Markets are relieved with the PBOC’s decision to weaken the yuan at a slower pace, a sign that we might not just yet see the peak escalation in the US-China trade war. China fixed the yuan both below the 7 level and about 300 pips less than economists’ expectations. The PBOC’s stronger-than-expected fixing comes after the US labeled the country as a currency manipulator. China’s currency decision is probably more of a move to deliver some stability following Monday’s collapse and not a reaction to any action or rhetoric from the US. Since tariffs have come into play, China has been steadily lowering the yuan to offset the tariffs. If they lower the yuan another 3%, that would pretty much cover the whole 25% tariff on the $300 billion of Chinese goods.
The formal designation of being a currency manipulator allows the US to deliver sanctions on China and for the Treasury Department to try to convince the IMF on doing something about the China’s unfair competitive advantage. FX markets are not expecting any immediate impact on the formal designation as the yuan’s move was a depreciation and not a devaluation. The ball is now in China’s court and we could see them try to make life harder for US businesses. It is growing unlikely that we will see any breakthroughs this month and that will remain a difficult an environment to be bullish with equities.
Over the next couple of weeks, we will see the US try to deliver rhetoric that will weaken the greenback. The US might seek a Plaza Accord agreement that will look for other nations support in devaluing the dollar. In the 80s, the G5 (US, UK, Germany, Japan, and France) agreed to lower the dollar to help deal with trade imbalances. In today’s world of economic weakness, a Plaza Accord agreement would likely get not any support outside of the US.
This trade spat is going away no time soon, but we should see central bank easing bets rise globally and that will help limit some of the market carnage over the next couple weeks. The odds for a half-point Fed rate cut at the September meeting are growing and with more cuts to come as expectations for a trade deal get pushed into 2020.
Oil
Oil prices steadied today following China’s decision to limit the yuan’s plunge, a sign that the pace of escalation in the trade war will ease up a bit. The trade war is likely to go deep into 2020 and the oil trade might see a shift towards global easing efforts. The latest chapter in the US-China trade war have increased easing bets for the Fed this week, which should provide a slight safety net for commodities in the short-term.
Gold
Gold remains an attractive investment, down modestly despite the overall risk rebound today which saw the VIX slide 12%. US-China escalation fears have faded a tad today, but gold did not break as rate cut expectations jumped for a half-percentage point cut in the September meeting. The $1,500 level is still key short-term resistance that will likely see strong momentum trades following a clean break.
Brexit
The news flow for UK assets remains unfavorable as the risks of a no-deal Brexit remain and as Europe both remains skeptical that Parliament will allow a hard Brexit and that a general election would give rise to the pro-EU parties. If the Government calls for an election after October 31st, we could see a no-deal split that might ultimately see a second referendum. What is certain is that Opposition Labour Party leader Jeremy Corbyn will call a vote of no-confidence when Parliament returns from recess after September 3rd. Time is running out to get a deal done and if Boris loses a confidence vote, the UK might not have enough time to avoid a no-deal scenario. We cannot assume Parliament will be able to prevent a no-deal from happening and risks are growing that we could see the UK stumble out of the EU at the end of October.
PM Boris Johnson’s strategy of convincing the Irish and Europeans that a no-deal Brexit will happen is losing traction. The base case seems to be a coin flip that the UK will crash out and that we will see an general election by next summer.
Germany
German economic indicators are strongly pointing to a recession this year. Today’s release of factory and construction data provided a mixed picture, but the overall trend with most German data is lower. Factory orders did see a stronger than expected rebound with the headline, but the situation with the eurozone saw a third consecutive decline. The eurozone needs further support from the ECB and expectations are high for plethora of policy measures to be unleashed in September.
