A dovish Fed is a welcomed tailwind for risky assets, but potential lack of improvement in the trade talk between China and US is not. Lack of progress could spur new USD strength versus Asian FX. This would not be good news for risky assets.

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Fed: Closing in on neutral?

Risk appetite has rebounded on the heels of more perceived dovish Fed talk by chair Powell. At the beginning of October Powell said that the Fed may go above neutral and that neutral was still “far away”. Now Powell says that Fed Funds may already be close to the bottom of the range of neutral rate estimates. That change of rhetoric has led markets to re-price the Fed outlook markedly in a dovish direction – short-term good news for risk appetite. Maybe Powell is “Trump’s guy” after all.

Should the Fed decide to communicate a pause after a hike in December, then the 10yr treasury yield could be headed to 2.80% or thereabout (grey line below). If they just keep March live as well, the 3% mark on the downside should hold (green line below).

The market interpretation looks contingent on data being bad in the US over the next 1-2 quarters. Powell has still not ruled out going to neutral or above, but the Fed may be even more data-sensitive in the months ahead given the uncertainty around the level of the neutral rate (Fed watch: Closing in on neutral).

Chart 1: 10yr treasury yield to stay above 3% as long as Fed intends to hike in December and March

G-20 summit: Don’t count on Trump/Xi

While a more dovish Fed interpretation is a welcomed tailwind for risky assets, potential lack of progress in the trade negotiations between China and US is not. All eyes will be on the G-20 summit starting today. Recently USD vs. Asian FX has stabilised, which likely reflects either i) expectations of a postponement of US tariffs on Chinese exports, or ii) Asian central banks using FX reserves to prevent further local currency weakening. We subscribe mostly to the former, which is why any perceived lack of progress in the trade negotiations could spur another round of USD strengthening versus Asian currencies.This would not be good news for risky assets.

Currently USD/CNY has picked up roughly 10% since the trade war started in the spring (roughly reflecting a 10% tariff rate). What if Trump goes on and delivers on the 25%tariff rate from 1 January 2019? We remain sceptical of progress being made this week (The G20 is a sideshow)

Chart 2: Current USD/CNY levels roughly counter a 10% tariff rate. What if a 25% tariff is implemented?

As we see it there are two outcomes in case of a 25% tariff imposed on Chinese exports. Either i) USD/CNY (or USD/ASIA) picks up to counter the effect of the tariff, or ii) US inflation will be pushed substantially higher due to the tariff effects. Both are ultimately USD positive scenarios, which is why the only USD negative scenario is an outright postponement of the tariffs. A softening of the trade war is likely a prerequisite for the broader USD development to turn negative (FX weekly: Taxation mirror on the wall, who is the fairest of them all?).

Currently the USD is sufficiently strong against Asian FX to add downside risks towards 2% in US core inflation over the next 2-3 months.

Chart 3: A strong USD adds to downside risks for US core inflation short term

Meanwhile, financial conditions in Asia remain tight, which is likely one of the most important catalysts of the recent PMI weakness in the Euro area. Usually Euro-area export orders suffer from tighter financial conditions in Asia. This is slowly turning into a headache for the ECB.

Peter Praet recently said that the ECB would not consider pulling out unconventional ammunition again, unless more substantial tightening of the financial conditions in the Euro area was seen. We are certainly not there yet, but leading indicators continue to point south for the Euro-area momentum. Given that the core inflation print yet again didn’t show any momentum in the Euro zone, risks are now tilted towards ECB not delivering a rate hike at all in 2019.

Chart 4: Tighter financial conditions in Asia is an issue for the Euro-area outlook

However, it is not only the Euro zone that seems ripe to suffer from tightening financial conditions in Asia. The export orders component of the US ISM index looks set to drop to 50 or below over the coming months. Spill-over on the US economy from the tighter US monetary policy (that initially led to tighter EM financial conditions) may become more visible in coming months. Could this be the real reason for the Fed’s and Powell’s softening in recent weeks? We tend to think so.

Chart 5: US export orders could also suffer more from weakening Asian real activity

We have been arguing for a while that US key figure momentum could drop faster than the Euro-area ditto. The tightening of Asian financial conditions (driven by the trade war and tighter US monetary policy) has so far had the biggest negative impact on the Euro area. However, lower oil prices will likely have a bigger negative impact on the US due to a deteriorating CAPEX cycle. On the margin, US momentum may drop faster than the Euro-area ditto, but leading indicators continue to point south on both sides of the pond.

Scandinavia: The NIBOR puzzle and more bad news for the Riksbank

Another week, another couple of bad data prints in Sweden. That seems to be the current pattern. This week both retail sales and the Q3 GDP number surprised negatively in Sweden. Q3 GDP even declined by 0.2% quarter on quarter (Swedish Q3 GDP review: Weak). It is turning out to be weird timing of the first hike from the Riksbank given the late-cyclical signals that the Swedish economy is sending.

The market is staying remarkably resilient to all the negative news from Sweden, though. Market pricing of the December meeting remains at an elevated +17 bp. It seems as if the market has concluded that the Riksbank will hike in December or else the window closes.

We stress that the December hike is far from a done deal.

