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Trade, Earnings, Teapots And The U.S. Dollar

Published 07/16/2018, 12:03 AM
Updated 03/05/2019, 07:15 AM
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Strong domestic growth and on-target core inflation continue to suggest the US economy is in that happy place, but this week’s US economic data will begin to shape market expectations for Q2.

And equally significant will be Fed Chair Powell’s semi-annual monetary policy testimony before the Senate Banking (Tuesday) and House Financial Services (Wednesday) Committees. We should expect Powell testimony to reflect the minutes of the June 13 meeting broadly. But members did note the increased risk to their base economic outlook from trade wars, but since then, President Trump has tabled a review of tariffs on $200 billion of additional goods from China. But of course, this escalation was widely telegraphed by the Trump administration, which suggests the FOMC trade concerns were based on the 200 billion in trade war escalation anyway.

However, the new tariffs would not be put in place before the end of August and could be even further kicked down the road as the US and China seek to a secure a lasting bilateral trade based on freer and fairer policy.

But, should the US eventually move ahead with these tariffs, China could not escalate on an even basis given China only imports roughly 130 billion annually from the US suggesting they would either need to levy higher trade tariffs on a small number of selected products or take the least attractive measure of tactically weakening the Yuan. Hence the lack of immediate response from China, as administrators will be ultra-careful not to send the wrong signal triggering another market melt in China.

One does get the sense that investors believe this latest threat from Trump will bring back both parties to the negotiating table and yield some form of compromise.

Economic Union (EU) chiefs Jean-Claude Juncker and Donald Tusk will take their anti-Trump trade roadshow to China and Japan hoping to preserve some semblance of free trade world order. And as opposed to Trump's fire and fury style of negotiation, there’s excepted to be fewer fireworks although the EU leader will press China for free access to China markets while discussing China's propensity to dump cheap steel on EU markets.

But absent continued headline risk from trade war this week, desk noise should be a few decibels lower, but it will be far from a walk in the park, with the Trump-Putin still tentatively set for Monday despite Friday's “coincidental” set of indictments of 12 Russian military intelligence agents in Mueller-gate. While this isn’t great news for US-Russian relations, unless the citations reveal an actual smoking gun, don’t expect too much to be focused on this despite the abundance of partisan political posturing.

US markets

What trade war? It is clear as a bell the US economy is on fire. Soaring business confidence and corporate tax cuts are fueling surging company profits, but more significantly for the prolonged effect, Americans are returning to the work force en masse.

So, despite all the trade war bluster, US markets continue to grind higher, even with numerous trade headwinds. Indeed, the only thing unlucky about Friday the 13th was for equity market bears.

But earnings season is always a bit of a wildcard, and with investors hoping for a continued buying binges. They could be a bit disappointed given that sentiment continues to run at peak optimism, even more so, if markets start dialing more trade war pessimism into the calculus.

To keep the US equity market wheels greased, this week’s key US economic data will be so crucial in shaping investor expectations for Q2, especially around the retail sales data.

Among the companies due to report are Bank of America (NYSE:BAC), Goldman Sachs (NYSE:GS), Johnson & Johnson (NYSE:JNJ), Morgan Stanley (NYSE:MS) and Microsoft (NASDAQ:MSFT).

Oil markets

The oil market consolidated into the weekend as traders were still rehashing the myriad developments which saw prices head sharply lower last week. The reported increase in Libyan crude oil production was perhaps the most significant fundamental eye-opener of the week, but then Russian Energy Minister Alexander Novak chimed in about a possible supply increase and then stated Russia might swap goods for Iranian oil, a move that would severely dent the impact of US sanctions. Brent spreads have flattened on position unwinding but perhaps overcorrected

Also, the decline in China’s crude oil imports for June raised a few eyebrows on Friday and did weigh negatively on the demand side of the equation. But given that China crude import numbers are highly volatile, the markets tend to sidestep a one-off print. But looking under the hood, China's crude imports fell -12.04% month on month to 34.35 m tons last month, its lowest level since December. Reduced imports were likely due to China ordering at least five independent refineries (teapots) in Shandong to cut run rates ahead of the Shanghai Cooperation Organization (SCO) summit to be held the port city of Qingdao on June 9-10. So, it possible the teapots will gear up again on additional quotas.

