Equity markets retreated somewhat, while safe havens gained yesterday, following reports that China wants more talks before signing a first-phase trade deal, something suggesting that last week’s negotiations may have not progressed as great as initially reported. Among the G10 currencies, the pound was the main gainer, rebounding again after the UK Telegraph reported that a Brexit deal appears to be taking shape.
The dollar traded higher against most of the other G10 currencies on Monday and during the Asian morning Tuesday. It gained the most against NOK, AUD, NZD and CAD, while it underperformed only fractionally against GBP and JPY. The greenback was found virtually unchanged against EUR.
The strengthening of the yen, the fact that the franc was among the currencies that lost the least against the dollar, and the underperformance of the commodity-linked currencies suggests that market sentiment was somewhat subdued. Indeed, major EU and US indices closed their session slightly in the red yesterday. As fort today, Asian markets were more on the mixed side, with China’s Shanghai Composite sliding 0.56% and Japan’s Nikkei gaining 1.87%, perhaps catching up from the previous session as it was a holiday in Japan.
On Friday, US President Donald Trump said that the US and China have reached a phase-one deal and decided to suspend tariff hikes on Chinese goods, scheduled for this week. All this may have raised hopes that a final and sealed deal is closer than previously thought, but the optimism was quick to fade yesterday. After all, judging by the equity rally in the end of last week, an interim deal may have already been priced in. What stopped the party so early may have been reports that China wants more talks before signing this first-phase deal, something suggesting that last week’s negotiations may have not progressed as great as initially reported. On top of that, US Treasury Secretary Steven Mnuchin said that the next round of tariffs will kick in on December 15th if a final accord is not reached by then.
In our view, all this suggests that there is still a lot work to be done before we see signatures, but it does not point to breakdown. We believe, that China’s wish for more talks indicates that the nation remains willing to work things out, while Mnuchin’s “threat” may be a way to push things in order to get the deal done as soon as possible. As for the markets, it is still hard to start examining a long-lasting path. Anything suggesting that the world’s two largest economies are moving closer to finalizing an accord could boost investors’ appetite, but until we see handshakes and signatures the risk of everything falling apart again remains well on the table. After all, we saw this happening again in the past.
After a strong run to the upside in the end of last week, the Euro Stoxx 50 index managed to correct back down a bit on Monday. But in the second half of the day, the buyers managed to fix the situation slightly and pushed the price to the upside, closer to the high of last week, at 3572. The index is trading above its short-term tentative upside support line drawn from the low of October 4th. Even though we could see another move lower, as long as the price remains above that upside line, we will stay positive, at least for now.
A small correction back down again might bring Euro Stoxx 50 closer to the 3530 area, which if holds, could be seen as a good bouncing ground. The index may once again fall under the influence of the buyers and the price could drift to the above-mentioned 3572 barrier, a break of which may set the stage for a test of the 3588 zone, which is the current highest point of October. Initially, the index might stall around there, but if the buyers are still feeling more comfortable, a further move up, bypassing the 3588 hurdle, could lead to the 3600 level, marked by the highest point of May, 2018.
In order to examine the downside, at least in the short run, a drop below the 3481 area is needed. This would also place the index below the aforementioned upside support line and could lead the price to the 3444 obstacle, a break of which might clear the path to the 3423 zone, marked by the low of October 8th. We could see Euro Stoxx 50 rebounding from there, but if it stays below that upside line, we could see another round of selling, which this time might push the index below the above-discussed 3423 zone and aim for the 3403 level. That level marks the low of October 2nd.
Flying to the UK, the British pound was the main gainer among the G10s. Over the weekend, headlines that the UK and the EU still have a lot of work to do before securing a Brexit agreement casted doubts over the possibility of such an outcome. This gave a reason for GBP traders to liquidate some of the long positions they initiated in the end of last week, thereby allowing the British currency to pull back during the Asian morning Monday. However, the retreat was short-lived, and the pound rebounded again after the UK Telegraph reported that a Brexit deal appears to be taking shape, with sources saying that negotiations have yielded a possible solution with regards to the Irish backstop.
