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Ebullience Galore

Stephen Innes

Reports that the US-China trade deal will include tariff rollback underpinned positive risk sentimentThe S&P500 ripped to record highs, gold was down 0.9%, and oil was up 2.2%. The WSJ reports the spokesperson for China’s Commerce Ministry as stating that if Phase 1 of the US-China trade deal is signed, both sides have agreed to lift some tariffs “simultaneously based on the content of the deal”.

The bond market responded especially favourably: US 10-year treasury yields were up 9bps to 1.92%, their highest since the end of July.

Recall back then the markets were mulling a minuscule % reduction in tariffs in exchange for China buying agricultural products, so the markets have undoubtedly taken the road less travelled since then.

That said and read into this how you will, pouring a glass of ice water on the enthusiasm Reuters headlines suggesting that no decision has been made on the US side have weighed a little on sentiment and causing risk asset to stumble into the NY close. 

So, missing this critical piece of the puzzle there remains a touch of uncertainty, but assuming the phase one is all but fait accompli, from here to the actual execution of the deal it’s hard to expect much if anything else to propel expectations in a positive direction further. If the phase one deal is signed, the markets will then pivot to the degree of rollbacks in exchange for harmony on remaining structural issues.

Its been a hugely busy 24 hours and while the trade headlines are being pointed to for the market moves. But the old bond trader in me from a former life still thinks this is as much about market positioning and the start of the pain trade unwinds as it is about the actual headlines.

Traders were forced to mark up probabilities on reaching a deal on the other structural issues. With bonds lower, cyclical stocks higher and banks ripping. Defensive strategies like gold fell prone to the trade truce euphoria.

Bond yields are still the signal for these moves, and if this momentum continues, institutional equity market bears could be stopped in. With more pain to be had if a break of the critical 3100 SPX level unfolds and then beyond, on that basis alone it might be too early to fade the move even with the Whitehouse throwing cold water on the rally.

Oil markets

Headlines  that the US and China have agreed to roll back tariffs in phases sent oil markets ripping overnight. The level of tariff reductions that would accompany the first phase of the deal will depend on the content of the agreement, which has yet to be finalized, but it is a significant positive to see a softer stance from the US, and consistent with the view that President Trump would prefer the trade issues resolve to suggest he might be more inclined to make tariff compromises.

But the day would not be complete without its usual trade talk twists and turns as oil prices veered lower after Reuters headlines suggesting that no decision has been made on the US side have weighed a little on sentiment.

The possible tariff rollbacks have for the time being put to rest a lot of hand wringing in the oil markets. Still, there remains an element of uncertainty as the US administration has yet to stamp their seal of approval to the latest China trade headlines.

Outside of the binary trading impulse on trade talk headlines the market continues to mull the reports that OPEC delegates may choose to focus on stricter compliance with the existing production cut agreement rather than new reductions which is also spooking the market, especially in the face of the seemingly never-ending run of US inventory builds.

Gold markets

Since gold was the primary beneficiary of escalating tariffs so now, it’s a casualty of their rollback.

Gold finally took out the omnipotent $ 1480 level and after that trap door sprung it was a one-way street to $ 1460. Seventh time was indeed a charm after gold had touched $1,480 six times since October 2 and has held. But with US yields soaring, gold buyers predictably absent as ETF flows have been flat all week, and with China reporting a halt in buying for the first time in ten months, the writing was on the wall. Recall the PBoC gold purchases in late 2018 was the primary catalyst that started the 2019 version of the gold rush. So, removing that critical central bank backstop, gold investors may not have the same sense of bravado as what they had when the central bank was backing up the truck on gold markets.

China hits pause on its gold-buying spree after ten months  (Bloomberg)

In November 2018  PBoC Gold purchases were the clearest signal that China was digging in for the long haul on the trade war front and provided a significant impulse for investors to buy gold .So could  the reverse hold true that China hitting the pause button  could be the  signal that we have finally reached a thaw in the US-Sino tensions?

But what matters for gold, and I hate to sound like a broken record amid all the inane theories on why gold should go higher. What ultimately matters more for gold is the hard and exact inverse correlation to US yields and the US dollar. With US 10-year nominal yields loitering around 1.95 % and the dollar looking  attractive, gold lost  some of its shine.

The market’s latest direction of travel on US bond yields has weighed on gold allocations significantly as has the neutral Fed monetary policy guidance and stronger US equities.But absent a significant risk-off event or material shift in trade talk momentum, it’s hard not to expect the current trend to continue albeit with a possible phase of consolidation between the new $1460-1480 goal posts most probable.

Currency markets

As we mentioned yesterday, despite the risk-on mood, it seems higher US yields will naturally generate some bid for the dollar. But with very low vols its tough even for the G-10 pros to find a directional bias outside of USDJPY which remains the primary beneficiary of higher US bond yields and frothy risk on the momentum. But if the trade truce froth returns chances are commodity-linked currencies could also be boosted.

Yesterday we got a relatively dovish Bank of England with two votes in favour of a cut. Despite this, the market still doesn’t have a full cut priced in

Cable dropped on the 7-2 split vote from the Bank of England and dovish statement. But with the market skew towards a bullish Brexit outcome, position in sterling is very much to the top side. Under normal circumstance an unexpected central bank dovish pivot could trigger a sell-off in the 2-3 % magnitude, even more so with  some participants thinking rate hike post-Brexit. So, with cable precariously perched just above 1.2800, it appears to be on less than stable footings even more so when you factor in the bullish Brexit position and the potential for a long squeeze to unfold.

Before dipping your toe into the Euro pond, the EU commission cuts it eurozone growth forecast and now sees muted inflation making for a pretty grim read.

EU Commission cuts eurozone growth forecast, sees muted inflation (Reuters)

This article was written by Stephen Innes, Asia Pacific Market Strategist at AxiTrader

This article was originally posted on FX Empire