Despite last week’s plethora of bearish signals Oil prices rallied towards $71.50 during Friday’s New York session, but the rally was cut short by media headlines suggesting “The Trump administration is actively considering tapping into the nation’s emergency supply of crude oil as political pressure grows to rein in rising gasoline prices before the mid-term congressional elections.”

While trade war rhetoric should subside this week and could be a possible plus for oil prices, with the Trump administration actively considering tapping into the nation’s Strategic Petroleum Reserve, it could weight negatively on traders' cerebral side of the oil price equation.

Gold Markets

The precious space continues to hold critical support at $1,240, but the gold complex remains under pressure. US equity markets continue to trade well triggering few if any defensive allocations into gold as ETF flows have remained muted lately. With sluggish demand for precious metals and the USD on solid footing, gold prices will stay pressured lower for the foreseeable future as gold has wholly lost its glittering appeal in this enduringly bullish equity and USD environment.

While gold does look increasingly oversold with a strong fundamental backdrop gold investors remain sidelined.

Currency Markets Overview

The dollar opened a bit softer this morning likely influenced by an escalation of headlines around Meuller-gate, a miss on the University of Michigan Consumer Sentiment and the resulting fall in US yields. But these ensuing minor position adjustments should not change the big picture opinion, specifically a stronger USD near-term.

JPY

The massive move in USD/JPY last week which caught everyone flat-footed given the volumes turned and the breadth of the movement. The break above the yearly highs does suggest this move has more ways to run although, during Friday trading session, flows were much more balanced perhaps reflecting the softer Michigan Sentiment index and the negative US political fallout for Mueller-gate escalations. USD/JPY is signalling the most significant break out in years, and the long USD/JPY is a position severely under-owned which suggests the pair will explode higher on any positive news. One can only imagine spot will trade if an intense wave of risk on kicks in or trade war fizzles out.

Only a week ago we were lamenting on how USD/JPY was the low beta range trade so what the heck changed? For one, equity markets are surging, two year US yields are moving higher, but that only paints a corner of the picture.

1) There is the fair value argument that USD/JPY is undervalued supported by interest rate differentials

2) Trade war fears are good for the US dollar because it could shrink the trade deficit when they become competitive enough. Primarily, if the Trump administration puts the automobile tariff in practice, it will exert a fatal blow to Japan’s economy and an already weakening trade balance, which will act as a JPY negative eventually.

3) Japanese institutional investors are increasingly looking outward for investment particularly in the US. And as well are not hedging full returns. The how the notion of Japanese investors repatriating when global risk rises are diminishing.

4) The old FOMO as traders move from what’s not to what’s hot. But arguably this position is under-owned with many structural risks off long JPY still in play, so a push into the 113 could trigger a significant extension of the current rally as more risk off hedged unwind, and more traders become believers.

MYR and the knock-on effects of the Yuan

The perfect storm of negatives saw the USD/MYR predictably take out the 4.05 level on Friday trade. Despite the KLCI trading in the green while tracking local burses higher as risk sentiment recovered on Friday, the local currency unit didn’t fare so well. Despite the apparent political overhang from IMDB investigations and political and fiscal uncertainty weighing negatively for the Ringgit. The USD started to reassert itself, and when coupled with increasingly bearish signals from the oil patch, the market was prone to a selloff. But even worse when Asia shows signs of recovering, the Ringgit continues to lag the moves.

Besides, the RMB complex continues to set the pace of play in regional currency markets, and besides the daily risk YO-YO on equity markets taking its toll on regional sentiment, with the PBoC weighing possible policy options around mainlands economic slowdown, this uncertainty is having an adverse knock-on effect in local currency markets. Uncertainty around policy, trade and retaliation will keep the riks reward needle skewed negatively for the yuan near-term.

However, with trade war rhetoric expected to taper this week, unless there’s a definitive shift in PBoC policy, we could expect the yuan to much less explosive and dare I say consolidate around current ranges.

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