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.

The anatomy of a rate cut

Yesterday, the US Federal Reserve cut its benchmark interest rate by a quarter of percentage point to a range of 2%-2.25% which was the first cut since 2008. Usually, stock markets enjoy when the Fed slashes rates as easing means cheaper funds which at least partially will go back into stocks, propping up prices.

However, the outcome was a drop in US share prices coupled with a higher US dollar. One could easily think neither result was intended. That seems to be opposite to a logical intention because its rather hard to believe the Fed wanted a lower stock market and/or a stronger dollar at the present time. A stronger dollar makes it harder to pay down debt as well as hurting exporters in the current trade disputes. And a slumping stock market going into election is bad for politics. President Donald Trump has been tweeting continuously, bragging about the all-time highs in shares and at the same time ‘advising’ the Fed to take measures to weaken the US dollar.

So let’s see what happened in detail.

By and large the markets had been widely expecting a very dovish Fed which means a 25basis point cut accompanied by hints the second and eventually third cut will follow by the end of the year. But faced with a rather stronger than anticipated economic data lately, the Fed struggled to justify the decision going into the meeting. It blamed the US trade policy, slowing global growth and a lingering below target inflation. Many called it ‘an insurance cut’ reminiscent of ‘Greenspan put’ (a cut in interest rates done by the former Fed Chairman at the first sign the US economy went into troubles).

Nonetheless, during the press conference that follow the decision Fed Chair Jerome Powell described the cut as a ‘mid-cycle adjustment’ adding that ‘it was not the beginning of a long series of rate cuts’. The markets were shocked and interpreted the comments being rather on the hawkish side. After all they were widely expecting a dovish statement, betting on interest rates being pretty much a full percentage point lower in the next 12 months.

In reaction, the US dollar strengthened hitting a more than two year high and the Dow Jones fell 478 points initially. It closed the day 330 points down in its worst session since May.

Now we know that the midcycle adjustments down in 1995 and in 1998 were 75 basis points each (three cuts each). On the other hand, usually when the Fed starts cutting is not a one off move. Is Powell trying to say yes I’m going to make it easier for you markets but not that easy? So poor communication or not we might expect the next Fed decisions to be more data dependent.

The main trend Dow Jones according to the chart is down. The trend turned south mid July as we can see a string of lower highs and lower lows in a move that was exacerbated with yesterday’s big drop to 26,718. The price action needs to see a rise above high of 27,402.5 seen on July 15 for the long term trend to turn bullish again.

Bearish outlook

The next immediate support is around 26,720 which held its ground during the last test. A sustain move below that level will signal the growing presence of sellers and opened the door for a test of 26,640 where bulls and bears were at loggerheads in late June. If that level fails then look for selling pressure to test 26440.

Bullish outlook

A slight rebound is currently underway but it’s hardly bargain hunting feeling more like a dead cat bounce at the moment. We need to see at least a rise above 27,000, next resistance ( and 9 day moving average ) to indicate the presence of returning buyers. If the rally back then creates enough upside momentum investors could see the rebound extend to 27,078 and possible 27,157.

To be noted that yesterday violent nosedive took the price below both 9 and 21 days moving averages and in another bearish sign 9 day moving averages crossed below the 21 days moving averages.

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.