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China Tariff Cut Was The Eureka Moment But It’s a pre-NFP Friday And The Situation In Hubei Still Looks Challenging

Stephen Innes

Markets

It was another good day for global equities, which saw the S&P500 up 0.2% to notch a fresh record high. European stocks again saw similar gains. US 10-year treasury yields slipped 1bp to 1.64%. The eureka moment came on the back of China’s pledged tariff cuts, which has captured the imagination of analysts and bullish investors alike. And with indications that the coronavirus outbreak is plateauing outside of China, it too provided an open invitation to strap on risk as investors appear increasingly prepared to shrug off concerns about the viruses enduring impact on growth.

Provided the US reciprocates the Chinese tariff cut with one of its own, the trade calm will be viewed in a very trade-friendly light and well beyond the immediate fiscal benefits. The sweetener is a fantastic pacesetter for Phase 2 of the trade negotiations. Still, the frontrunning commitment is also very reassuring after the legacy of delays to Phase One while also eases some coronavirus growth concerns.


Why market could pare risk today

Beyond the usual pre NFP moves which typically sees traders jockeying for a position amid their regular Friday housekeeping duties

While the outbreak appears to be stabilizing outside Hubei Province, but the situation in Wuhan and Hubei may still be challenging, and the disruption to China’s economy will likely continue in the short term. This may give cause for pause or at minimum investors coming up for air as the street feels a wee bit long after aggressively front running both the reflation and Wuhan transitory trade this week.

And the possible equity market correction when the full economic impact of the virus is realized in the next series of ASEAN data releases is supporting the gold market diversification hedge.

Outlook for next week

With the thought that global central banks are more than willing to cover the markets back, the extent to which investors look through” weak China data in the coming weeks will help determine whether this week’s risk rally has the legs to run.

Remember, its an election year, and a timely roll back in a chunk of US tariffs could trigger a move in the S&P500 to 3500 all but assuring a Trump victory.

Gold markets

Gold suffered quite a capitulation this week, yet demand endures.

  • The gold seasonality effect is ebbing.
  •  The Wuhan shock and awe fear are receding.
  •  US exceptionalism inflows are punching both SPX and USD tickets higher.
  • US 10-year yields have begun to move off their post-coronavirus lows, and less easing is being priced in, yet gold endures.

Why is gold so strong? Wednesday’s strong ADP payroll result has put the USD back atop the king of the hill, and the US currency looks firm. Equities have been surging, with new highs hit in the US and European markets, and bond yields have been nudging higher. All this implies lower gold prices. Not to mention weak EM physical demand, where the bulk of the world’s gold bullion is purchased. Yet gold still remains firm.

Ultimately in this Risk on Risk off (RoRo) environment, gold is perceived as a fantastic asset to hold if equities correct. Investors do not have, in many cases, better alternatives with the bulk of government bond yields globally are still negatively yielding. So, gold remains bought for portfolio diversification and as a quality asset, which seems to have room to outperform other safe havens regardless of whether risk sentiment deteriorates further given its strong inverse correlation to lower short term interest rates.

In short, gold offers an excellent hedge with the market possible, returning its focus to US-China trade headlines while US election risk comes into focus.

Oil markets

PEC+ technical meeting results in a recommendation for a 600kb/d production cut. This will need to be discussed at a ministerial meeting at a date that has yet to be agreed upon. This cut would be above the low end of the range recently mentioned in press reports, but well below the high end (1mb/d+), and price action is enough to tell you the market is disappointed

But the bigger fly in the ointment is Russia as the remain a reluctant cutter given their breakeven are much lower, so we’re starting to see the U-turn in prices I alluded to yesterday if Russia doesn’t play ball. Still, we’ve seen this all before, and at this time, there is little reason for the market to suspect Russia will break from the usual pattern of flip-flopping until the last minute but ultimately agreeing to cut.

Regardless of Russia’s motivations, the 600kb/d may only provide little more than a band-aid on a broken leg as more oil price downgrades are expected to come down the pipe due to ruinous demand effect the virus is having on Chinese consumption. For instance, the more pronounced the virus effect is on China, the more significant the oil demand devastation as estimates are now getting nudged higher to 3.2Mbd + (~25% of China demand and ~3% of the global market) amid the extended period of industrial and consumption gridlock in the Chinese economy.

But with the market preparing for (black) swan dive, its critical that OPEC + compliance comes through to put a floor on oil prices.

Currency markets

Asia FX

To the extent that currency traders are willing to front-run both the global reflation and Wuhan transitory trade in the absence of quantifiable economic data will dictate the pace of play in Asia FX.

The Ringgit is trading to the top end of my weekly range. Possibly due to  Malaysia’s export sensitivity to a weaker China economy, and now with local traders are adjusting risk tolerances for a possible BNM proactive interest rate cut, we could see a bit more weakness into the weekend. Indeed, this could be a case of short-term pain long term gain, but look for 4.15 to hold; however, as bond inflows should pick up with a rate cut in the offing.

With a litany of ASEAN central bank cutting interest in the face of weaker economic growth, ASIA China sensitive FX may not be the best place to hold currency balances with the US dollar holding firm. Let alone leveraged foreign exchange risk over the short term, given the market risk on risk-off (RoRo) proclivities around the key bellwether USDCNH.

While the Wuhan rebound trade could be a home run this year, traders may feel more comfortable getting the widely expected doomy China’s high-frequency data and regional export numbers, which are going to be weak, out of the way before entering the rebound trade.

Currencies that are most sensitive to the China/Asia growth cycle and commodity demand took a hit during this growth scare. The Won and Aud stand out the most. While currencies with high real yields have performed surprising well like the IDR, as the Indonesian bond market remains extremely attractive for real money investors

G-10

The Eur continues to languish through the Risk on-risk off RoRo cycle. There is no haven appetite as Europe has the developed world’s lowest real yields. But when risk appetite turns on, because of those low yields, the Euro becomes the world’s best funder as everyone short trades the Euro to fund those EM carry trades. It’s a continuous cycle of ” lose-lose ” for the Euro in a “RoRo” environment.

 

This article was originally posted on FX Empire

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