Morning Commentary: Flash Dance

Foreign Exchange - Morning Commentary
Flash Dance
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
With Brexit and US-China trade talks taking a turn for the positive last week, two of the market’s main concerns have been addressed.  With these issues in the rearview mirror, at least for now, the market’s focus should turn to economic data as it searches for direction. 

To this end, today’s session has featured flash PMI data with readings from Europe continuing to show weakness in the manufacturing sector.  In Germany, manufacturing gave back a large part of last month’s recovery.  A similar situation played out in France with the manufacturing sector also slumping.  However, the French manufacturing PMI number still remains above 50 (signaling expansion) whereas the German number remains below 50 (signaling contraction).  Finally, there is the UK manufacturing data that fell to a seven year low.  The caveat to this is that the data was collected ahead of the UK election when Brexit-related uncertainty spiked.  With PM Johnson winning a decisive victory, some of the near term questions about the UK’s future path should be removed. 

However, it isn’t all bad news.  Industrial production data out of China beat expectations by a significant margin both against expectations and against its last reading.  With the US and China reaching a Phase 1 deal and the US suspending new tariffs, the decreased uncertainty should provide a better backdrop for an economic recovery in China.

In fact, this also holds true in Europe.  Much of the slowdown in manufacturing in Europe can be tied back to trade uncertainty between the US and China.  With monetary conditions more accommodative now than last year and with major headwinds subsiding, there is hope that the global economy can achieve slow positive growth next year.  Of course, we would be remiss if we didn’t point out the risks.  History has shown US-China trade talks to be volatile.  Phase 2 will address the most contentious issues, so it’s reasonable to believe US-China tensions could flare again.  As for the UK, the large Conservative majority should guarantee the passage of the Withdrawal Agreement, but the trade deal (seen as the more difficult part) between the UK and the EU still remains to be negotiated. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • While the Phase 1 deal is a positive for the markets, and tariffs did not go up on Sunday, the macro impact of the deal is likely minimal.  This is because the details known so far lack substance with the rollback in tariffs minimal.  As a result, economic worries simply shift from acute to chronic as there are no near term deadlines but high tariffs still remain high.
  • USMCA appears to have hit a bit of a road bump with Mexico’s objection to the US’ plan on how it will monitor the labor market.  Market reaction has been fairly muted as NAFTA stays in place should USMCA not be ratified.
  • The UK government is expected to introduce its Brexit bill to Parliament on December 20.  After the bill passes, the UK is expected to seek a Canada-style free trade agreement. 
  • RBA minutes will be published later today.  The statement after the RBA’s last meeting leaned a bit hawkish so markets will be looking at the minutes to confirm how many members shared this view.  Since the RBA’s latest rates decisions, economic data has disappointed.  The key employment report is due this Wednesday.
  • The repo market faces similar circumstances that many blame for the September spike in rates.  Today brings a mid-month Treasury auction settlement and corporate tax payments.  Since September, the Fed has been adding liquidity to the markets and today will be a good test to see whether its steps have addressed some of the issues. 
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