True Risk-Off Returns, Stubbornly Strong USD

Quick Take

The equity market has shown some credible technical cracks, and since the pendulum was in a transition from ‘risk-on’ dynamics into cloudier terrains, that’s all it took for the likes of the Yen and the USD to top the leaderboard.

The rise in the US Dollar portrays a disturbing theme, that is, there is ample demand for the currency in part as a function of the very limited alternatives to diversify one’s currency portfolios. That’s one way to rationalize how the US Dollar keeps strengthening amid the constant bleeding in US yields. Spoiler: All economies show the same gloomy tendencies.

Make no mistake, the yield curve trends in developed economies are absolutely terrible. It essentially communicates that in the grand scheme of things, there is a firm conviction by bond traders that the slowdown in China and the expected deceleration in US growth (ongoing in the EU) is spreading out to affect the outlook for growth and interest rates across the globe. This week, the admissions by the RBA prove my point, with horrible ramification for the Aussie, as the Central Bank finally comes to grips with the new reality in the Australian economy, one characterized by falling house prices hitting the real economy (consumption, business conditions, credit tightness, …)

The script, ever since the Dec Fed Put (hint at ending QT) has followed its course, with the ECB next to cave in by acknowledging its poor outlook, and this week, it’s been the turn of the RBA. On the background, you also have the PBOC injecting aggressive amounts of liquidity into the system.

There are 2 key drivers keeping markets afloat this year. One is the prognosis that excessive liquidity will ultimately be maintained into the system, while in parallel, the US and China must keep the hopes high that a trade deal will ultimately come to fruition.

The gravitation towards risk aversion on Thursday harbingers that the market is assigning way more question marks to an eventual trade deal than previously anticipated. Reports that Trump won’t meet Xi ahead of the March 1st tariff increase deadline has definitely moved the needle. It’s far from being baked in the cake and that’s translated in the behavior of financial markets.

Narrative In Financial Markets

  • Reports emerged on Thursday that a much-awaited Trump-Xi meeting ahead of the March 1st deadline won’t be happening. The widely held belief is that a trade deal won’t be formalized unless the two leaders meet beforehand, so understandably, the markets seem to have entered into a bit of a panic mode by pricing in more uncertainty on the trade deal.
  • To make matters worse for the negative rhetoric surrounding the US-China trade talks, Larry Kudlow, Direction of the US National Economic Council, said that there is a sizeable distance before they reach consensus. The comments acted as a catalyst to see further selling in US stocks, which further anchors the belief that any Sino-US trade headlines with sufficient substance to latch on is acting as the number 1 driver.
  • EU’s Tusk said that the letter by UK’s Labour Leader Corbyn has some merits as a foundation from which to re-negotiate some of the clauses in the divorce agreement. The BBC reports about the story and what are the 5 Labour demands for supporting a Brexit deal. There might be light at the end of the tunnel after all, even if the move is highly costly for UK PM May’s popularity amongst some sectors of her own Conservative party. In a tweet on Thursday, EU’s Tusk said there is still no breakthrough in the negotiations with talks ongoing.
  • The BoE left rates unchanged at 0.75% by unanimous decision. The accompanying monetary policy statement came on the dovish side by slashing GDP growth forecasts and inflation estimates, by reiterating that policy normalization remains conditioned by the Brexit situation. BoE’s Governor Carney press conference failed to ignite any major surprises we didn’t already know. Poor Carney sound like a broken record with his hands tied until Brexit clears up.
  • The European Commission cut the EZ GDP growth estimate for 2019 by a significant margin from 1.3% to 1.9% as part of its latest economic forecasts report of the region. There were lower revision across the board, led by Germany and France. By now it should not be a surprise as the slow down has been very well telegraphed and this feels like old news.
  • The ECB published its economic bulletin of the Jan monetary policy meeting, highlighting that incoming information about the EZ activity has surprised to the downside and risk are increasing due to a moderation in global growth momentum. The bulletin also contained a rather cloudy outlook for inflation expectations due to lower energy prices.
  • I lost count of the number of times since December that I had to mention yet another miss in German economic data. Dec’s industrial production came at -0.4% vs +0.8% exp. This is the engine of growth in Europe we are talking about, which means that if the data has been so poor, which has led to call for a recession in H2, there are two key takeaways. Firstly, be skeptical of any normalization of policies by the ECB in 2019, in other words, a rate hike looks like an unrealistic expectation. Secondly, given the very strong ties between Germany and China, it strengthens the case even further that the slowdown in China goes far and deep.
  • The RBA monetary policy statement slashed its growth forecast by 0.75bp from 3.25% down to 2.5%. Today’s statement, with more detailed information and full updated forecasts, offers a deeper look into the Australian economy and reflects the weakening trends in the country.
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The Daily Edge is authored by Ivan Delgado, Head of Market Research at Global Prime. The purpose of this content is to provide an assessment of the market conditions. The report takes an in-depth ...

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