"Your problems never cease, they just change” Phil Jackson
An uncharacteristically long period has passed since our last post. Yet while the levels, dynamics and even participants may have changed, the dominant issues in the global macroeconomic backdrop remain. Arguably the biggest driver of global market sentiment continues to be the Sino-US trade spat and the extrapolated implications for global growth and interest rates. The conclusion of the G-20 at the end of June led to a month of agreed, if temporary, truce between the US and China. Over recent days, the seemingly timely progress towards a trade deal, has ceased.
Last week, the US trade delegation visited Shanghai for a fresh round of talks. However, reports following the discussions - which reportedly only lasted 4 hours - suggested that China may be attempting to draw out the discussions in order to gauge Trump’s reelection prospects. The result, perhaps unsurprisingly, was a further tariff threat from the Trump Administration - a 10% levy on up to USD 300 billion of Chinese goods - to take effect on September 1st if there is no progress in the meantime. The Chinese response, it seems, was to facilitate a move in the CNY above the psychologically significant 7.00 level to the USD a move that further unnerved financial markets, driving a sharp fall in equities, EM and other risk assets.
This trade tension escalation has also exacerbated the focus and extent of expectations of US (and by extension, global central bank) rate cuts. In our last post, we expressed the view that markets had priced too much of a monetary response from the Fed in relation to the current state of the US economy. With growth above trend, inflation on all but the PCE measure at target, domestic equity markets near record highs (even after the significant falls of the start of August), we continue to believe this to be the case. However, the Fed have clarified further their intention to cut preemptively as an insurance measure against potential negative global growth risks. If we combine this with sharply revised monetary accommodation from much of the rest of the world, then we maintain the view that the USD should continue to outperform as a function of continued growth and yield premia - exacerbated by monetary settings likely to be looser than the level required by the strong domestic economy.
The combination of our first two arguments also have significant connotations for global markets. We have stated a number of times in previous posts that there are two linked but distinct dynamics related to the backdrop for the global export economy and industrial cycle at the current juncture. The first is the trade dispute; the second is the likely L-shaped trajectory of the Chinese economy, as monetary and fiscal stimulus take a more targeted, less asset inflation-inducing approach. If we add the further global dovish monetary pivot - where the ECB are now expected to cut the deposit rate further into negative territory (and even restart asset purchases under its QE programmes), then we continue to expect the EUR to underperform - perhaps significantly over coming months.
King of the World?
And of course there is Brexit. In the UK, while the issues remain the same, the personnel change has put a new perspective and a new dynamic on the discussions. Having finally been named as the new PM in what was likely a needlessly drawn out process given the urgency of the situation, Boris Johnson has framed the process very differently to his predecessor.
From an FX perspective, markets are acutely focussed on the October 31st / November 1st transition; however, we are of the view that it should be the last week in August / first week in September. The last week of August is significant not just because if signifies the end of the partial ‘grace period’ for Johnson where his actions and demands are not directly rebuffed or undermined by the increasingly ‘creative’ (obtrusive) sitting Parliament, but also because it contains a G7 meeting where the PM will almost certainly have sideline meetings with Merkel, Macron and likely even Juncker. The first week of September is significant as Parliament returns on the 3rd and it is expected that a vote of no-confidence in the PM will follow shortly after.
The Conservative Party under Johnson are currently enjoying a bounce, if polls are to be believed, as the hard line ‘no matter what’ approach to the October deadline appear to be winning votes back from the Brexit Party (the liberal / centrist domestic measures - such as 20,000 police hires and GBP 1.8B NHS cash - may, at the margin, have also contributed to this). This is important in the context of a no-confidence vote as there is no convincing sign that the Labour Party is regaining pledges lost to the Liberal Democrats. Ironically, If Labour (it is conventionally the opposition Party that call such a vote) call a no-confidence vote that ends up in a General Election, the biggest losers at the current juncture could well be the Labour Party. Furthermore, recent rhetoric from the PM’s chief strategist Dominic Cummings, backed up by constitutional experts muddies the water further as it suggests that the PM would not be legally required to step down as PM even if he lost a no-confidence vote - and even under such circumstances could delay any resultant general election vote until after the UK had left the EU on the 31st October.
Perhaps ironically, after the recent conscious ebb towards no-deal, it is likely that it would only take a minor concession from the EU (though likely around the backstop) to facilitate a Withdrawal Bill’s (WAB) passage through Parliament - particularly if Johnson (and more likely Cummings) can more successfully frame the positive aspects of the WAB and the upside potential that awaits on the other side. While the near term remains fractious for GBP, we are increasingly of the view that the balance of risks beyond the very near term are shifting further towards the upside.