Key Themes at Play in the Markets:
source: finviz.com
On Monday, the sentiment was clearly dominated by USD weakness as the market comes to terms about the lower-than-expected 10% tariffs by the US on $200b of Chinese imports. One of the arguments undermining the USD originates from the idea that the punitive move against China could have been worse, something that seems to resonate with the current state of flows.
When considering that the announced 10% Chinese tariff comes amid the depreciation of the Chinese Yuan during 2018, the actual implications for trade activity are not as harsh as feared. The notion that one cancels the other out, is a line of thinking that enough market participants bought into on Monday.
But…. after the well-flagged 10% tariff on China, the US Trump administration has come forward in the last minutes by threatening China with more tariffs on another $267b if China retaliates. The off-the-cuff headline has hit risk-sensitive instruments, such as the Aussie or S&P 500 futures, while this time, unequivocally benefiting safe-haven instruments, including the US Dollar, which has seen a decent pop higher.
US equities were sold off, with the escalation of trade tensions having its most evident impact on the tech-centric Nasdaq index, down by 1.43% at the close. The uncertainty about the potential retaliation actions that China will pursue against the US saw stocks such as Apple (NASDAQ:AAPL) down more than 2.5%. The S&P 500 and the Dow Jones suffered losses of 0.56% and 0.35% respectively.
The Canadian Dollar ends as the worst performing currency amid the absence of further trade negotiations between Canada and the US on Monday. While both sides have made it quite clear that progress has been made, the market is seeking a resolution that is not yet coming. In fact, Canada PM Trudeau said that a decision might be days or weeks away. The latter remark exacerbated the selling in the Loonie. Canada’s Trudeau has vowed to stand up for dairy farmers, which remains one of the sticking points to potentially hash out a deal as part of the NAFTA talks.
In contrast to the slew of positive economic indicators out of the US, Monday’s US empire manufacturing for Sept came at 19.00 vs 23.00 exp. Business activity in the NY state continued to grow albeit at a more moderate pace. Firms remained fairly optimistic in the next 6 months.
Despite the weakness in the US Dollar, EM currencies continue under pressure as the Chinese vs US trade war worsens. The EM-weighted currency index is not far from recent trend highs. The MSCI EM index has also suffered losses in tandem with the Shanghai Composite, down by over 1%.
A contributing factor for the appeal of the Euro has clearly emanated from the latest reports out of Italy, where the Italian FinMin has been vowed to hold a budget deficit of 1.6%, which is significantly lower than the 3% cap set by the EU. As a result, the Italy 10-Year vs German 10-yr bond yield spread saw a further slide from 2.51% to 2.37%, undoubtedly helping the bid tone in the Euro.
The lack of new developments in the Brexit front allowed the Sterling to correct higher, in a move that was also clearly fueled by the vulnerability of the US Dollar across the board. In an interview with the BBC, UK PM May said rebels in her party must endorse the Chequer’s Brexit deal with the EU or else there will be no deal. For now, the benefit of the doubt is helping the Sterling, which as pointed out, has been trading with much more pessimism than optimism priced into.
The USD sell-off must be put into proper context, as it occurs amid a barrage of trade war-related headlines which may easily lead to losing sight of the forest for the trees. One must be reminded that the case to be pricing further rate hikes by the Fed above its long-term neutral rate is still very much a valid one following the clue provided by Fed’s Brainard over the need for ST above-average neutral rates in the US (prob around 3% by Q2 2019) as part of a speech in Detroit last week. In other words, the market has lots of room to price this story into the USD in the next few months.