A Fragile State Of Trade War NeutralityIt was a quiet Monday session with the U.S. and parts of Asia out for bank holidays. Risk assets skewed lower, and US equities fell back a little on Monday after China signalled it wants more discussion to iron out details of any partial deal before signing it, including the removal of added tariffs planned for December.
Beyond chiselling out those details, doubts continue to swirl whether China and the U.S. can reach a full trade agreement to end the trade spat. Investors were reluctant to jump on the rally bus while enthusiasm about the potential for a significant U.S.-China trade breakthrough waned.
But this possibly goes well beyond a tariff detente as trade friction has also spread to technology and financial sectors in the past few months. Suggesting, the U.S. administrations attitude towards China does not appear to have improved significantly.
Given the recent economic war escalations, it might suggest we remain in a fragile state of “phase one” trade war neutrality unsure if it may last or even what sweeteners and apparatus have been constructed to ensure both parties compliance.
While bullish momentum has faded somewhat, risk steadied overnight when Treasury Secretary Mnuchin said U.S. and China reached “fundamental agreement” on several trade issues last week and a tweet from the Global Times’ editor-in-chief sketched a more cheerful outlook.
Oil dropped the most in two weeks amid concern that the recent U.S.-China trade talks won’t lead to a deal reinforcing the fact that the outcome of the agreement is probably the most significant near-term factor for oil sentiment.
Indeed, a definite conclusion of trade talks, even a phase one deal, could do a great deal to alleviate those gnawing emotional concerns about global demand as traders continue to wear demand sensitivities on their sleeve.
But oil prices stabilised after calming trade talk comments from Treasury Secretary Mnuchin.
While oil traders are all too knowing that chasing headline risk is fraught with peril. But demand erosion from the trade war is such an overwhelming pervasive bearish skew; it might be impossible for traders to ignore the ebb and flows from headline risk.
The Japanese Yen
Risk markets fell under pressure after headlines reported China wants more talks before it signs up to the tentative trade deal announced by the U.S. on Friday.
USDJPY slipped to 108.05 from 108.20 but remained bid on the dip after risk market steadied
The British Pound
The Pound looked a little perky slicing through 1.2600 in the late New York afternoon possibly due to the absence of any negative headline suggesting that the talks are not breaking down.
The Chinese Yuan
The Yuan may remain stable while the phase one trade deal gets chiselled out within the current 7.05-7.10 level While the Yuan rallied convincingly in Asia yesterday down to 7.05 USDCNH level , the weaker China trade data provided a stark reminder if not a reality check that a weaker Yuan from a pure fundamental landscape may still be in the cards.
But given the extremely high probability of a Phase 1 deal getting inked, a subsequent Yuan currency accord and China’s ongoing commitment to stabilising the Yuan, 6.90 USDCNH now appears to be a reasonable target for USDCNH at the end of 2019 assuming phase 2 and 3 remain on target.
Of course, this view differs wildly by 30 “big figures” from some banks analyst who are pegging year-end USDCNH at 7.20 expecting no significant developments from the phased-in trade talks.
Yesterdays USDAsia selling flows were reversed overnight after a run of not so friendly trade talk headlines. But with markets zeroing in on ADXY 103.70 resistance which has thwarted several rallies in 2019, the reversal may also have been compounded by some profit-taking.
While positive momentum is building and the rally in local currencies may extend further particularly on the basket of THB/SGD/IDR/MYR/KRW, traders may be waiting for this fundamental level (103.7 ADXY) to breach on a closing basis to confirm the next bullish leg higher.
Gold is trading firmer this morning but off overnight highs. Headline risk will continue to dominate, but at the end of the day, what matters most for gold is lower interest rates. And through all this tangled web of headline and phased in confusion, there is one essential narrative that seems to be getting lost.
There is a difference between detente and a deal. A detente means things don’t get worse, but it doesn’t implicitly suggest that global economic conditions get better at once. So, with the latest run of weaker financial data implying that central banks may keep interest rates lower for longer, gold could remain supported short term.
And despite hopes building on a trade truce and a Brexit breakthrough, defensive positioning remains high. And predictably so as if trade talks are struggling at this soft-pedalled level, discussions may not get more comfortable when the complicated intellectual property and technology transfer issues get tabled.
But over the near term, gold could face significant fundamental headwinds in the form of higher US yields and improved equity market risk sentiment especially as we move through to phase 2 and 3 of the US-China trade deal. And if a comprehensive trade deal is inked in November, then the extremely extended long gold positions might be prone to a significant correction lower.
FX Traders who are caught offside may look for opportunities to pare back currency risk aversion trades, as such gold investors need to respect the underlying movement on the Yuan and Yen. USDCNH 7.0 and USDJPY 109.00 are a hugely critical “risk-on” sentiment level
This article was written by Stephen Innes, Asia Pacific Market Strategist at AxiTrader