Wednesday, December 4, 2019

US-China trade deal may be delayed until after 2020 presidential elections; No strong reason for BoC to cut interest rates

  • Dollar
  • Gold
  • Euro
  • Pound
  • Stocks

Market recap: Will the Kiwi be affected by RBNZ’s final capital review decision tomorrow?

US equities fell for the second day in a row as hopes for a trade deal dampened on Tuesday. US President Donald Trump said on Tuesday that a trade deal with China may only be done after the US presidential election in November 2020. US Commerce Secretary Wilbur Ross later supported Trump's statement by saying that the US will proceed to impose the planned tariffs for December 15th if there is still no deal in the next two weeks. The DJIA tumbled 1.01%, the S&P500 fell 0.66% and the Nasdaq retreated 0.55%.

Meanwhile safe haven assets gained as investors shifted away from risky assets thanks to fading prospects for a US-China trade deal in the near future. Gold spiked up 1.04% and the yen advanced 0.32% against the greenback. The Dollar index fell 0.12%. US treasuries gained across the board as well. Two-year yields slipped 6bps to 1.54%, 10-year yields sank 10bps to 1.71% and 30-year yields dropped 10bps to 2.16%.

In Asia, stocks look set to track US losses for the second session in a row on Wednesday. The Nikkei, Hang Seng Index and Straits Times Index started Wednesday's trading sessions 0.83%, 1.21% and 0.64% lower.

Highlights for the day ahead include US private sector employment change at 9.15pm (GMT +8) and the Bank of Canada's (BoC) decision on monetary policy at 11pm (GMT +8). Also, look out for the Reserve Bank of New Zealand's (RBNZ) final bank capital review decision that's due at 7am (GMT +8) tomorrow. If the RBNZ decides to raise the capital reserve requirements for banks, there is likely to be a drop liquidity in the New Zealand economy which may possibly affect the Kiwi. Expect the Kiwi to remain little changed before the decision as traders wait for the announcement. If RBNZ does decide to raise the capital requirements for banks, then NZD/USD may fall as a result.

Today’s Analysis: Costs of rate cuts outweigh the potential benefits for the Canadian 

The BoC is set to make its decision on monetary policy later today at 11pm (GMT +8). But it is unlikely that the BoC will ease monetary policy in today's meeting, and investors expect this. As of December 3rd, Overnight Index Swaps imply that the market is only pricing in a 4.1% probability for a rate cut in December.

Canada's GDP growth eased from 3.5% in Q2 to 1.3% in Q3 and fell short of economists’ expectations for a 1.7% growth. But details in the GDP report did raise optimism for the Canadian economy. Q3's GDP growth was fuelled by increasing business investments and household spending; business investments rose 2.6% in Q3, the fastest pace since Q4 in 2017 and growth in household spending advanced to 0.4% from 0.1%. BoC's monetary policy meeting in October revealed that BoC officials will pay close attention to consumer spending and fiscal policy as exports and business investments were likely to be negatively impacted by the trade war and global economic slowdown. With improving domestic demand and an unexpected rise in business investments, the BoC does not have a compelling reason to cut rates.

High levels of household debt in Canada is a factor that BoC officials will likely take into consideration as well. Reducing rates is likely to push household debt levels even higher thanks to cheaper loans. This could consequently put the BoC in a tricky situation in future as a rate hike would increase the cost of debt and consumer demand will be greatly impacted due to the higher levels of debt. Furthermore, the impact on consumer demand will only grow if household exposure to variable interest rate loans continues to grow as it has since 2017.

Household debt to service rations reaching new record levels since 2008's 14.88 level

Household non-mortgage debt levels is on a rising trend since 2017

With annual inflation still hovering within the BoC's target range and near the target midpoint of 2%, the BoC is unlikely to cut rates as the cost of cutting rates would outweigh the benefits. 

Inflation levels still hover near BoC's target midpoint of 2%

It is more likely that the BoC will leave rates unchanged in today's monetary policy meeting and continue to adopt a similarly dovish statement as in October, especially since the US looks increasingly likely to impose tariffs on December 15th. The Canadian dollar is then likely to fall slightly on the announcement as a rate cut by the central bank in early 2020 will look increasingly likely. USD/CAD is likely to range between 1.3294 and 1.3323 as a result. But if the BoC surprises the market and sounds much more dovish on future monetary policy, then USD/CAD will likely spike up as a result, possibly to 1.3339's level.

Scenario with effect on USD/CAD