Chart 6: Car registrations continue to point to downside risks for household consumption in Sweden

In Norway, the Nibor-folio rate spread remains at elevated levels between 45-50 bp.The main culprit is the widening USD Libor/OIS spread, as Nibor is constructed as the funding cost in US dollars swapped to Norwegian kroner (there is no actual unsecured interbank lending in Norway any longer). Therefore Nibor can live a life on its own decoupled from domestic developments in Norway (The truth about NIBOR).

The Nibor-folio spread has increased 15-20 bp since the September hike from Norges Bank and as the Nibor rate is THE reference rate in the Norwegian economy, the spread widening implicitly counts almost as much as another rate hike on top of the one in September.

This is an issue for Norges Bank, as it is not fully in control of the monetary impulse on the economy, but rather a “slave” of the developments in the price of USD liquidity. The wider Nibor spread is something that will filter into the thoughts of Norges Bank at the December meeting.

Norges Bank will try to add cheap NOK liquidity to the market over the turn of the year (an extraordinary F-loan auction is already announced for 31st of December) – a scenario with downside risks for the NOK.

Chart 7: Nibor spread is widening due to wider USD libor/ois spread.

What is most important in the week ahead?

Next week has PMIs and Brexit written all over it.

In China, the most interesting PMI figure (Caixin/Markit) will be out early Monday. The developments in the Shanghai composite index continue to point to downside risks for the Chinese momentum short term.

Chart 8: Shanghai composite points to downside risks for the Chinese PMI

In the US, we will get a new test of the resiliency of the ISM index to tighter financial conditions in the US (and in Asia). Recently both the wider spreads in the credit space and partly the equity sell-off in October/November (before Powell’s dovishness) have led to a tightening of US financial conditions. The sharp drop in oil prices is another thing adding to the tighter financial conditions (due to the spill-overs to US credit and CAPEX).

The early consensus expects the ISM Manufacturing index to rebound to 58 from 57.7in October (Mon). We see clear downside risks to that view. The ISM may be headed as low as the range between 52.5-55 over the next few months as a lagged consequence of the tighter financial conditions.

We expect the labour market to continue to show resilient numbers in the US job report on Friday.

Chart 9: Financial conditions point to downside risks for the ISM manufacturing index

On Tuesday the Brexit debate will start in the House of Commons, with a tough task ahead for Theresa May in terms of convincing a majority of the members to vote in favour of the negotiated draft Brexit deal. We see very slim chances that Theresa May will ultimately be able to get the deal through the House of Commons (at least in the current format). The debate starts next week, while the “meaningful vote” in the House of Commons is due 11 December.

In Scandinavia, the Swedish manufacturing PMI index is out on Monday. Given the orders-to-inventories ratio of the most recent PMI print, we see mainly downside risks to the headline PMI this month. In fact, the Riksbank has never hiked with as a weak an orders-to-inventories ratio in the manufacturing PMI. They would usually have prepared a cut. This goes to show the magnitude of the Riksbank reaction function shift since 2013.

In Denmark the market will closely watch the monthly update of FX reserves in the Danish central bank. We see a risk that the Danish central bank has already been forced to intervene lightly to contain the upside pressure on the EUR/DKK peg. We will be wiser Tuesday at 17:00.

In Norway the monthly house price developments will be interesting to follow on Wednesday, as the inventory-to-sales ratio has recently started to point south. Housing market downside risks could be a risk for the NOK outlook as well. Also the OPEC meeting on Thursday will have potential important repercussions for the Norwegian outlook.

Key research pieces over the past week:

FX weekly: Pikachu ain’t no hobbit (25 November)

The G20 is a sideshow (27 November)

Nordea On Your Mind: Capex II – Running to stand still (27 November)

Fed Watch: Closing in on neutral (29 November)

Swedish Q3 GDP review: Weak (29 November)

Nice Danish Growth (30 November)

Finland: Gloomy outlook (30 November)

Table 1: Main releases to watch


This week is a big PMI week and the focus on Monday will be on manufacturing PMI figures from the US (ISM) and China (Caixin). We also get manufacturing PMI figures from the UK, Sweden, Norway, Spain, Italy, Russia, France (final), Germany (final) and the Euro area (final). The inflation figures from Turkey are released on Monday and it will be interesting to see if they are still sky-high. In the past two months, Turkish inflation has been over 25%. During the day, Fed’s Kaplan (neutral, non-voter) will speak.


On Tuesday, the House of Commons starts a debate on Theresa May’s Brexit deal ahead of the “meaningful vote”, which is held on 11 December. During the day, the construction PMI figures from the UK are released, Norges Bank publishes its regional network survey, the Reserve Bank of Australia announces its interest rate decision and the BoE’s Carney speaks.


Wednesday’s focus is on composite and services PMIs. We get service PMIs from China (Caixin), the UK, Spain and Italy. The final composite and service PMIs from the Euro area, France and Germany are also due. The ISM non-manufacturing and the ADP job report from the US are released and the Indian, Polish and Canadian central banks publish their interest rate decisions. During the day Fed’s Powell (neutral, voter) will speak.


Thursday is a light day on the data front. The ECB’s Guindos (dove/neutral, voter) and the Fed’s Bostic (dove, voter) will speak during the day.


Friday’s key event is the US job report where the wage data will as usual receive the most attention. We also get manufacturing production figures from Norway, the Halifax House Price index from the UK and the final Q3 GDP figures from the Euro area.

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