Today is D-day as Trump's trade tariffs on China kick in. The market eagerly awaits China's response, especially as the Shanghai Composite Index broke through 2700 for the first time since March 2016.
As the yuan flirts around the 6.70 level, continued devaluation and further capital outflow worries persist in the market, leading investors to question the prospects of Chinese economic growth going forward.
Global PMI's have been slowing down, no doubt. China has been in deleveraging mode since last November post the Chinese National Congress meeting that cemented President Xi Jinping's role for decades to come.
The best way to approach how the authorities think about managing their economy and growth is as though they are steering a ship one-two degrees around its course for 6.5% GDP growth.
It's on a slower trajectory, but it is on cruise control and government will not let it deviate from that path. Of course, this is if we "believe" the official figures, but then history has shown us we have no choice but to do so, because that is all we will get from them.
Arguably, we have seen the most disappointing Chinese data in two years with the Citi Economic Surprise Index showing its latest reading of 48.5. But the Caixin Market China Services PMI continues to be steady around 53.9, close to its highs. What is more fascinating is what is happening behind the scenes.
The Chinese 7-day SHIBOR rate and the two-year Chinese swap rates, namely are at 2.65% and 3.8%, the latter down about 15% since April. This is unofficial "easing" in the background. We have also seen similar RRR cuts over the last few weeks as well.
Could the Chinese be boosting liquidity in the background artificially to try to support markets going forward? One thing is for sure, no one is positioned for it.
Let's go back to the Fed and their minutes released yesterday. Previously we know Fed Powell was happy to keep raising rates "gradually" as the economy and inflation prospects warranted it. But a lot has changed in the last month or so with emerging markets currencies collapsing, trade war uncertainty taking asset prices lower and hints of recession everywhere.
The dollar has had a great run vs. most G7 currencies, rightfully so, to price in the higher interest rate yield prospect. But one needs to ask how much further does it have to run here?
The minutes released yesterday showed that the committee was happy to stay on its "gradual" path pushing the fed funds rate to or even above its long run estimate of around 3% currently. But many district contacts expressed concern about possible adverse effects of tariffs which could pose substantial risks to growth. Aha, and here it is! Is the Fed starting to get a little worried?
Most of Trump's tax stimulus benefits have been offset by higher oil/gasoline prices that negate the increase in disposable income. If things stay as is, US GDP prospects are looking a lot lower in 2019 and 2020. What can Trump do now, ask Congress to approve an even higher spend? It seems he has no option but to keep tweeting trying to bully the world but not taking any responsibility himself.
Going back to fundamentals. The US 10yr/2yr yield curve spread is now firmly below 0.3%. The market is pricing in less than 50% chance of 2 additional rate hikes for this year. The ADP private payrolls report came in softer at 177 vs. 190 yesterday, but we await the official non-farm payrolls today. If it is "soft" in any way, the dollar is in for a surprise; a surprise no one is positioned for.
The market is new to Fed Powell's way of thinking so not entirely sure if a "Powell put" is in place as one was for Yellen and chairpersons before her. But one thing is clear, if investors keep focusing on the back and forth sensationalist tweets between China and US and not notice what is happening behind the scenes, they could be caught short.
US and China both know the consequences of an outright global trade war. No one wants global momentum to slow down. Trump just needs some concession to go back to his supporters to claim a "victory" ahead of November midterm elections. It is all one big soap opera.
Let's take a step back and look at the bigger picture. Global momentum is softening, but it is still robust.
If the US Fed or China start stimulating even in the slightest in the background, we are in store for a rally especially given where the global risk appetite measures are currently according to CSFB indicators showing almost at panic level.
It is easy to be bearish when the whole world is telling you to be so. The risk reward looks good to go the other way it seems.