With little data out, the market is focused on the growing trade war between the US and China. Shortly after the US Senate passed a bill with an amendment that would kill Trump’s rescue of Chinese telecom firm ZTE, Trump directed the US Trade Representative to identify $200bn of Chinese goods for additional 10% tariffs. Needless to say, China has threatened to retaliate with “comprehensive measures” if the US goes ahead with this plan. China-related stocks are down sharply this morning, e.g. the CSI 300 -2.85% and the Shenzhen Composite -4.35%. The S&P 500 held up fairly well yesterday (-0.2%) but the futures were trading -0.9% this morning.
Clearly it’s a risk-off environment. Against that background, it’s no surprise that the commodity currencies did badly and the “safe haven” JPY and CHF did well. AUD was particularly hard hit, for two reasons: first off, it’s often traded as a more free-floating proxy for CNY, and secondly, Australia’s economy would be hardest hit by a slowdown in the Chinese economy. USD fell, as is to be expected in a trade war that’s likely to take an increasing toll on the US economy (see Mr. Bostic’s comments below).
So far the trade war has been confined to trade. The fear however is that it may spill over into the financial world. Specifically, China could start selling off some of its massive holdings of Treasury bonds. The country owns some $1.18tn of Treasuries, or 30% of all foreign official holdings of Treasuries, which is not to mention their holdings of agency bonds and others.
Of course to some degree it would be shooting themselves in the foot to sell these bonds aggressively, because once the market realized what was happening, bond prices would plunge. However, US mortgage rates would soar as a result, and China might feel the pain was worth it to make middle-class US voters sit up and take notice.
Would that be good or bad for the dollar? Oddly enough, it might be good for the dollar. As you can see, in general USD has risen and fallen along with US yields over the past several years.
GBP fell as the House of Lords defeated the Government over giving Parliament a “meaningful vote” on the final Brexit deal. The vote kicks the bill back to the Commons. I’m not an expert on how these things are done and so I looked at the Parliament website to see what it said about the bill. It said the status of the bill was in “ping-pong.” That made no sense to me until I saw what’s happening: the House of Commons sends it to the House of Lords, the House of Lords sends it back to the Commons, Commons sends it back to the Lords, etc. etc. It’s ping-ponging back and forth as they try to work out a compromise. The lopsidedness of the vote – 354 to 235, or a majority of 119, with the fourth largest turnout on record and 22 Conservative members voting against their government – shows the resistance to the Government’s stance. I expect this dispute to go on for quite some time and to further destabilize the pound.
We had some interesting Fedspeak yesterday, with two voting members presenting quite different assessments of the outlook.
Atlanta Fed President Raphael Bostic said, “I began the year with a decided upside tilt to my risk profile for growth, reflecting business optimism following the passage of tax reform. However, that optimism has almost completely faded among my contacts, replaced by concerns about trade policy and tariffs…"Risk off"behavior appears to be the dominant sentiment among my contacts. In response, I've shifted the risks to my growth outlook to balanced.” In contrast, incoming NY Fed President John Williams said, “Our economy’s in great shape; we’re in the second-longest expansion in history,and economic data from both the United States and countries around the world continue to trend upwards.” So a mixed view on the FOMC.
A relatively quiet schedule today.
In Europe, ECB President Draghi will be giving the opening speech at the ECB’s forum in Sintra, Portugal on Price and wage-setting in advanced economies. His speech is to last 30 minutes. Then, ECB Chief Economist Peter Praet will chair the first session, on Macroeconomics of price and wage setting. Participants include St. Louis Fed President James Bullard. They break for lunch at 13:30 local time and that’s it for the day.
The only major data out from the US today is housing starts and building permits. The market is looking for a 1.9% mom increase in starts, a rebound from the fall in the previous month, but a 1.0% mom decrease in permits. A fall in permits of that degree wouldn’t be particularly worrisome though as the upward trend seems to be still in place. In any event, my research suggests that the FX market pays more attention to the starts than to the permits number. USD positive.
Overnight, New Zealand announces its current account balance for Q1. It’s expected to be slightly in surplus. However, the 4-quarter calculation of the current account as a percent of GDP will show a slightly wider deficit, because the Q1 2017 surplus, which now falls out of the calculation, was a bit larger than the Q1.
Early in the European day Wednesday, Bank of France Gov. and ECB Board Member Villeroy de Galhau will hold a press conference on the Annual Report of the Banque de France. According to Google Translate, he’ll talk about the economic situation of France and the Eurozone. We might get more insights into the ECB’s recent decision.
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