Macro: Sandcastle economics
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China eases, market uneasy
John J. Hardy
Head of FX Strategy
Summary: China announced a coming cut to banks’ reserve requirement ratio (RRR) to support liquidity, but Asian markets generally failed to put a positive spin on this development and markets are uneasy coming into this week after the weak close on Wall Street Friday.
China’s move overnight to cut the RRR for banks was taken more as a sign of weakness than as a sign of hope that the situation in China will soon be on the mend. After last week’s national holiday, China’s equity markets opened with a gap lower that outpaced the declines in the main DM markets, although if we look over at the USD-denominated MSCI EM index, it is pushing on the lows for the cycle. As well, China’s currency is under renewed pressure, with the USDCNY at the 6.90 level, above which it only achieve one daily close before China stressed again that it wouldn’t pursue devaluation as a policy. Market concerns will pick up if China allows the rate to drift above 7.00 in a regime of broad USD strength to avoid CNY strength against the non-USD basket.
Markets remain uneasy after US bond markets closed on a weak note on Friday, further cementing the recent break higher in yields above key levels for 10- and especially 30-year over the last week. Markets will be left stewing a bit today as it is a US bank holiday in which the bond market won’t trade during market hours while the stock market exchanges will be open.
Italy’s Di Maio has mounted an effort to wrest some of the spotlight from his coalition partner Lega’s Salvini with a number of rhetorical broadsides against the EU’s budget rules. Over the weekend, he declared that the EU would see a popular upswell of resistance against austerity next year that would change attitudes across the bloc after the EU parliamentary elections (late May). Italy’s yields have jumped again this morning and are providing fresh existential stress on the euro. The EU side has remained critical of Italy’s budget plans even after a few positive comments last week, when the Italian side suggested that 2020 and 2021 deficits would be smaller than the one planned for 2019.
An earthquake in Brazilian politics as the right populist handily outperformed pre-election polls and narrowly missed getting an outright majority in the first round, polling at 46%. Brazilian assets and the real are celebrating the prospects of a likely Bolsonaro victory as his platform is seen as far more market friendly. Bolsonaro is a right-populist, law and order candidate appealing to traditional values and strong arm tactics. Very tough work lies ahead for the country in getting its fiscal house in order, especially the thorny issue of an overgenerous pension system. Given the weak EM backdrop, the real rally is impressive, but we wonder how long it can extend from here.
Chart: EURJPY
Widening Italy-core yield spreads driving euro weakness this morning and we continue to watch EURJPY for signs of a breakdown as we trade near the recent lows and the 200-day moving average. A close below 130.00 starts to look like a break down leading to a probe of much lower support.
G-10 rundown
USD – broad strength after last week’s hawkish turn from Powell and the lifting of the long end of the yield curve. A strong USD from here will wreak havoc.
EUR – the 1.1500 level in EURUSD is the local bull-bear line as we gauge whether Italy’s yields remain orderly here or provide fresh pressure on top of the broad USD strength.
JPY – the JPY in an awkward place, normally weak on global bond yield rises, but supported by weak risk appetite. As well, yield rises aren’t necessarily JPY negative if market gets the sense that BoJ’s commitment to yield-curve-control is faltering. Watching EURJPY with interest here as noted above.
GBP – the sterling rally late Friday turning tail a bit here as traders are perhaps reluctant to hold positions for long, fearing the next headline. But UK rates are on the rise and GBP-supportive until proven otherwise. EURGBP 200-day moving average was broken Friday and comes in around 0.8840.
CHF – EURCHF looked like it wanted an upside break, but it will have a hard time finding one as long as EU existential pressure from Italy is ratcheting higher. Suspect that EURCHF would be trading even lower were it not for the powerful GBPCHF rally last week likely driving some CHF flow.
AUD – concerns that China’s policy easing is a sign of weakness could continue to weigh on the Aussie, where the only counterargument to further Aussie weakness is in market positioning. AUDUSD at 0.7000 likely an important psychological level from here.
CAD – USDCAD bears look to be suffering a full reversal of the break down below 1.2900, especially if it rallies up and closes through 1.3000.
NZD – a bit of relative weakness versus the AUD, but AUDNZD only gets technically interesting for upside interest above 1.1000.
SEK – EURSEK backfilling well above 9.44 as SEK doesn’t tend to do well when the the euro is faring poorly. The chart looks bearish on the rejection of the 10.70 area, but conviction for SEK bulls starts to wane if we can’t get a follow up sell-off going in coming sessions. Sweden’s CPI release on Thursday the key event risk for the week.
NOK – oil backing off sharply works against NOK’s favour, though we remain constructive on the currency from a valuation perspective as long as global markets don’t lurch into a risk-off meltdown. Norway latest CPI release up on Wednesday.
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