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Stephen Innes
Not Such A Big Deal But Might Be Enough For The Santa Claus Rally.

China and the US have reached an agreement on a Phase One deal in which the US will halt December tariffs and reduce the 15% tariffs to 7.5% on the September USD120bn list.

So, the US only had to give up a small nominal rollback in tariffs apparently and a December tariff deferral in exchange for China’s commitment to purchase some form of US agricultural products totaling 40-50 billion per year over the next two years. Yes, we have a deal, but trade negotiations will continue; for now, escalation seems to be off the table. However, the path to the comprehensive agreement is still miles away.

Ultimately, phase one deal fell short of market expectations and is probably not enough to fully restore business confidence or generate a meaningful recovery in exports or investment.

But the big question for investors is will this Santa Claus rally still have legs?

The second half of December is typically associated with robust seasonal demand for risk assets and given the market has cleared three significant overhangs (US election, USMCA, December 15 tariffs). The optimist in me suggests that risk appetite among financial investors is now likely to remain high despite the expected gyration in the trade talk narrative. However, the pessimist in me thinks a limited deal means limited risk as investors turn cautious, ultimately viewing Friday’s partial deal as a short-term detente rather than a clear road to a lasting and comprehensive resolution of the trade tensions.

Still, given the way President Trump has played this affair out so far, I wouldn’t surprise me one bit to see some watered-down phase two deal in mid-2020 to goose the US economy a bit more ahead of the 2020 presidential election.

Traders will now be forced to consider the prospect of phase two trade deal and beyond, but for now, they might be just as happy to put trade in the rearview mirror for a few weeks and focus on the economic data

Critical for the Yuan and global risk sentiment is that China could kick start the week on a positive note with a rebound in high-frequency data.

Analysts expect China to report stronger consumption and production data. Retail sales growth is likely to accelerate to 8% in November, from 7.2% in October, while IP growth rises to 5.2% from 4.7% in the same period.

Although fixed asset investment (FAI) growth is likely to have moved sideways, unchanged from October at 5.2%yoy YTD in November, its rebound is expected in 2020, led by a recovery in infrastructure and manufacturing investments. At the minimum, the data is likely to support the view that China’s growth has bottomed.

Oil markets

Oil traders were happy that the December tariffs were deferred but not so comfortable that September USD120bn trade duties were only reduced to 7.5% when they were expecting a full roll back in September and far from the rumored 50 % across the board rollback.

None the less, oil futures closed 1.5% higher in New York on Friday, supported by a partial trade truce. Even a partial trade deal is good for oil as it adds another tailwind for oil into year-end, but frankly, it wasn’t much of a surprise.

However, last week, the IEA OMR was mildly supportive, flagging a cut to 2020 US production growth, which provides some evidence that US production growth estimates are too high. So, we could start to see the big forecasting agencies cut US production estimates, and then the market consensus view would then shift to a lower bias through 4Q19 and 1Q20. If this trend materializes, it could provide another year-end fillip for oil prices and offset concerns that the market is facing a massive supply glut and inventory build, at least in the first half of 2020.

However, with oil near a three-month high and the trade deal failing to meet market expectations, there is a risk of profit-taking into year-end. IMM oil positions jumped materially higher following OPEC decision to reduce output quotas, along with a promise to tighten compliance, so if there is limited risk appetite from a limited trade deal, oil markets could shift into profit-taking mode.

However, I continue to believe the medium-term outlook is good, positively supported by OPEC compliance and a possible shift downwards in US oil production growth estimates.

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Gold markets

Gold rallies despite trade agreement, UK election, and USD gains, suggesting there is a lot more underlying resilience in the yellow metal than expected. Gold held up remarkably well in the face of a marked shift towards risk-on assets.

Reasons

  • US bond yields are likely capped as the US interest rate policy remains on lower for longer, if not lower forever mode.
  • Equity markets are looking a bit toppish, and that could trigger some defensive allocations into gold
  • Traders have now turned focus to the long and arduous road to a phase two trade deal. so, gold could do well on escalating trade tensions
  • The phase one deal fell short of market expectations and is probably not enough to fully restore business confidence or generate a meaningful recovery in exports or investment.

Still, without the Fed pivoting into a dovish stance and signaling a rate cut, explosive returns are unlikely until the US data shifts negatively enough to force the Fed’s hand.

Investors maintain a favorable attitude towards gold over the medium to long term; an environment of low rates, persistent macro uncertainty, and elevated equities makes a case for holding gold as a hedge and varier. This view could likely drive demand for gold higher into 2020 and lend support to the current medium-term uptrend. With the gold seasonality effect coming into the picture, investors may look back at the current price level with nostalgic longing at the end of Q1 2020. 

Currency Markets

The Pound

The million-dollar question facing Sterling traders is, will the much-touted 100 billion GBP of real money buying appear? Or will real money hedgers and FDI inflows wait for more certainty on the structure of the new EU vs. UK relationship?

Traders will turn focus to the Bank of England’s (BoE)decision this week. What to expect? Don’t expect any change to the Bank’s policy setting. Given the lack of communication since the November Monetary Policy Report, it’s unlikely there will be a rate change as the BoE usually telegraphs rate moves. But beware of a change in the voting split which could lean on the dovish sided and dent near term GBP sentiment.

Antipodeans 

The second half of December is typically associated with robust seasonal demand for risk assets and given the market has cleared three significant overhangs (UK election, USMCA, December 15 tariffs). Investors’ risk appetites may be supported despite the expected gyration in the trade talk narrative. This notion could bring focus on the AUD and NZD as traders begin the process of positioning for the Big global growth rebound trade of 2020

The Yuan 

The Yuan surged to below 6.95 Friday on what was thought to be a robust trade deal — but then backtracked after the reference rate fix, which held above 7, indicating an unwillingness for the PBoC to strengthen the Yuan quickly. Eventually, the Yuan gave up more ground and then traded above the 7 handles after as the market was disappointed by the details in the phase one trade deal and particularly the level of the tariffs rolled back. The Yuan momentum is a linear function of the degree of US tariff rollbacks.

The Ringgit

A partial trade deal is better than no deal and certainly a whole lot better than trade war escalation, which should reinvigorate demand for the Ringgit as the market has managed to navigate numerous worst-case scenarios this month successfully. But critical in this view, which should increase investor’s need for carry trade, is the less hawkish Fed who have signaled a lower for longer if not a lower forever interest rate policy.

Also, the Petronas deal is being viewed in a favorable light and attracting some foreign flows to the KLCI as Petronas stocks are a significant component of Malaysia’s key stock index and could also be stocking demand for the Ringgit.

This article was written by Stephen Innes, Asia Pacific Market Strategist at AxiTrader

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