G10 Model: Policy uncertainty rising, September risks elevated, China financial conditions easing - Westpac


Richard Franulovich, Head of FX Strategy, updated their Model signals whereby their model undertakes a major overhaul of its exposures to the majors; sharply cutting its USD long to a bare 6%, flipping from EUR shorts to EUR longs and significantly upping its JPY exposure.

Key Quotes:

"Model themes: 

Policy uncertainty rising, September risks elevated, China financial conditions easing
Baker, Bloom and Davis’ global policy uncertainty index is surging. Yet “risk premia” remain mostly subdued even after the sudden surge stemming from the sharp slide in the Turkish Lira. 

That challenging backdrop likely intensifies in coming weeks, September especially brimming with event risk. Trump is threatening to shut down the US government if the appropriation bills necessary to keep government open beyond Sep 30 do not include border wall funding. Midterm fever election usually takes a hold in September too. The FOMC meets September 25/26 and is likely to sound more assertive” after upgrading their assessment of the US economy from “solid” to “strong”. The Trump administration is likely to make a decision on the threat of a 25% tariff on $200bn in Chinese exports (section 301 hearings slated Aug 20-23 and submission of final comments due Sep 5). Italian debt sustainability likely becomes a talking point in September once again too, the populist government to flesh out details of their highly contentious expansionary 2019 budget that will likely draw the ire of both ratings agencies and the EU.

Against that, financial conditions in China have eased measurably now that policymakers there have adopted a more pro-growth stance as a hedge against trade risks. The easier footing is a marked shift from the last two years when financial conditions were steadily tightening. Slide two shows a simple composite index of financial conditions based on equities, M2, the SHIBOR spread, China’s real effective exchange rate and 1yr and 10yr real interest rates. The link from financial conditions to growth is patchy (see slide two) and is arguably even more doubtful when deleveraging pressures are present. That said, the relationship from slide two is strong enough that we should at least expect China’s data pulse to broadly stabilise in the coming months."

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