Trade concerns hit the market hard despite a report that China and the US are making last-minute behind-the-scenes efforts to avoid a trade war starting on 6 July, when tariffs on an additional $16bn of Chinese goods will be triggered. More immediately though, Daimler AG cut its earnings outlook, citing US-China tensions. The S&P 500 was down 0.6% and NASDAQ off 0.9% from its record high, while US Treasury yields fell across the curve.
Adding to the gloom for USD was an unexpectedly large fall in the Philadelphia Fed’s manufacturing index, which dropped to 19.9 from 34.4 (29.0 expected). The new orders index saw its largely fall since 2008, which was particularly worrisome coming the day after Fed Chair Powell said companies were starting “to postpone investment, postpone hiring” because of uncertainty about the trade outlook.
Safe-haven JPY and CHF gained in response to the risk-off trend.
GBP gained after the Bank of England voted 6-3 to keep rates unchanged. The fact that Chief Economist Andy Haldane joined the two usual dissenters was quite significant, as he is an influential member of the Monetary Policy Committee (MPC). The MPC also said it will begin considering unwinding the bonds that they bought in the quantitative easing program once rates hit 1.5%, down from the 2% level that they had specified previously. Haldane’s change of heart significantly raised the market’s estimate of the likelihood of a rate hike in August to 63% from 48%. For now though I would focus more on the 28-29 June EU summit than the 2 August MPC meeting. I expect the summit to be harsh on Britain and for GBP to fall next week as a result.
Speaking of GBP, the other day I mentioned I was having trouble understanding the British Parliamentary process known as “ping pong” whereby the House of Lords and the House of Commons pass a bill back and forth until they can all agree. The House of Lords finally agreed to the EU (Withdrawal) Bill yesterday. Here is how the Clerk read out the conclusion: “Message from the Commons as they agree to certain amendments made by the Lords in lieu of amendments made by the Lords to the European Union Withdrawal Bill to which they disagreed. They agree to the amendments made by the Lords to their amendment made in lieu of an amendment made by the Lords to which they disagreed. And they agreed to the amendments made by the Lords to their amendments made in lieu of the amendment made by the Lords to which they disagree with amendments to which they desire the agreement of your Lordships.” I now feel justified in my confusion.
Yesterday morning I included this graph to show how confidence was coming back to Italy. Today I include it to show how confidence in Italy ebbed again following the announcement of two euroskeptic appointments to the Italian Senate finance and Lower House budget committees. EUR still managed to rise vs a weakened USD, however.
NZD was the best-performing currency as the market apparently agreed with me that yesterday’s decline was overdone.
A busy day today!
The main event is the OPEC meeting. With the cooperation of Russia – which last Friday said it had decided to “institutionalize” its relationship with OPEC – the group has managed to withhold 1.8mn barrels a day (b/d) from the market. Now that supply and demand are back in balance, oil inventories are back to normal, and oil prices have recovered, Saudi Arabia and Russia want to relax the production ceiling, but the others don’t – naturally, since 10 out of the 14 OPEC countries are already producing almost as much as they can. Since OPEC takes decisions by consensus, it’s unusually hard to predict this time what will happen.
There was a Joint Ministerial Monitoring Committee meeting yesterday that was supposed to hammer out an agreement for the group to ratify today, but it was unable to reach an agreement. Apparently Iran doesn’t want to agree to any increase in production by the other members, as that would in effect inoculate the world against the impact of the US sanctions that have been reimposed on the country.
There are three basic scenarios:
- The market seems to be pricing in a modest increase of 500k-800k b/d. Russia apparently is looking for 1mn to the entire 1.8mn b/d; Saudi Arabia wants a much smaller 300k; settle for something in the middle. That would more or less offset the decline from Venezuela, whose output has collapsed.
- A larger increase of 1mn b/d to offset not only lost production from Venezuela, but also the expected decrease in output from Iran as the sanctions start to bite.
- No official change in the ceiling. If that happens, Russia and Saudi Arabia are likely to increase output on their own initiative in coming months, as the Saudis did back in 2014, but less aggressively than they had hoped so as not to anger the other producers.
I think #1 would be as expected and therefore might elicit a “sell the rumor, buy the fact” response. Oil could move up slightly and with it, CAD. #2 would definitely be bearish oil, bearish CAD. And #3 would probably be bullish oil, bullish CAD.
The three currencies most closely correlated with oil are CAD, NOK and RUB. The correlation of CAD isn’t as great as it used to be back in 2016, perhaps because NAFTA has emerged as a more important driver of the currency.
Today is the start of the monthly purchasing managers’ indices (PMIs). In Europe, the EU-wide service-sector PMI is expected to be unchanged, but the more cyclical manufacturing PMIs are forecast to decline in France, Germany and the EU as a whole. This suggests that the EU economy hasn’t yet stabilized and is still losing momentum – a worrisome thought for the markets. EUR-negative.
Later in the day, the US manufacturing PMI is also expected to decline, but by rather less. The service-sector PMI is also expected to decline, but that comes after a sharp jump in the previous month and so is to be expected.
The fact that the US manufacturing PMI remains above its EU counterpart is likely to reassure investors that the outlook for the US economy is more certain and may therefore boost USD vs EUR.
Canada’s retail sales are forecast to rebound after the previous month’s decline. (I follow sales excluding autos, which is the figure that the market focuses on). Much of the rise may be just from gasoline prices, which really doesn’t say anything about the overall economy. Nonetheless, a rise is a rise, and since this is an above-trend rise, the figure should prove modestly positive for CAD.
Canada’s headline inflation rate is expected to accelerate further, vaulting into the upper part of the Bank of Canada’s target range as gasoline prices rise. But the rate of change in the “core inflation – common component” measure (a measure of core inflation that tracks common price changes across categories in the CPI basket) is expected to be unchanged at just below the 2% target. The market puts a 65% probability on a rate hike at the next Bank of Canada meeting on 11 July, meaning there’s still some question. This figure can therefore still raise expectations. Unfortunately there isn’t enough data available to judge whether the market puts more weight on the headline figure or the core figure. The Bank of Canada has said that while it expresses its inflation target in terms of the headline CPI, it “looks through” the impact of temporary factors on inflation by utilizing the various measures of core inflation to strip out their effect. “Using multiple indicators will help the Bank transparently manage the risks associated with the shortcomings of any single indicator,” is how they explain their technique. In other words, nobody really knows which measure they’ll use to decide. Possibly CAD positive.
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