The trade war heated up on Friday, with the US slapping tariffs on $50bn in from China, and China quickly announcing reciprocal tariffs on $50bn of US imports, mostly agricultural products. You can see how the Bloomberg grains sub-index (comprised of corn, soybeans and wheat) has plunged 11% in just a few weeks since its recent high on 28 May.
The relatively muted reaction in US stock markets (S&P 500 -0.10%, Russell 2000 -0.05%) shows though that the move was already anticipated and discounted by the US stock market, although Asian markets were hit harder today – Japan’s TOPIX and South Korea’s KOSPI were both down 1.2% at the time of writing, while China’s Shenzhen Composite was off 1.8%. Fears of a trade war or other disruption certainly didn’t boost precious metals, which fell sharply as that market looked forward to higher US interest rates.
Oil collapsed nearly 5% as the trade war threatened global growth. As the graph shows, the price of oil (roughly) follows the volume of world trade, as world trade is an indication of world output and the health of the world economy. This Friday’s OPEC meeting, which raises the possiblity of an increase in OPEC production just at a time when demand might be slowing, is also pressuring the oil price.
The tit-for-tat-tariffs plus the fall in oil hit the commodity currencies, particularly CAD as the currency plunged (along with MXN). Trump’s willingness to get into a trade war with China suggests he might also be willing to dig in his heels with NAFTA. Things look bad for CAD until later this week. In the face of such uncertainty OPEC may decide to keep the output ceiling in place for now, while an expected acceleration in Canadian inflation (to be released Friday) may also boost the currency.
USD weakened on the trade dispute, while EUR gained as a result. However, I expect EUR to come under pressure as Chancellor Merkel faces dissent within her fragile coalition. It took several months for her to form a government in the first place. Now, Minister of the Interior Horst Seehofer, who is also the head of one of the coalition partners, is refusing to follow her instructions with regards to immigrants. If he continues to go against her wishes, she may have to dismiss him. In that case, his party (Christian Socialist Union, or CSU) would probably leave the coalition, causing it to fall two votes short of a majority in the Bundestag. Watch for more news on this dispute. Note that Seehofer said over the weekend that “nobody in the CSU” has an interest in ending the coalition or kicking Merkel out, so they will certainly try to find a solution. If nothing else, this means the problem of immigration will be one of the key issues to address at the 28-29 June EU summit.
Commitment of Traders
The market stopped cutting its overall USD shorts over the past week and instead increased those positions. Wrong, wrong, wrong! In particular there was only a small fall in EUR longs, which are still at a relatively high (but not overextended) level. That may help to explain why the market dumped so aggressively on Thursday following the ECB decision: long and wrong! Investors actually increased their long GBP positions and closed out some short CHF, CAD and AUD positions. On the other hand though they increased their DXY longs, which suggests that maybe some people are turning bullish USD but just don’t know what it’s likely to go up against.
Speculators increased their positions in both gold and silver – oops!
WTI longs increased, which is interesting with the OPEC meeting coming up – perhaps the market doesn’t expect the group to agree to a hike in its production ceiling. US Treasury shorts also increased, which was the wrong way to go as US interest rates declined.
A quite day ahead, insofar as scheduled events are concerned.
Nothing on the schedule for Europe.
In the US, the New York Fed is holding its (almost) annual conference on “Reforming Culture and Behavior in the Financial Services Industry: Progress, Challenges, and the Next Generation of Leaders.” According to the NY Fed’s website, “This event will build upon previous New York Fed conferences in 2014, 2015 and 2016 on reforming culture and behavior in the financial services industry. The program will focus on assessing progress to date; exploring ongoing and new challenges; and preparing the next generation of leaders to continue driving cultural reform.” Speakers include retiring NY Fed President William Dudley and his replacement, John Williams (previously San Francisco Fed President). They won’t speak for very long however. I don’t expect anything market-moving from the conference, but you never know.
The National Association of Home Builders (NAHB) housing market index is expected to stay at the relatively high level of the previous month even though mortgage rates in the US have recently been at a 4 ½ -year high. For perspective, the recent high of 74, set back in December, was the highest level since Aug. 1999. During the peak of the housing boom, 2004-05, the index averaged 68. So the current level of 70 in the face of rising mortgage rates is really, really good. USD positive.
Atlanta Fed President Raphael Bostic speaks on the economic and monetary policy outlook. He’ll be the first voting member of the FOMC to speak since last week’s decision to raise rates. Bostic is considered a neutral/middle-of-the-road kind of guy. It will be interesting to hear his take on the upgraded economic projections and the increase in rate expectations and to see how his views have changed, if at all, because that could indicate a shift in the center of the Committee’s thinking.
ECB President Mario Draghi will give some opening remarks at the ECB’s annual conference at Sintra, Portugal. This is one of the highlights of the week. The theme this year will be “Price and wage-setting in advanced economies.” This is a big issue for central banks. They’ve all been counting on an improving labor market to push wages higher, and for higher wages to push up prices, but it just isn’t happening like the textbooks say it should (although the Phillips curve, which relates the unemployment rate to the inflation rate, does seem alive and well in the US – see graph). The highlight of the forum will be the closing policy panel on Wednesday featuring the heads of the ECB, Bank of Japan, US Federal Reserve and the Reserve Bank of Australia.
Last year, Draghi used the Sintra forum to signal a possible change in ECB policy when he said that renewed reflationary forces may provide room for “adjusting the parameters” of the ECB’s stimulus measures. His comments sparked a rally in EUR. This year however the focus is likely to be on the divergence in wage and inflation trends around the world, which may weaken EUR.
Overnight, New Zealand holds its biweekly dairy auction. The relationship between dairy prices and NZD seems to have broken down somewhat recently, however.
The minutes of the Reserve Bank of Australia (RBA)'s June meeting are unlikely to hold any surprises. The Bank left both the cash rate and its broad policy assessment unchanged at the meeting, which suggests there wasn’t much new in the discussions.
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