Monday, May 6, 2019

Trump raises the stakes in the US-China trade talks: “art of the deal” move or risky bluff?

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MORNING BRIEFING

Currency markets start the week in a mixed manner following two important twists of events: the release of the Non-Farm Payrolls report last Friday and President Trump's tweet on China over the weekend. Risk sentiment turns negative following Trump's threat to raise the tariffs on Chinese goods as soon as Friday, citing China's attempt to renegotiate the proposed deal. The Dollar ended last week on a low note even though the NFPs beat expectations; however, wage growth printed slightly less than expected. Equity futures point sharply lower, Gold rallies and Oil breaks towards the $60 mark.

Starting with the Non-Farm Payrolls report at the end of last week, the figures revealed a robust labor market with the number of jobs added to the US economy topping estimates and unemployment dropping to 3.6%. Wage growth was also strong but came in at 0.2% on a monthly basis, compared to expectations for a 0.3% advance. Nonetheless, the Dollar sold off on the back of the seemingly bullish set of data and the question is why. Do investors put such excess weight on the lower wage inflation reading that drove them to disregard all the other positive pieces of the report? It seems a bit far-fetched as a plausible cause but this will all become clear this week when the US PPI and CPI figures print.

However, even though the Dollar ended the week on weakness, President Trump's tweet in regards to the progress of the Sino-US talks brought it back to life. The US President threatened to increase the rate on US' tariffs on Chinese goods from 10% to 25% as soon as this Friday as a result of the negotiations going “too slowly, as they [China] attempt to renegotiate” according to his Twitter message. Risk sentiment dampened on the back of his threat with the Dollar kicking off trading higher almost across the board, with the exception of the Yen. This is a classic risk averse reaction from investors seeing months of encouraging progress potentially going down the drain.

The million dollar question is “does he mean it”? Given Trump's record of “art of the deal” negotiation tactics this may be a high risk/high reward maneuver to put pressure on the Chinese side to close the deal. Will it work though? It remains to be seen: at a time when China's economy seems to be picking up pace again one would suppose that they wouldn't risk putting themselves in a tough spot. However, the other side of the argument suggests that the pickup in growth itself proves that China can weather the US-led levies so why not strive for a move favorable deal, particularly during a period that Trump has to start preparing for his Presidential re-election campaign?

In any case, the standoff weighs heavily on risk appetite and the Dollar stands to gain from this. Whether China decides to attend this week's round of talks in the US or call Trump on his potential bluff will be telling and if they don't show up, the greenback will likely shoot higher. Higher beta currencies like the Euro and the Pound are at risk of giving up their recent gains while the commodity dollars appear vulnerable too. Dollar/Yen on the other hand points lower and a move towards 109.80 may be the next step.

Gold climbed higher on Friday on the back of Dollar's bearish reaction to the NFPs and Trump's tweet sent prices to test the $1,285 resistance when Asia opened overnight. The re-escalation of geopolitical risks seems beneficial for Gold while at the same time the US decision to send an aircraft carrier group to the Middle East to address “troubling” warnings from Iran raises the stakes. Should prices break above the $1,290 level, it would alter the current bearish bias for the yellow metal and a move towards $1,300 would seem the next step. Oil hit the $60.50 level we mentioned in our Friday note and if the current trend in place penetrates this important near-term support, then a further extension lower exposes the $58 area.

Finally, equities are coming under pressure at the start of the week. Trump's threat to re-escalate the trade war with China bodes badly on investors' sentiment and equity futures in Europe and the US are pointing sharply lower. The major markets are expected to open between 1.5% to 2% in the red and this now threatens to change the bullish bias in place. Strong US growth and low chances of the Fed raising rates were supportive catalysts for stocks around the world; albeit, if the US and China leave the negotiating table then the risk of increased tariffs having a knock-on effect on trade and global growth will force investors to turn defensive and lead equities significantly lower.

MARKET EVENTS TO WATCH

  • Eurozone Services PMI - 12pm
  • Eurozone Retail Sales - 1pm

All times are GMT +4.

Written by Konstantinos Anthis, Head of Research