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A Pause For Thought

Stephen Innes
The market paused for thought overnight while shifting away from the recent buy all trend that was triggered by the definitively dovish tone from Chair Powell last week.

U.S. stocks scratched out another round of records Monday, as investors consumed the second-quarter results from Citigroup and awaited a swath of second-quarter earnings. But they remain bullishly predisposed as the central bank’s cavalry led by the Federal Reserve rides in for the rescue while some thought, misguided of sorts, that a tsunami of China stimulus is waiting in the wings.

Just a thought, while cavalry charges might win a battle, but without a strong commander and chief, they seldom if ever win the war.

Oil Markets

Weekend headlines continue to exert pressure on oil prices overnight. The U.S. Gulf of Mexico production returned to normal quicker than expected, a tempering in Gulf tensions as Iran is willing to talk if sanctions are withdrawn while U.K. Foreign Secretary Jeremy Hunt said a seized Iranian oil tanker might be released if Iran could guarantee the vessel would not find its way to Syria.

But the more significant drag on oil markets is China’s weaker consumption data, which contributed only 3.4 percentage points to growth in Q2, down from 4.2percentage point in Q1 suggesting Trade war effects are taking their toll on China’s consumer’s spending habits.

Indeed, the devil is always in the detail on China’s data dump.

So, with the only supportive headline coming from a drop in the Baker Hughes rig count, and after a 7% move higher this month, investors switched into profit-taking mode ahead of this week’s inventory data.

Gold Markets

With the increased chatter around a possible currency war, long Gold is the easiest way to trade a multiplex currency conflict.

And even if we don’t get to a full out currency war, the constant stream of headlines that would suggest the Treasury and the Fed will likely cross swords in itself makes for a very compelling reason to own Gold as any signs of infighting between these two market influencing behemoths could potential destabilise global markets.

And while I’ve argued with my colleagues to no end that intervention will never happen at these levels, I always forget to add the Trump factor whose policies are motivated more by domestic politics than economic realities. If the President weaponised trade to get his way with Mexico, who’s to say he won’t weaponise the dollar to get back at Europe?

Bond markets

Bond traders are still coming to terms with last week’s bond selloff and bear steepening which has presented some headaches and an uneasy market predicament ahead of the upcoming ECB and FOMC meetings. Was this move little more than an unwinding of overly dovish bets and Japanisation fears or is the market coming to terms that the shift in Fed policy could be a reflationary one?? Let’s see what lies in wait when US retail sales hit later this evening.

Pboc watch

Investors breathed a sigh of relief after there were few surprises in yesterday’s China dump.

Pboc watchers are attributing the slowdown in GDP to weaker consumer consumption, which contributed only 3.4ppts to growth in Q2, down from 4.2ppts in Q1. Which is at odds with the surprising boost in retail sales, but this was attributed to a one-off increase in cars sales due to inventory clearance discount. However, the critical industrial production data was a huge bright spot suggesting that the fiscal measures, particularly the VAT tax cut, have started to filter through the economy.

If anything, this supports the notion that China is not headed for a hard landing.

Most China economists are still factoring in a full years GDP growth at 6.2% well within the government 6-6.5% growth target but with consumer consumption the principle drag we could expect a measured stimulus response from the Pboc who by their latest cautious tone suggest aggressive easing is unlikely.

But what should be more concerning for regulator and before they start throwing good money after bad again, they need to address the structural issues as the Pboc tremendous credit impulse, and the RRR cuts are still not flowing into the targeted sectors especially with global trade slowing.

Currency market

Euro

With the ECB getting ready to tee up looser monetary policy at the July 25 meeting, it’s neutralising the weaker dollar pressure as the ECB attempts to out-dove the Fed in an attempt to weaken the Euro overtly. The ECB relies on a weaker Euro to do much of the heavy lifting in times of economic despair; after all, there is not much left in the ECB policy bag.

Australian Dollar

The Fed cut in July should lend support to the carry trade, and with the fed all but a lock for a pro cycle rate cut in July risk on and high beta currencies should benefit, which makes the Australian dollar stand out.

There is a lot of dovishness priced into the Australian rate curve, perhaps more than warranted suggesting broader liquidity induced risk on trade could squeeze shorts, but with domestic yields stabilising and with a likely bounce in commodity markets from the deluge of central bank easing, the Aussie looks primed to move higher in this environment.

Fed rate cut will boost the AUD while the ECB is expected to take some aggressive measure soon, suggesting EURAUD lower could be a great way to express a short term bullish Aussie view.

The Malaysian Ringgit

The Ringgit should benefit from the Fed pro-cyclical rate cut even more if they cut 50 bp I believe there is still a strong chance this could happen given the Fed has regimen shifted to global based monetary policy outlook. None the less, we think the Fed cut .25 bp, or .50 bp will be good for EM Asia Carry and support liquidity induced risk-on environment.

Provided we do not have a significant sell-off on oil prices we see the USDMYR testing our July target of 4.10 and to eventually move below supported by a dovish Fed and an ECB that is set to tee up looser monetary policy both of which should boost commodity prices. All around it’s a win-win scenario for the Ringgit in our view.

This article was written by Stephen Innes, Managing Partner at  Vanguard Markets LLC

This article was originally posted on FX Empire

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