Thursday, April 5, 2018

Capital Markets: "Investors Find Comfort in Brinkmanship Blinks"

From Marc to Market:
Global equity markets are higher, following the stunning recovery in the US yesterday, where the S&P 500 rallied 76 points or 3% from its lows to it highs, near where it finished. The outside up day is seeing following through today. Without China and Hong Kong, which are on holiday, the MSCI Asia Pacific Index snapped a three-day down draft and closed 0.55% higher. The Nikkei led the region with a 1.5% gain, led by real estate, health care and financials. It posted its highest close since in two weeks.

Gains in Europe have been stronger. The Dow Jones Stoxx 600 is up 1.5% in late morning turnover. It is led by information technology and materials (both sectors are up more than 2%). Real estate is the laggard, up 0.65%. While the Asia Pacific Index is well below its 20-day moving average, the Stoxx 600 is straddling its.

There is a 60-day period between the announcements and when the US tariffs will be implemented. China has not indicated when it will enforce its tariffs. This is understood to allow room to negotiate here in Q2. Also, this is seen as compatible with the Trump Administration's bold rhetoric and climb down in practice. Consider the recent flip on NAFTA--from threatening to leave it to seek an agreement in principle next week. As part of the effort, the US appears to have softened its demands on the controversial domestic content requirement for autos (presently 62.5%, and the US had sought 85%).

From camps that have been critical of China, about its holdings of US Treasuries, large debt accumulated since 2008, currency practices, etc., bellicose language is still fanning the flames. This war camp worries that one-way China could retaliate is to allow its currency to depreciate. Sure, it could, but over the last few months there is only one major country that stood accused of talking its currency down. In fact, it was so disturbing that it raised addressed at ECB press conference, and was subsequently, walked back by the US President and the Treasury Secretary.

The war camp that is playing up the possibility that China sells its Treasuries in displeasure also complains when China buys US Treasuries. We can also test the hypothesis of what happens when China has sold US Treasuries in the recent past. From June 2016 through November 2016, China's Treasury holdings, according to US data fell by $200 bln, which was 15% of their holdings. What happened to the US 10-year yield (as a rough and ready metric of the impact), you ask? It was virtually unchanged.

The Chinese yuan has appreciated 3.2% against the US dollar this year. As we have noted, the US Treasury's report on the international economy and foreign exchange is expected this month. China's behavior in the foreign exchange market has not changed. It is slowly rebuilding its reserves that were previously run down by 25%. Capital controls appear to have arrested some of the outflows. China is expected to report March reserves figures in the coming days. They are expected to have risen by about $14 bln.

Outside of the focus on the trade and the bounce in global equities, Europe's service and composite PMIs were the data highlight. The eurozone service PMI was revised to 54.9 from the 55.0 flash reading, which itself was down from 56.2 in February and 58.0 in January. The composite was also revised lower, to 55.2 from 55.3. It peaked in January at 58.8 and fell to 57.1 in February. While the loss of momentum is significant, the impact on GDP may be more measured. Consider that the Q4 17 average was 56.4 and the Q1 18 average is 56.7. We think that the if the loss of momentum spills over in the start of Q2, for which some data will be available in the coming weeks, then investors may be more sensitive to it. It could help determine in which direction the euro breaks out of its range.

The loss of momentum is especially evident in Germany....