US labels China a currency manipulator

Morning Note

Markets stabilise a touch after the US labels China a currency manipulator, but sentiment remains fragile.

Stocks suffered their worst day of the year on Monday and it’s not looking much better today, albeit we have noted some tentative signs of a stabilisation in the selling. S&P 500 futures have rallied a touch overnight, but the carnage has already been wrought and the open could be nasty again given the wounds that have been opened up. Sentiment remains fragile.

We’ve had such heavy selling I wouldn’t be surprised to see some bump-ups as bulls test the water for a dip. But this is a risk for sure – the nature of China’s retaliation, and the latest move by the US to name China a currency manipulator, is such we should expect things to get worse before they get better. There is likely a bit more pain ahead, but I feel the market will eventually turn around on (hopes for) an eventual trade deal in 2020 and the Fed to riding the rescue. 

European shares are flattish today on the open, regaining some poise in the wake of the heavy selling yesterday. Asia has been weaker again overnight but not as bad as the US.

Yields have sunk – US 10yr at 1.738%, 2s at 1.587%. Markets are now betting big on a September rate cut by the Fed – in fact now futures markets suggest a roughly 25% chance the Fed will cut a full 50bps. Trump took that rate cut by the Fed as his green light to push China even further. He’s confident the Fed has his back – the risk now over the next 3 months or so for equity markets is that the Fed doesn’t play ball. Bullard and Evans are speaking today and could be instructive on this front.  

US-China relations worsen

It all kicked off Thursday night with Trumps move on tariffs. China’s move to let the yuan slide above 7 produced a wave of selling in equity markets and sent investors running for cover. As per Thursday’s evening’s note: ‘Donald Trump torpedoed the markets with a surprise decision to slap a 10% tariff on an additional $300bn in Chinese goods effective Sep 1st. China is sure to retaliate – this is real escalation.’ As noted on Thursday too, the likely retaliation was to let the yuan slide through 7. China has also said it will stop purchases of US agricultural products and may impose tariffs on farm goods purchased after August 3rd. 

Now after the market closed on Monday in the US, the White House added to anxiety by labelling China a currency manipulator.  

In labelling China a currency manipulator, the US has simply made it clear that there is no goodwill in discussions and no desire for a swift resolution to trade talks. Given the US has already imposed tariffs, the move has little real meaning anyway, but it provides the ammo to press harder on tariffs. As I’ve argued for some months, there is no chance of a deal until 2020 and the US presidential election. 

But the PBOC has eased concerns a touch by setting the reference rate a little stronger than expected. China doesn’t want the yuan to depreciate too quickly and too deep as it risks creating fresh problems like capital outflows. 

FX flows

The dollar has regained some poise too after slipping to its weakest level in a year (ex the Jan flash crash) versus the yen. USDJPY has stabilised around the 105.60 level, which coincides with long-term 23.6% Fib levels. We’ve seen a little bounce overnight – waiting to see if it holds. 

GBPUSD is steady around the 1.2160 level – this might crack again an open up recent wounds on the 1.20 handle. The no-deal scenario increasingly looking inescapable with reports indicating the PM Johnson has no intention of renegotiating the withdrawal agreement and that no-deal is now his central scenario. Further risks for the pound ahead. 

Gold has made a good stab at $1475 but has found some resistance and come back to sit around $1462 as of send time. The dollar has picked up just a shade and we have seen S&P 500 futures rally a little, indicating some tentative reversal of the big risk-off moves yesterday. But these are very much only tentative moves for now.  Oil has bounced off its lows, confirming that there is a degree of stabilisation in the markets.

Bitcoin – firmer again above $12200. Turning into a risk-off play in many ways (not that this is necessarily a sensible haven asset), but it certainly is exhibiting some characteristics of a haven play.