The Week Ahead: Stuck Between a Rock and a Hard Place

Foreign Exchange: The Week Ahead
Stuck Between a Rock and a Hard Place
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
At the end of last week, markets received a boost from reports that China would accelerate purchases of US farm goods to meet its Phase 1 commitments.  While this represents an incremental positive, the US-China relationship remains deteriorated and strained. 

According to a recent survey by the Pew Research Center, Americans’ unfavorable view on China has moved to a 15 year high with 66% of Americans holding an unfavorable view of China.  While this cautious view of China is shared across the board, there are some partisan differences.  Here are some of the highlights from the survey.

Traditionally Republicans or people who lean towards the Republican party have consistently had a more unfavorable view of China than Democrats or people who lean towards the Democratic party.  This held true in the Pew survey with 62% of Dem/Dem leaning respondents holding a negative view of China versus 72% for Rep/Rep leaning respondents.  Rep/Rep leaning respondents were also twice as likely to see China as an “adversary.”

When looking at the issues that posed the biggest threat to the US from China, ~60% of respondents identified the impact on the global environment, cyber-attacks and China’s policy on human rights.  US job loss to China, the US trade deficit, and China’s growing military power were identified by roughly 50% of respondents. 

This results in a US-China relationship that is strained with a very pessimistic outlook. But the yuan hasn’t really moved in part because the Phase 1 deal remains intact. The trade deal is the culmination of 3 years of negotiation.  President Trump is unlikely to allow it to fall apart ahead of the November election especially in light of the pain the US agricultural sector endured during the negotiations.  It’s notable that Trump stepped away from his suggestion to cancel the deal soon after Beijing ordered a temporary suspension of agricultural purchases.  Of course, there are also incentives on the Chinese side to honor the deal. 

This leaves both sides in an uncomfortable state of elevated tensions with little in terms of actionable moves.  The Phase 2 deal is unlikely to move forward and while the US ended Hong Kong’s special status, there is little else the US can/is willing to do.  The Hong Kong peg will continue to hold as it was set up with FX reserves 6x the amount of currency in circulation.  The local government has the political will to sustain the system and Beijing will likely add additional support if needed to demonstrate that foreign interference cannot undermine Hong Kong. 

Developed market businesses also aren’t leaving China as the gap between the Trump administration and corporate behavior grows.  83% of US companies and 89% of EU companies indicate no plan to shift current or planned investments and manufacturing from China.  Simply put, the Chinese manufacturing ecosystem is strong.  The wide distribution of infrastructure, labor force and local expertise to deliver high volume production makes it difficult to find acceptable substitutes.   

Looking forward, expect the yuan to remain stable. While US-China tensions should remain elevated, the improvement in China’s current account surplus supports the CNY with extraordinary DM policy support also adding tailwinds. 

FORECASTS

EUR

The euro continues to drift lower from its June 10th highs as markets have become more aware of downside risks.  The FOMC meeting refocused markets on what should be a long and difficult journey back.  Much of the easy economic gains have already been made and the spike in infection numbers around the world highlights the risk of a second wave (or continuation of the first wave depending on your POV).   For now the view on the euro is a neutral one.  Hopes of stimulus, both from the ECB and other central banks have supported risk sentiment.  To this point, Europe has started negotiations on the 750 billion euro rescues package.  While an agreement isn’t expected in the near term, how talks evolve will impact the single currency.  Markets have already priced in expectations for stimulus so any breakdown in talks or spike in infections should weaken the euro.  Conversely, any hints of a deeper fiscal union should be euro positive. 

GBP

Cable broke down with the BoE expanding its QE program and Brexit talks failing to yield any progress.  Overall risks to sterling appear to be two-sided.  Regarding Brexit talks, both sides are still far apart but recent headlines around meetings between top officials have struck an optimistic tone.  We are fast approaching the July 1st extension deadline and while markets remain hopeful, the closer we get to this deadline without a deal, the more markets will be forced to price in a hard Brexit.

JPY

The yen has also been trading in a tight range.  Investment outflows have picked up again with the uptick in US yields.  While these flows are expected to be stable, they will likely be at a lower rate than the historically large flows seen earlier.  The BoJ left its policy rate unchanged at its most recent meeting but this was expected.  FX markets feel as if they are stuck in a tug of war with central bank support arguing for risk on and rising infections/second wave fears arguing for a pullback.  Expect the USDJPY to range trade in the near term as the markets seek direction. 

CAD

The loonie has weakened from an overbought level and has traded in a tight range over the past 5 trading sessions.  In the near term, expect risk sentiment to continue to drive USDCAD as the markets remain stuck between a tug of war between stimulus and negative infection headlines.  Tiff Macklem, the new BoC Governor, recently made his first public appearance and stated the BoC’s balance sheet has more room to grow than its peers.  Longer term the view remains bearish on USDCAD as the Canadian economy is being hit by a double whammy in terms of oil prices and demand shocks.  However, the near term range feels pretty established with the currency likely to remain there for now.

CNY

The yuan has received support from a weakening USD and a more dovish than expected response from the US on China’s recent moves in Hong Kong.  The market’s main concern was then escalating rhetoric from both sides would lead to a breakdown in the Phase 1 deal.  This has not happened as China has announced it would accelerate its purchases of US farm goods.  While US-China tensions are expected to linger and skepticism is warranted for risks to remain receded over the medium term, near term optimism and fund inflows should keep the yuan supported near term.   

AUD

The expectation remains for the AUD to continue to weaken as the strong rally has left AUDUSD stretched as the Aussie has been one of the biggest beneficiaries of the global risk rally.  Thus far the Aussie has shown a strong correlation to risk markets but this correlation should fall as a lot of good news has been priced into the markets.  With valuations already high, the currency should struggle to make further gains especially if data shows a fading of the initial reopening bounce.  To this point, Australia’s most recent jobs report was a disappointing one. 

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

6/23 New Zealand Expectations for rates to remain unchanged at 0.25%
6/24 Thailand Expectations for rates to remain unchanged at 0.50%
6/25 Mexico Expectations for rates to be cut by 0.50% to 5.00%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

6/23 US Manufacturing and Services PMI Expectations for a 50.0 and 46.9 print, respectively
6/25 US Durable Goods Expectations for a 10.5% increase
6/25 US Initial Jobless Claims Expectations for 1.3 million claims

Europe/Eurozone 

6/23 EZ Manufacturing and Services PMI Expectations for a 43.8 and 40.5 print, respectively
6/23 German Manufacturing and Services PMI Expectations for a 41.5 and 41.6 print, respectively
6/23 UK Manufacturing and Services PMI Expectations for a 45.0 and 39.0 print, respectively

Asia/Japan, and New Zealand 

6/25 Tokyo CPI YoY Expectations for a 0.3% increase
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