Friday, July 13, 2018

Capital Markets: "Trump Trips Sterling, but Greenback Enjoys Broad Gains"

From Marc to Market:
President Trump weighed in on Brexit and spurred the largest drop in sterling in more than two weeks. Trump encouraged Brexit, but he indicated he "would have done it much differently" and that he "actually told Theresa May how to do it, but she did not listen." Trump cautioned that May's plan would mean it would still be too close to the EU and this would "kill" a free-trade deal with the US. In effect, Trump backed the harder Brexit camp position. Sterling's slide accelerated as stops below $1.3170 were trigged.

Sterling's 0.6% loss (@ ~$1.3120) is co-leading the downside in the firm US dollar environment, having to share that role with the New Zealand dollar today, where a weaker manufacturing PMI (52.8 from 54.4) is taking a toll. Both sterling and the Kiwi have little chart support ahead of the lows made at the end of June near $1.3050 and $0.6690 respectively. Ironically, perceived fragility of Prime Minister May, despite her tenacity, and now with the US President siding with the most disruptive expression of Brexit, the EC may soften its position. Indeed, in recent days, even before Trump's comments, we detected movement by some officials, including Germany's Merkel and Ireland's Varadkar.

The other noteworthy development is on the trade front. China has not responded by publically detailing how it will make good on its threat to retaliate against the US if it carries through with 10% tariff on $200 bln of its goods. Given the level of US exports to China, we have consistently warned of an asymmetrical response. Still, some are suggesting that lack of specificity from China, is helping spur the equity market rally today. We are skeptical. The strong US equity rally yesterday, with the S&P 500 knocking on 2800, which has capped gains since February, helped lift sentiment more broadly. Also, as we noted yesterday, Japanese investors have stepped up their buying of foreign equities, and the four-week average now stands at a three-year high.

China reported its June trade figures and its overall surplus increased more than expected. In dollar terms, the surplus rose to $41.6 bln from $24.2 bln, which is the largest since the end of last year. Month-to-month data trade data tends to be volatile, and there may have been efforts to beat the pending trade action. In the H1 18, China recorded a $139.6 bln trade surplus. This compares with a surplus of $177.5 bln in H1 17 and $241.8 bln in H2 17. China's bilateral trade surplus with the US rose to a new monthly record of almost $29 bln. Its surplus with Europe rose to its highest level since 2011, while China's deficit with Japan narrowed.

Treasury Secretary Mnuchin made the administration's position very clear but also demonstrated why the conflict with China is not really about trade. He said that while the US remains open to talks, China must commit itself to deep reforms of its economic system. The economic system is inextricably intertwined with its political system. China can and has changed its behavior over time and through pressure.

However, to make fundamental changes in its system a prerequisite to de-escalating the trade conflict is troublesome. Literally.....