Rising US-China Tensions Dent Market Sentiment

  • Rising US-China tensions are the main driver today for markets; the dollar remains under pressure
  • The White House and Republican Senators are struggling to present a united front in fiscal negotiations; Trump’s two Fed nominees advanced to a full Senate confirmation vote
  • Today is another quiet day for US data; Canada reports June CPI
  • UK press reports that government ministers believe a Brexit deal won’t be reached; South Africa reports April retail sales
  • Japan reported soft preliminary July PMI readings; Japan’s Cabinet Office upgraded its assess of the economy for the second straight month; Australia reported preliminary June retail sales

Rising US-China tensions are the main driver today for markets. China vowed to retaliate after the US gave it three days to close its consulate in Houston in order to protect US intellectual property, which the Foreign Ministry called an “unprecedent escalation.” The closure comes after the Justice Department yesterday accused Chinese hackers of trying to steal data related to coronavirus research. While this is just the latest in a long string of diplomatic skirmishes over the past couple of years, there has been some notable escalation in recent weeks.

The dollar remains under pressure. DXY traded at a new low for this move yesterday around 95.05 and is on track to test of the March low near 94.65. Break below would set up a test of the September 2018 low near 93.814. The euro broke above the March high near $1.15 and is currently testing the 2019 high near $1.1570. Break above would set up a test of the September 2018 high near $1.1815. That’s where things get really interesting, as $1.1820 is the 62% retracement objective of the big February 2018-March 2020 drop. Break above that would set up a test of the 2018 high near $1.2555. Recent price action whereby markets sell into dollar strength rather than buy the dollar dip supports our view that the market bias for the dollar is for further broad-based weakness ahead.

AMERICAS

Reports suggest the White House and Republican Senators are struggling to present a united front in fiscal negotiations. President Trump continues to push for a payroll tax cut. While that is a non-starter for the Democrats, several Republicans are also opposed. It would be bad optics, as the payroll tax funds Social Security and Medicare. It also would not benefit the 20 mln Americans that are still unemployed, nor would it boost hiring. Other reports suggest the White House opposes new funding for virus testing and contact tracing, as well as extra funding for the Centers for Disease Control and Prevention. Again, the optics are bad and some Republican lawmakers are pushing back against this.

Adding to the confusion, Treasury Secretary Mnuchin appears to have abandoned his stated limit of $1 trln for the package. In turn, this has set off alarm bells with some Republican lawmakers that are growing concerned about rising deficits and debt. One area of progress appears to be the possible extension of the extra $600 weekly unemployment benefits. Democrats want to extend the full benefits through January, while Republicans appear ready to agree to an extension if it were cut to $200-400 per week.

Democratic leaders Pelosi and Schumer were highly critical of the lack of Republican coordination. They said after meeting with Mnuchin and White House Chief of Staff Meadows that the lack of consensus across the aisle means real negotiations cannot begin in earnest, and time is clearly of the essence.

President Trump’s two nominees to the Federal Reserve Board of Governors advanced to a full Senate confirmation vote. Both Judy Shelton and Christopher Waller were approved yesterday in the Senate Banking Committee. Of the two, Shelton is the most contentious due to her past statements about moving back to a gold standard as well as her lack of central banking experience. She passed by a 13-12 vote split down party lines. If the full vote goes along party lines again, she would pass by a 53-47 vote, Four Republicans would need to defect in order to derail her nomination and that seems unlikely. Waller passed 18-7 and is seen as a much more conventional candidate.

Today is another quiet day for US data. Only June existing home sales will be reported, which are expected to rise 21.4% m/m vs. -9.7% in May.

Canada reports June CPI. Headline is expected to rise 0.2% y/y vs. -0.4% in May, while common core is expected at to remain steady at 1.4% y/y. Yesterday, May retail sales came in at 18.7% m/m vs. 20.0% expected, while ex-auto rose 10.6% m/m vs. 11.9% expected. Bank of Canada just met last week and left policy steady. It sounded relatively upbeat but warned of downside risks that likely require low interest rates for a very long time. Next policy meeting is September 9 and no change is expected then.

EUROPE/MIDDLE EAST/AFRICA

UK press reports that government ministers believe a Brexit deal won’t be reached. UK officials are now working on the central assumption that it will trade with the EU under WTO rules after the transition period ends December 31, though a basic deal remains possible if the EU makes more concessions in the fall. UK businesses have reportedly been told to start preparing for the possibility of a no-deal Brexit. The current round of talks between Frost and Barnier will wrap up tomorrow, with no progress seen in the contentious areas of fisheries, level playing field guarantees, governance of the deal, and the role of the European Court of Justice. The two are ready to meet again in August if there is any progress. The EU reportedly believes that the true deadline for a deal is the end of October, which would allow time for ratification before year-end.

South Africa reports April retail sales. Sales are expected to contract -32.0% y/y vs. +2.7% in March, as the impact of the pandemic was felt. SARB meets tomorrow and is expected to cut rates 25 bp to 3.5%. However, the market is split. Of the 16 analysts polled by Bloomberg, 7 see no cut, 5 see a 25 bp cut, and 4 see a 50 bp cut. The bank cut 50 bp at the last meeting in May. Since then, inflation fell to 2.1% y/y in June, the lowest since September 2004 and below the 3-6% target range. With the rand relatively firm and the economy so weak, we see risks of a dovish surprise tomorrow from the SARB.

ASIA
Japan reported soft preliminary July PMI readings. Manufacturing rose to 42.6 from 40.1 in June, while services rose to 45.2 from 45.0 in June. This led the composite PMI to rise to 43.9 from 40.8 in June. The readings are of course disappointing and may set the tone for other major countries’ PMI readings later in the week.

Japan’s Cabinet Office upgraded its assess of the economy for the second straight month. It noted that conditions are picking up in 6 out of 14 economic categories, but warned that they remain “severe” compared to “extremely severe” last month. It saw no improvement in capital spending, corporate profits, bankruptcies, or employment, adding that the jobs market is weakening and business income is falling quickly due to the pandemic. We think this is a balanced outlook given the risks, as rising case numbers will surely continue to weigh on the economy going forward.

Australia reported preliminary June retail sales. Sales rose 2.4% m/m, led by cafes, restaurants, and takeaway food services. However, the ABS noted that turnover in these industries remained below year-ago levels. Meanwhile, the rising virus numbers in the state of Victoria led Australia to record its worst day ever. The government will release updated economic and fiscal forecasts tomorrow, and reports suggest the outbreak will cut around 0.75 percentage points from Q3 growth.