Trump has effectively killed the Asian green shoots narrative, but will he kill Europe with auto tariffs this weekend as well? Meanwhile semiconductors paint an extremely gloomy earnings picture, as Matteo Salvini is gearing up for EP elections.If you want to receive a copy of Week ahead directly in your inbox, you can sign up via this link.
Tariffs were raised on China last Friday, while the soft deadline on increased European auto tariffs is Saturday. A six-month delay is currently mulled over. Is Trump effectively willing to kill two birds with one tariff? The green shoots narrative is certainly killed in the market for now, and the earnings outlook still looks worrisome to say the least. But signs of a pick-up later this year still exist. USD/CNY (or CNH) is the most important international sentiment gauge currently.
USD/CNY (or CNH) is the most important gauge worldwide currently
If, or when, USD/CNY breaks the 7 handle it should be considered a very worrisome signal for global risk appetite. Through 2018 China allowed USD/CNY to move almost exactly 10% higher compared to the levels seen before the trade-war inauguration, maybe in a very concrete attempt to counter the 10% tariffs on Chinese export goods.
What if China attempts to counter the 25% tariff via USD/CNY? Then 7.91 is the next USD/CNY target. We don’t see high risks of such a move, though, as it would be almost suicidal if the Chinese authorities allowed USD/CNY to move swiftly through the 7.00 level – Chinese asset prices would suffer massively as would the growth momentum in Asia. There are though signs that the PBoC has fought against a move above 6.90 already.
Chart 1: USD/CNY the most important gauge of trade-war optimism/pessimism
Earlier this week the Chief Editor of Global Times tweeted that China pondered dumping Treasuries as part of the response to US tariff increases. While you are probably all overloaded with comments on that matter already, we would like to point out three things in relation to this question.
1) If China is serious about dumping Treasuries, it likely means that they will have to buy another USD-denominated asset (gold or oil?), as they otherwise risk a lower USD/CNY fixing along the way. 2) China needs USD. Will e.g. Australia accept CNY for iron ore? Likely not. 3) If China dumps Treasuries, we would consider it a buy signal for US treasuries (see chart 2). Periods of falling Chinese FX reserves historically coincide with dropping Treasury yields – due to slipping world growth momentum. Often China has sold Treasuries when the CNY was weak (to support the CNY). So it is possible to both keep USD/CNY high and sell Treasuries at the same time.
Chart 2: Fewer Chinese purchases (or outright selling) of Treasuries often lead to lower treasury yields
A weak CNY is not in China’s interest, though, as a weak CNY has recently coincided or even spurred weaker PMIs both in China and globally – maybe because asset prices are vulnerable to USD/CNY trends. Asia doesn’t need a weaker CNY, it needs a stronger CNY to grow. The move higher in USD/CNY doesn’t bode well for short-term PMI prints in China.
Chart 3: A weaker CNY is nowadays a short-term bear signal for PMIs, both in China and globally …
Hope is not dead for a trade deal, but we don’t expect anything but a cosmetic deal and an accordingly temporary ceasefire to be signed in June. The underlying battle on intellectual property rights will likely continue for years still (US-China trade war: escalation does not kill deal hope)
Achtung, Achtung: semiconductors rule the world
While Trump has killed the green shoots narrative in markets (at least for now), we have been warning for some months about an imminent earnings recession due to the combination of slowing growth and increasing costs. Analysts took down Q1 earnings estimates materially based on the turbulence in Q4 (and Q1 became an easy beat), but analysts still expect a perfect v-shaped recovery of earnings into Q2/Q3.
You should look no further than semiconductor sales (the timeliest gauge of trade-trends) for an almost perfect indicator of global earnings with a 90-day advantage on MSCI World EPS. Would you bet against an earnings recession after having seen this chart? We wouldn’t (Nordea View: Priced for perfection).
Chart 4: Where are earnings headed? Ask semi-sales 90 days earlier
But it’s not all that bad; sales of semiconductors are often pre-empted by equity performance of semi-conductor producers. Even despite Trump’s fierce attempts to kill the improving mood world-wide, we would still expect semi-sales (and hence world trade) to bottom during H2 2019. This bodes well for risk appetite into the latter part of 2019. But we expect a potentially material correction first.
Chart 5: Semi-sales and world trade could bottom in H2 of 2019 … it’s not all doom and gloom …
On top of the above market-based measure of green shoots in H2-2019, we would also like to highlight that the jury is still out on whether the Chinese money supply could increase rapidly later this year. It seems as if the Chinese struggle to get the “printer running”, but it usually takes up to 12 months before the stimuli effects peak on M1 growth. China may be much better prepared/positioned for the trade war now than in the spring of 2018.
Chart 6: Chinese bond yields hint of a pick-up in Chinese M1 growth over the next 9-12 months
In Fixed Income: Receiver party restarted
The receive-a-palooza is back in the EUR rates space with Bund yields below -0.10% and 10yr EUR swap rates close to 0.40%. The 10yr swap rate is still firmly placed in a downtrend and priced as if the ECB will be 100% on hold during 2019-2020 (something that we find likely). i) Tariffs, ii) Matteo Salvini’s big-spender remarks and iii) weak data are behind the re-start of the receiver party. We don’t expect a reversal of either of the three on this side of the European Parliamentary elections.
Chart 7: 10yr EUR swap stuck in a downtrend and priced as if the ECB is sidelined throughout 2019-20
In the credit space, USD IG spreads have widened relative to EUR peers, which leaves room for another 10-12 bp move lower in the 5yr EUR/USD FX basis. So, as long the hunt for yield is ongoing, we would expect further USD-EUR credit spread widening, as the hunt for yield matters most in low-yielding areas (such as the Euro area).
