- Markets’ risk-on mood intensified this week on the back of increasing optimism over a US-China trade deal that would also lead to a gradual rollback in bilateral tariffs. Strong U.S. non-farm payrolls and services sector figures, along with better-than-feared earnings also helped to improve market sentiment.
- China noted that it has agreed with the U.S. to roll back tariffs on each other’s goods in a ‘phase one’ trade deal if it is completed. However, the U.S. has not agreed to fully rollback tariffs. China’s statements have sparked divisions amongst White House advisors, with trade advisor Navarro saying that there is no agreement at this time to remove any of the existing tariffs as a condition of the phase one deal, and that only President Trump can make that decision. Meanwhile, U.S. congressmen have urged Trump to phase out tariffs in stages as China complies. The phaseone deal is expected to be signed before year-end by Presidents’ Trump and Xi at a yet-to-be determined location.
- This week’s positive economic data in the U.S. also supported risk appetite. The U.S. showed better-than-forecast ISM non-manufacturing figures in October (54.7, consensus 53.5, previous 52.6), tempering concerns that the widespread weakness in manufacturing will spill over into the service sector. In the Eurozone, the final PMIs for October were slightly revised upwards across sectors. Nonetheless, the manufacturing index remains in contractionary territory, alongside the cuts of the EC forecasts for the EZ growth and inflation in the next two years. Moreover, China’s trade surplus widened in October with exports declining less than expected (-0.9% y/y, consensus -3.9% y/y, previous -3.2% y/y).
- Safe-haven yields saw a significant increase (10Y yield +20 bps in US and 12.5 bps in Germany), with both the US and German yield curves steepening, suggesting investors are pricing in some reflation. In fact, market-based inflation expectations climbed (+12 bps in U.S. to 2.06, and +5 in Germany) while the U.S. term premium increased (+8 bps). Risky bonds attracted fresh demand, (corporate spreads narrowed by -14 bps and the EMBIG by -9 bps), while the Italian risk premium remained high in Italy (146 bps) after the EC cut Italy’s growth estimate and increased debt projections.
- The prospect of the U.S. rolling-back China tariffs strengthened the yuan against USD (USDCNY breached below the 7 threshold intraday). Unlike other safe haven currencies (such as the JPY), this time, risk-on mood did not weigh on the USD, which appreciated against main DM (DXY +1.1%) as robust labor and services data supported the Fed's recent rate pause signal. In fact, markets continued easing expectations of additional interest rate cuts (60% probability of at least a 25 bps cut by December 2020, down from 78% last week). The euro and the GBP depreciated (-1% against the USD), the latter especially after the Bank of England cut its growth forecast, and left monetary policy unchanged in an unexpectedly split decision. Apart from the yuan, EM FX currencies performance was uneven. MXN and COP were flat, while TRY slightly depreciated (-0.8%), despite improving inflation dynamics, as geopolitical factors still weigh. The BRL also depreciated (-3.6%) led by the absence of foreign firms in the auction of oil deposits, thwarting expectations of strong dollar inflows.
- Equity indices gained across the board, led by cyclical sectors, with the banking sector in Europe and the U.S. increasing significantly (+6% in EZ and 2% in the US).
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