It seems that the pound remains hostage to Brexit headlines and it could react even more violently to those heading into the EU summit scheduled for Thursday and Friday. Remember that last week, it skyrocketed after Irish PM Varadkar said that a Brexit deal could be reached by the end of October, and after EU Brexit negotiator Michel Barnier said that he had a “constructive” meeting with his British counterpart. Barring any new negative headlines, sterling could continue gaining heading into the summit, but it is too early to talk about a long-term uptrend in our view. First, all EU member states would have to agree to a new exit deal, and even if they do, any such deal would have to be approved by the UK Parliament, perhaps at a rare session on Saturday.
Thus, we still believe that a finalized and sealed deal in less than a week’s time is not such an easy task, and if it doesn’t take flesh, Johnson would have to ask for a new extension, at least according to law. However, with the UK PM sticking to his guns that Britain will exit the EU by October 31st, with or without a deal, what would happen if no accord is approved remains largely a mystery.
Last week, on Thursday and Friday, GBP showed spectacular performance against other major currencies, including its Australian counterpart. GBP/AUD moved sharply to the upside, but found resistance near the 1.8682 zone, from which it corrected back down. The pair tried to move above it yesterday, where it managed to break that level, but was unsuccessful to stay above it. This morning we are seeing another move towards that barrier. We need to see another clear break above that area before examining a further directional move, hence why we will stay cautiously-bullish for now.
A push above the 1.8682 barrier could clear the way to the next potential resistance zone, at 1.8785, which is the high of May 7th. If the pair struggles to move above it straight away, it may reverse back down for a small correction. That said, if the rate remains above the 1.8682 hurdle, the bulls could see it as another opportunity to step in and drive GBP/AUD higher. If this time they manage to overcome the 1.8785 obstacle, the next stop for the buyers might be seen around the 1.8881 level, marked by the highest point of May.
Alternatively, a rate-drop back below the 1.8495 hurdle, marked by the highest point of September, could spook the bulls from the field temporarily and place the pair below the 21 EMA and the 20 SMA of the Bollinger bands on the 4-hour chart. Such a move could send GBP/AUD to the 1.8430 obstacle, a break of which may clear the path to the 1.8275 level, marked by the low of October 11th.
During the European morning, we get the UK employment report for August. The unemployment rate is expected to have remained unchanged at 3.8%, while average weekly earnings, both including and excluding bonuses, are expected to have slowed to +3.9% yoy and +3.7% yoy from +4.0% and 3.8% respectively. According to the IHS Markit/KPMG & REC Report on Jobs for the month, starting salaries for permanent workers rose at the slowest since December 2016, while temporary pay growth slid to a five-month low. This supports the case for lower official wage rates. Having said all that, even if the pound reacts to the data, we stick to our guns that the main driver behind the currency remains Brexit.
The German ZEW survey for October is also coming out. Both the current conditions and economic sentiment indices are forecast to have slid further into the negative territory. Specifically, the current conditions index is expected to have declined to -26.0 from -19.9, while the economic sentiment one is anticipated to have fallen to -27.0 from -22.5.
Later in the day, from the US, we get the New York Empire State Manufacturing index for October, which is forecast to have declined to 1.00 from 2.00.
As for tonight, during the Asian morning Wednesday, New Zealand’s CPIs for Q3 are scheduled to be released. The qoq rate is anticipated to have remained unchanged at +0.6%, something that would drive the yoy rate down to +1.4% from +1.7%. Although a +1.4% yoy CPI rate would still be just a tick above the RBNZ’s latest projection for the quarter, which is at +1.3%, it is very unlikely to alter the market consensus over the Bank’s upcoming decision. According to New Zealand’s OIS (Overnight Index Swaps), investors assign a 95% probability for a quarter-point cut at the next meeting.
With regards to the speakers, we have six on today’s agenda: From the BoE, Governor Carney and MPC member Gertjan Vlieghe will step up to the rostrum, while in the US, we will get to hear from St. Louis Fed President James Bullard, Atlanta Fed President Raphael Bostic, Kansas City President Esther George, and San Francisco President Mary Daly.
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