production cuts by an additional 9 months, concerned with the excess oil supply from the US. The trade truce is seen as bullish for global growth but the rally in oil prices was short lived as the markets came off the highs. 

On Friday, the US nonfarm payrolls report showed 224k jobs were added in June, a lot higher than markets had anticipated. In reaction, the Dow fell 100 points and gold prices slipped below $1400 (hovering around $1415 before the announcement) amid a strengthening US dollar. Analysts were quick to speculate the numbers would now make it much harder for the Fed to justify a rate cut at the next meeting ( if it wasn’t for a meddling President who has three words in regards to monetary policy ‘cut cut cut’….). 

The pound sterling started the week on the back foot due to ongoing poor UK data. It fell below the previously good support level of 1.25 USD after the US jobs report.