Markets Outlook: Plenty of room for positivity despite ominous escalation in trade tensions

The market calendar picks up again this week and the primary focus will no doubt be the May employment report (Friday). Economists expect nonfarm payrolls to decline by 6.1 million (vs. -20.5 million previously), which should raise the unemployment rate to a new post-WWII high of 19.1% (vs. 14.7%).

But another encouraging decline in continuing claims this week on the Jobless Claims (Thursday) would continue to suggest the negative economic knock on effects from the pandemic are not as severe as once feared. 

The other data in focus will be the PMI releases from around the world. The flash readings earlier in May did see an uptick from the record lows of April, though they remained well below the 50 mark that separates expansion from contraction. 

The central bank spotlight next week will be on the ECB's monetary policy decision on Thursday and President Lagarde's subsequent press conference from central banks. One of the big questions will be whether they increase the size of their Pandemic Emergency Purchase Programme. 

The two other main decisions next week are from the Reserve Bank of Australia on Tuesday and the Bank of Canada on Wednesday. In both cases the consensus expectation is that rates will be left unchanged at 0.25%. It’s also worth noting that there will be a change at the helm of the Bank of Canada next week, with former Senior Deputy Governor Tiff Macklem becoming Governor on Wednesday. Finally, the Fed doesn’t meet until the week after next so there’s a blackout period for Fed speakers starting on Sunday.

Asia Week Ahead 

It’s the dreaded export data week, which could prove the most definitive signal of how ASEAN economies are recovering. To a tee, economists expect a further deterioration in Asia's exports in May as the Covid-19 outbreak depresses global demand. China's exports are likely to worsen significantly, contracting 15% in May vs. 3.5% growth in April, while South Korea's will likely suffer another month of double-digit decline during the month: -25.9% vs. -24.3% in April. Like the latter, Malaysia is also likely to see a sharp fall in exports in April: -25% vs. -4.7% in March. 

Markets 

Despite the ominous re-escalation in trade tensions, it’s been another positive week. Equities again rose sharply last week, driven by optimism that the re-opening of economies around the world has not led to a surge in the number of coronavirus cases. Traders have cast a favorable light on the European Commission's proposal for a recovery fund built on the Franco-German suggestion of EUR500 bn in grants and added another EUR250 bn in loans. Investors believe the plan for joint debt issuance brings the EU one step closer to fiscal union. 

While there are incrementally growing concerns about US-China tensions, these worries are being offset, for the most part, by the comfort of global monetary and fiscal support.

The market thinks the security law headline is mostly behind us so it will be looking for the actual list of US reactions and whether it will make a change on Hong Kong’s special trade status. It’s deemed unlikely at this moment, hence the USDCNH is trading relatively tame.

President Trump's reactions to the Hong Kong Law

President Trump's press conference started somewhat aggressively as he rolled out a laundry list of grievances he has with China going back some years (COVID, South China Sea, Hong Kong, EM Status, Trade, WHO).

Critical points for US Policy:

• US terminating its relationship with the WHO
• A proclamation on higher education, including the suspension of some foreign student visas
• Financial system – Has ordered a study on the fairness of companies listed on US exchanges (but no immediate delisting)
• Hong Kong – Beginning the process of removal that gives Hong Kong special status
  • Dual purpose
  • Increased use of surveillance
  • Action to revoke a preferential treatment
  • Sanction PRC directly or indirectly

There was nothing immediately risk-off or worrisome for stock markets in the comments. Still, President Trump has left the door open for more unfriendly reprisals at a later date, suggesting this overhang will remain a steady theme in the market narrative for some time. Undoubtedly he’ll continuously accent these points during the run-up to the Presidential election, providing more fodder for political grandstanding on an anti-China mandate.

For the time being, the markets have shelved the trade war playbook in favor of the no response from China is good news playbook into the weekend. But traders will be on the lookout whether or not China's reaction is offered up next week and how the news headline reading algorithms react to the follow-up news flows. Given the elevated level of bullish positioning in the market, as we bore witness last week it takes little more than a love tap to give the market a nosebleed at lofty levels about 3050.

The impressive level of policy support makes it increasingly challenging to argue the relevance of Cold War 2 or HK going to one system risks

Currency Markets 

Asia FX has been focused on the USDCNY fix, which has drifted higher over the past week. But the fix has consistently come in close to expectations and capped USDCNH below 7.20so far. The latest Reuters Positioning Survey for EM Asia FX shows the market lean, which has increased long USD vs. CNH and CNY, to the highest level in nearly eight months, while slightly increasing long USDKRW positions. And for the broader market concerns it’s all about crossing key barriers where a break of 7.20 will be the truthsayer. But given the tamer reactions to the HK law by President Trump, we’ll see a pullback in bearish CNH bets – even more so if China doesn’t respond. 

Lifting of lockdowns and further stimulus is keeping risk sentiment buoyant. G-10 traders intensified their USD selling versus G10. Individual themes were very much still in play, including EUR topside since the Franco-German debt agreement and USDCNH and USDHKD spot and forward jitters, as the selective re-engagement in selective economic re-opening short USD plays continue to surge. Consistent with the theme I highlighted three weeks ago, macro names and asset managers have been selling USDs, mostly concentrated in EURUSD. 

Indeed, the Euro has performed strongly since the European Commission's EU recovery fund proposal earlier this week. EURUSD has broken some key resistance levels, forcing a further unwind of bearish Euro positions and increasing new topside demand on month-end portfolio rebalancing. But after the move higher over the last couple days, the pair seems vulnerable to profit-taking – even more so with month-end rebalancing out of the way.

And despite the trade war cautionary tone being struck by the CNH, it’s been a soft USD story in Asia with the most unusual move coming in USDSGD, with the pair bouncing off 1.4100 level into the weekend close.

The oil market recovery is expected to extend next week

A recovery is underway with Chinese refinery demand now entirely up to year-ago levels, but only a third of the way up from the trough in US product demand with further to go.

There are indications of strengthening and continued OPEC+ commitment to the OPEC+ April deal, which extends for a more extended period than usual and includes a larger-than-normal contribution from Russia (even if no extension of May/June levels is agreed)

And CAPEX divestment in US oil production starting from early this year, and a sharper downward adjustment in drilling activity than in 2015, which indicates greater discipline and may moderate future supply growth as prices rise in 2021-22, is supportive of the current bullish oil narrative.

Gold markets expected to remain bid

Geopolitical risk remains supportive amid a plethora of bullish for gold themes. But any hint of a softening in US-China tension could see gold U-turn lower. However, dips are widely expected to remain on demand ahead of $1700 early in the week as the market waits for China's response to President Trump's reactions to the HK law.