Chart 8: Room for another 10 bp move lower in the 5yr EUR/USD FX basis to match IG-spreads?
Scandinavia: What inflation ketchup effect?
The SEK has regained its footing a little despite a lukewarm inflation print from Sweden this week. The price action seen in EUR/SEK right after the inflation print likely confirmed a very gloomy positioning in SEK and SEK rates. The inflation ketchup effect was nowhere to be seen (exported Chinese deflation?). According to our model of the SEK trade-weighted inflation impulse on import prices, one should have expected a big positive FX impulse on Swedish inflation by now. It is just nowhere to be seen (April inflation review)
This could leave a veeeeery dovish H2 in store for Swedish inflation, which is why we have also adjusted our Riksbank forecast and now expect rates to remain unchanged throughout 2019 and 2020.
Chart 9: The usual positive effect on import prices from a weak SEK is nowhere to be seen
In Denmark, EUR/DKK has traded in “unchartered” territory above 7.4690 in the past few days.We see a couple of triggers for the recent spike in EUR/DKK. 1) The equity setback worldwide and 2) The upcoming DKK liquidity addition in June. We think that EUR/DKK will remain lofty and that could leave room for some interesting trading opportunities in DKK markets (EURDKK: The Danish financing plan was always destined to push EUR/DKK higher)
What is most important in the week ahead?
Auto tariffs or not? That question will overshadow everything else over the next days. Trump is facing internal resistance against such a move within the Republican party, but it is not as if Trump is scared of using executive orders. And after all the Trump camp and the Bernie Sanders camp within the Democrats are odd bedfellows on several issues stemming from MMT-like spending to international trade. The soft deadline on the matter is 18 May.
We consider auto tariffs more than 50% priced in by now, though, as European Auto-stoxx almost trade at a post 2012 low versus Eurostoxx 600. This leaves upside risks to the EUR if reports are right that Trump will postpone the question another six months.
Chart 10: EUR/USD is somewhat connected to the auto tariffs story
In Europe, we need to follow the signals from the big-spender Matteo Salvini, who is clearly gearing up for the upcoming European Parliamentary elections. Without his “own” central bank it is difficult to promise MMT-like spending “…until we arrive at 5% unemployment, we will spend everything that we should and if someone in Brussels complains, that won’t be our concern.”. The market will not allow such spending and Salvini will probably calm down again in a couple weeks after the election. It’s not like he is the first politician who has promised to spend endlessly (and not delivered accordingly) ahead of an election.
Chart 11: Domestic financial institutions have bought the BTPs lately. Markets will NOT allow Italian overspending
The next Commission president is another important question for the coming weeks, which will have a bearing on the next ECB president as well. Manfred Weber has tried to pave his way by suspending Orban’s party from the EPP, but is it enough to satisfy the Europhiles within e.g. ALDE? If Weber doesn’t succeed (risks are larger than what bookies price), then the probability of getting Jens Weidmann as the next ECB president increases markedly. Will the Barnier/Weidmann narrative receive some tailwind over the next weeks?
Weber is the absolute frontrunner among bookies, with Barnier, Vestager and Timmermans as outsiders.
Chart 12: Implied probability of next EU Commission president in prediction markets
Another month, another bad print for the Euro area PMI (Thursday). Both our Swedish leading indicator and our market-based model point at another weak print next week. Both for manufacturing and the composite PMI. #SAD as Trump would have put it.
Chart 13: Another month, another bad Euro-area PMI print. Our composite PMI model is now below 50
US durable goods orders (Friday) will be interesting in the US since Chinese imports usually lead the developments by up to a quarter. The jury is hence still out on whether the yuuuge drop in Chinese imports will spill over to a material setback in US durable goods orders. In general, we find that the US economy is the next economy to surprise negatively en masse, even though regional surveys over the past week have been in almost tremendous shape.
Chart 14: Will US durable goods orders drop as a lagged consequence of the Chinese import slump?
Lastly, FOMC talk will be important next week, as one shouldn’t forget that the setback in S&P500 started already with Powells presser 1st of May (before Trumps tweeting). Powell speaks late Monday evening (CET) and he will be given the chance to feed the doves after Trumps re-escalation of trade tensions. Even though we dedicated a whole weekly editorial to tell you why Powell is not the thought-leader within Fed (Week ahead: Why you shouldn’t listen to Powell), it may still be more important than usual whether he softens on the “inflation is transitory” stance from 1st of May. Will Powell the flip-flopper strike again?
Chart 15: S&P 500 versus important monetary policy signals
Key research pieces over the past week:
A light start to the week with Japanese Q1 GDP figures being the only main release.
Tuesday is another light day with speeches from FOMC-members Powell (neutral, voter), Evans (neutral, voter), Rosengren (hawk, voter).
The main event is the FOMC Minutes from the meeting earlier this month. Noteworthy is also the latest print of UK inflation. Plenty of central bank will speak during the day with FOMC-members Bullard (dove, voter), Williams (hawk, voter), Bostic (dove, non-voter) as well as ECB-members Draghi (dove, voter) and Praet (dove, voter).
Thursday is a big PMI-day with new prints from the Eurozone, Germany, US and Japan. Also, German Ifo indicators and final GDP-figures are out. In Scandinavia, unemployment figures are out from Norway and Sweden. On the central bank front, the South African Reserve Bank will announce its interest rate decision and FOMC-members Kaplan (dove, non-voter), Daly (neutral, non-voter), Bostic (dove, non-voter), Barkin (hawk, non-voter) speak.
The week concludes easily with a new release of UK retail sales.