Morning Commentary: A Rose by Any Other Name…

Foreign Exchange - Morning Commentary
A Rose by Any Other Name…
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
It has been said that a rose by any other name would smell as sweet.  If this is the case, then risk by any other name is just as risky. 

Towards the tail end of 2019, some parts of the Chinese economy started to turn towards the upside.  Case in point, auto sector output in November rose on the year for the first time since June 2018.  Profits in the electronics industry have rebounded strongly as global smartphone and semiconductor demand has rebounded.  Additionally, the labor market should receive a boost from the expected trade truce between the US and China.  Granted, the Phase 1 deal leaves much unresolved between the US and China, but the expectation is that the US doesn’t escalate trade tensions in front of the 2020 presidential election. 

As such, the risks from trade appear to have faded, only to be replaced by the risk from elevated debt.  To be sure, elevated debt has long been an issue in China, but the acute risks from tariffs pushed debt concerns to the back.  Heading into 2020, this all could change. 

On a trailing 12 month basis through last October, the return on assets (3.7%) from state controlled enterprises was below the average bank lending rate (6.0%).  Moreover, heavily indebted property developers, which have been hit by China’s crackdown on shadow banking, have become more reliant on “preselling” houses.  With the real estate market cooling, this source of funding is starting to dry up. 

To be sure, the outlook for 2020 in China is seen, on balance, as positive, but the elimination of trade risk isn’t an all clear but simply a clearing of the path for other risks to take center stage.      
  • The US merchandise trade deficit narrowed in November to the smallest shortfall in three years as exports increased and imports decreased.  Details of the report showed US retail inventories fell 0.7% MoM versus expectations for a 0.1% rise and wholesale inventories flat MoM versus expectations for a 0.2% rise. 
  • Japan will be on holiday from December 31 through January 3.  During recent holiday periods, USDJPY experienced sharp spikes in appreciation as liquidity was thin with Japanese markets closed.  While it is tempting to think history would repeat itself, it is important to remember that things are different this time around versus a year ago.  Last year, the Nikkei 225 index fell more than 15% and market sentiment and conditions were poor.  That is not the case this year.  Additionally, USDJPY short positions are less than half of what they were a year ago.  Thin market conditions certainly make larger movements easier, but it’s unlikely that we will see the same magnitude of moves in the upcoming New Year holiday as we saw in early 2019. 
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