“Risk off” mood as questions about trade deal grow; preliminary PMIs

Rates as of 06:30 GMT

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Market Recap

Will it never go away? On Friday I thought we finally had a “Phase One trade deal between the US and China. Indeed even though the full details and signing probably won’t be until next month, the US did delay the increase in China tariffs that was scheduled to come into force on Sunday, and furthermore tariffs on some Chinese goods will be cut in half. Trump even tweeted that discussions on the Phase Two agreement would begin “immediately,” not after next year’s Presidential election as had been feared.

So we should be in huge “risk on” territory this morning, no? NO! Quite on the contrary, precious metals and CHF & JPY are up sharply, while AUD is the big loser – a huge “risk off” move despite sharply higher Australian rates.

Apparently the lack of detail in the trade agreement has spooked the markets. I think the phrase “plenty slips twixt spoon and mouth” or maybe it’s “don’t count your exports until they ship” would be appropriate here. Also, there are fewer tariff rollbacks than some had thought likely and the fact that they will start talk on the Phase Two agreement simply means that it will be a live issue much sooner than people had thought. So like Brexit, solving the first part of the problem doesn’t necessarily mean solving the problem as a whole.

The GBP rally didn’t last long! Profit-taking on the pound’s jump has already set in. One reason may be the increasing tensions between England and Scotland after the Scottish National Party (SNP) won 48 out of 59 seats (albeit with only 45% of the vote in Scotland – demonstrating once again how distorted Britain’s “first past the post” voting system is. Similarly, the Conservative Party got a huge majority in Parliament and Labour was devastated although the popular vote barely changed.) SNP leader Nicola Sturgeon said Scotland needs a new referendum on whether to split from the rest of the UK, but also suggested that she wouldn’t hold one without the consent of the London government as it wouldn’t be legally valid. PM Johnson’s team has ruled out the idea, even though the entire basis of his campaign was for the UK to split from the EU. Sauce for gander anyone? In any event, I think we may have seen the top for GBP for some time as the market comes to grips with the fact that Britain faces a long and difficult period of international negotiations and domestic tensions.

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Commitments of Traders (CoT) Report

Basically, specs pared their currency positions last week. Long, short, no matter – only AUD shorts increased, and very slightly at that.

Specs cut their short GBP positions significantly, but remain moderately short GBP. Looking at the price action, I’d think next Friday’s CoT Report will show that they closed these positions out further. However, the big question is what they do after that. Do they start to turn bullish on Britain? Or do they realize that this was just “episode 1 in a 10-season box set”, as Lib Dem leader Jo Swinson said, and believe the recent rally in GBP makes a good entry point for new shorts. Personally I believe the latter, although if I were a hedge fund prop trader whose bonus for the year had already been determined, I probably wouldn’t put the position on in size until next year.

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Today’s market

The main event today is the preliminary purchasing managers’ indices (PMIs) for the major industrial countries. These preliminary surveys were done too early to catch the impact of the quasi-resolution of the US-China trade dispute. I’d expect them to be revised upwards by more than usual when the final figures come out in two weeks.

Japan’s PMIs are already out, but nobody cares, oddly enough. Is that because they don’t care about Japan or they don’t care about the PMIs? In any event, no one forecasts them and no one seems to watch them. In case you’re curious though the manufacturing PMI was down 1 tick to 48.8.

The day then starts with Europe’s. France’s manufacturing PMI is expected to be down slightly, but Germany is forecast to be up – albeit still well below the “boom or bust” line of 50 – as is the EU-wide manufacturing PMI. With Eurozone services also forecsat to edge up a bit, the composite EU-wide PMI (not shown) is forecsat to nudge up 1 tic to 50.7. This should add credibility to the growing idea that the worst is over for the Eurozone economy, even if the recovery is likely to be gradual. EUR positive

The UK PMIs are both expected to show modest improvement but to remain below 50. Will anyone care about UK indicators now, or will everyone be focused on the post-election political maneuvering? If they are watching the indicators, then “confirmation bias” suggests that people will interpret this ambiguous result in whichever way will confirm their existing bias. Will this report, like the continent’s, suggest that things are getting better, or will it confirm that after three months of zero GDP growth, the economy is still contracting? I think the latter, which is why I think this result will be negative for GBP, in contrast with the similar forecast for the EU.

Later in the day we get the preliminary Markit PMIs for the US. The manufacturing PMI is expected to be unchanged while the service-sector PMI is forecast to rise.

The (forecast) substantial improvement in the EU-wide manufacturing PMI vs the (forecast) unchanged US manufacturing PMI could put some upward pressure on EUR/USD today, although clearly the relationship is not that tight.

In addition to the PMIs, we get the first of the Fed’s regional surveys today. As usual, we start with the Empire State manufacturing survey, the Empire State being New York. Although this index is closely watched by the market, in fact it’s #4 out of the five such regional Fed indices for its reliability in forecasting the ISM purchasing managers’ index, which is what it’s probably being used for. Only the Dallas index – a region dominated one industry, energy – is less representative of the US economy as a whole. In other words, it’s not very reliable, it’s just early. It’s particularly not very reliable nowadays. Nonetheless, improvement is improvement, so a higher figure as is being forecast should only confirm the steadily expanding figure expected from the manufacturing PMI. That could boost USD.

One brief note about tonight’s Fed speaker, Minneapolis Fed President Neel Kashkari. All 12 regional Fed presidents attend the meetings of the Federal Open Market Committee (FOMC), but only four of them vote at any given time. Voting rotates around the various regional Feds annually according to a predetermined schedule. This year it’s the turn of the Minneapolis Fed, so Mr. Kashkari gets to vote starting with the 29 January meeting. Thus we have to start paying attention to him. He’s the most dovish person on the Committee. For a long time he was presumed to be alone at the bottom of the Fed’s “dot plot.” He’s no longer alone over the forecast period, although he probably is in the “long term” column (see below).

Having said that, St. Louis Fed President James Bullard will rotate off. He’s probably the second-most dovish person after Kashkari. Kashakri will therefore tip the FOMC vote a little bit, but not that much.

Furthermore, the two most hawkish voters – Rosengren (Boston) and George (Kansas City) – will be replaced by two hawkish-but-not-quite-as-hawkish people, Mester (Cleveland) and Harker (Philadelphia).

On the other hand, the dovish Evans (Chicago) will be replaced by the centrist Kaplan (Dallas), a small shift to the hawkish side.

Three moves to the left, one to the right — the overall tenor of the FOMC is likely to shift slightly to the dovish side.

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DISCLAIMER

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The information and opinions in this report were prepared by Marshall Gittler and do not represent Fairmarkets’ views or opinions. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable, the author makes no representation as to its accuracy or completeness. This report is provided is General Financial Advice and does not take into account the particular investment objectives, financial situations, or needs of individual traders. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy.

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The author is not acting as a financial adviser, consultant or fiduciary to you or any of your agents (collectively, “You” or “Your”) with respect to any information provided in this report. Information contained herein is being provided solely on the basis that the recipient will make an independent assessment of the merits of any investment decision, and it does not constitute a recommendation of, or express an opinion on, any product or service or any trading strategy. The information presented is general in nature and is not directed to retirement accounts or any specific person or account type, and is therefore provided to You on the express basis that it is not advice, and You may not rely upon it in making Your decision.

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The author may hold positions in any of the currencies or commodities that are mentioned here. He may also be holding debt or equity securities in any of the markets or issuers he writes on.

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‘The key is not to predict the future, but to prepare for it.’ Pericles, 500 BCE

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