Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
FX Update: CNY breaks floor, volatility ramps
John J. Hardy
Global Head of Macro Strategy
Summary: Volatility is likely to pick up further across asset classes after China responds to Trump’s tariff threats by abandoning support for the renminbi exchange rate.
USDCNY trades above 7.00 for first time in over a decade
In direct response to US President Trump’s latest tariff threats, China has abandoned support for the renminbi exchange rate, allowing the USDCNY to pull above 7.00 for the first time in over a decade (early 2008 was the last time it traded near current levels). From the Chinese side, the PBOC stated that the yuan move was “due to the effects of unilateralist and trade-protectionist measures and the expectations for tariffs against China.” The absolute magnitude of the CNY drop was not overwhelming – at 7.025 some 1.5% from Friday’s close as of this writing, but the signal value of the move is enormous as it now represents a bilateral escalation of the conflict that becomes all the more difficult for either side to climb down from. The offshore yuan traded somewhat more aggressively higher, reaching as high as 7.11 overnight. How much the move further impacts risk appetite will depend in part on how far China allows its currency to fall. A move to 7.10-15 followed by clear stabilization efforts has far different implications from a larger move with significant daily two-way swings.
This massive escalation in the US-China showdown comes at an awkward time for global markets, which have engaged over prior months in an orgy or risk-taking and celebration of the Fed and other major central banks moving into a full throttle easing cycle. Already, equity markets and emerging market currencies are reacting strongly negatively to this turn of events, and that development could deepen badly, given the heights we have come from in complacency. From here, we’ll also keep an eye on corporate credit spreads and other measures of risk, many of which have shown little volatility. In currencies volatility has certainly picked up from near- or actual record levels, especially in JPY, and this may only be the beginning.
But most importantly, this latest response from China to Trump’s trade tariff threat accelerates the path to a major intervention into the level of the US dollar from the Trump administration – so the “USD as safe haven” may have limited legs against risky currencies. Headline (and Tweet-) risk is high.
Chart: AUDJPY weekly
AUDJPY is the classical risk-on, risk-off currency within the G10 and is playing its role to the hilt at the moment. Adding to the fundamental woes Down Under, the US-China showdown has finally begun feeding more forcefully into commodity prices, as iron ore, Australia’s largest export, saw prices tumble steeply overnight. The pair, not including the flash-crash in JPY and AUD crosses at the beginning of this year, has punched a 10-year low this morning and the 72.00-50 area looks a bit like a multi-year head and shoulders neckline. The RBA meets tonight and a surprise rate cut could add to the downside risk.
The G-10 rundown
USD – the US dollar is firm against risky currencies here, but weak against a hard-charging JPY, and even mulling a reversal against the euro. We await Trump’s response, but already his gambit to re-escalate the trade showdown with China dramatically accelerates the move toward direct US intervention in the exchange rates.
EUR – the euro rather neutral here – perhaps absorbing some support as a more liquid currency and due to position squaring in carry-land over this latest bout of volatility. Focusing on the 1.1150 area in EURUSD for signs that the new lows in that pair will not hold.
JPY – while most central banks around the world have geared up for a new easing cycle, the Bank of Japan has maintained a steady course and kept Japan’s yields largely stable, supporting the JPY, and now the currency is getting further support if carry trades into the riskiest high-yielders reverses. Given that Japan will feel hamstrung to do anything with its policy for fear of US reprisals, USDJPY could quickly head to 100.00 here with little resistance on the way.
GBP – sterling slowly grinding lower versus the euro, seeing little reactivity to the current environment as its weakening came prior to this latest bout of market volatility and the market is already positioned very short with no new developments to trade on.
CHF – the Swiss franc absorbing safe haven flows and EURCHF drive below 1.0900 – where is the SNB? The net apparent level is the last area of major stability in early 2017 around 1.0650.
AUD – the Aussie weak, but the move has not accelerated lower versus the US dollar despite the long-term support around 0.6828 breaking late last week. The RBA up tonight and could surprise with a rate cut, given the sudden escalation in the US-China trade policy showdown.
CAD – the Loonie enjoying relative stability here and USDCAD possibly one of the first places to look if Trump pulls out all of the stops to weaken the US dollar.
NZD – the kiwi in focus this weak over Q2 employment data up tonight and the RBNZ tomorrow night – maybe it’s time for Orr and company to impress with a larger than expected move – i.e. a 50 basis point cut?
SEK and NOK – the Scandies struggling in this environment and may continue to do so as pro-cyclical currencies. Watching the major highs in EURSEK (10.85) and EURNOK (10.00) to benchmark their weakness.
Upcoming Economic Calendar Highlights (all times GMT)
- 0715-0800 – Euro Zone Jul. Services PMI
- 0830 – UK Jul. Services PMI
- 1400 – US Jul. ISM Non-manufacturing
- 2245 – New Zealand Q2 Unemployment Rate / Employment Change
- 0130 – Australia RBA Cash Target Announcement
- 0300 – New Zealand Q3 Inflation Expectation
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