Morning Commentary: The Narrow Path

Foreign Exchange - Morning Commentary
The Narrow Path
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Last week, the economic data and the question of whether manufacturing weakness would spill over into services weakness and consumer confidence was the market focus.  For this week, data trends will take a backseat to trade talks as Chinese officials are due to arrive in Washington for the next round of negotiations.  In our Week Ahead publication, we expressed doubts over the possibility of a significant breakthrough this week and, unfortunately, news reports over the weekend support this view.    

Vice Premier Liu He, who will lead the Chinese delegation, has indicated that China is not willing to discuss reforming its industrial policies or its government’s subsidies that have been key issues for the US.  From a negotiating point of view, the Chinese government’s actions could be interpreted as a hardening of its stance due to its calculated belief that the US administration has been weakened by the impeachment inquiry and slowing US economic data.  This would make the prospects of a deal this week much slimmer. 

However, the reality was that a comprehensive deal this week was always a remote possibility.  From all indications, the resumption of contact between the two countries, after the talks broke down over the summer, was mainly focused on how to avoid further tariff escalation and calming the financial markets rather than on the substance of the issues that divide the two sides.  In this light, the most recent news headlines shouldn’t come as a surprise to the markets but rather a reminder of the current state of the world.  China’s current economic model is one that the Chinese government sees as critical to its future, and as such, it will not easily move from its current path.  Likely, this is one of the reasons why US Trade Representative Robert Lighthizer has been more focused on a pragmatic approach rather than adopting a laser focus on wholesale changes to China’s industrial policy. 

The markets would be well served to temper its hopes for a significant breakthrough this week.  But in an ironic twist, both sides do have motivation to strike a narrow or mini deal.  China needs the agricultural products that Trump is looking for them to purchase, and the US administration is keen to avoid an economic slowdown heading into the election. 
  • The EU has rejected the UK’s most recent Brexit proposal and is asking for significant changes to the proposal.  In response, PM Johnson has stated that the EU shouldn’t be “lured into the mistaken belief that the U.K. will stay in the EU after October 31.”  However, this contradicts his government’s repeated acknowledgement that it would seek an extension should an agreement not be reached by October 19.  In other words, Brexit drama continues. 
  • German factory orders came in weaker than expected, printing -0.6% against expectations for a 0.3% decline and supporting the narrative of continued European economic weakness.  On a positive note, last month’s disastrous print was revised up from -2.7% to -2.1%, providing an offset to this month’s disappointment.    
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