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Market Briefing
Santa Clause Rally?

Karl Schamotta December 3, 2018

Happy Monday. Really – foreign exchange markets are kicking off the week in high spirits, with equities, commodities, and risk-sensitive currencies soaring on signs of a rapprochement between China and the United States.

Global oil benchmarks are also trading sharply higher after Russian President Putin said that he and Saudi Crown Prince Mohammed Bin Salman had agreed to an extension of the “OPEC+” arrangement into 2019 – raising odds on a material cut in output when Moscow joins other oil exporting countries to discuss the market on Friday.

Primary North American benchmarks are receiving lift after Alberta announced it would curtail production by 8.7 percent next year. The province is attempting to reduce a bottleneck that has seen the discount between its heavy oil stream (Western Canada Select) and the West Texas Intermediate price regularly blowing out to $50 a barrel.

Traders are looking forward to a week in which monetary policy guidance (Jerome Powell’s Congressional Testimony) will compete with macroeconomic data (a raft of purchasing manager indices and Friday’s non-farm payrolls report) and oil market developments (Thursday’s OPEC meeting and Friday’s non-OPEC producing countries meeting) for attention – but for now, the focus remains squarely on developments emanating from the weekend’s meeting in Buenos Aires.

At a dinner on the sidelines of the Group of 20 summit in Argentina, Presidents Trump and Xi agreed to hold off on the introduction of new tariffs, while entering a new round of commercial negotiations designed to address frictions that have put the rival powers in open conflict with one another.

The United States postponed its threat to increase tariffs on $200 billion in goods to 25 percent from 10 percent and set a three-month timeline for talks, in exchange for a Chinese commitment to expanding its buying activity. The White House said, “China will agree to purchase a not yet agreed upon, but very substantial, amount of agricultural, energy, industrial, and other product from the United States to reduce the trade imbalance between our two countries. China has agreed to start purchasing agricultural product from our farmers immediately.”

Chinese Foreign Minister Wang Yi said, “Both sides believe that the principled agreement reached between the two presidents has effectively prevented the further expansion of economic frictions between the two countries”.

Markets may be setting up for the traditional late-year Santa Claus rally, but there are enough caveats to sink a sleigh.

Forewarning of the difficulties ahead can be found in the incongruent statements issued by American and Chinese diplomats after the meeting. Both sides said they would begin negotiations on “structural issues’’, but China avoided discussing the agenda, and made no mention of a 90-day deadline.

Under the agreement outlined, China will resume purchases of low value-added goods that were restricted in the run-up to the mid-terms – primarily commodities and large, labor-intensive products like aircraft. This may reduce political pressure on Trump (particularly from members of his own party) but will do little to reduce the bilateral trade deficit, or to increase American productivity in the years ahead.

More importantly, the two sides remain far apart on forced technology transfer, intellectual-property protections, non-tariff trade barriers, and rampant cyberespionage – and the United States hasn’t set out clear objectives that might guide the negotiating process. Beijing is overwhelmingly likely to leave its large state-owned enterprises in place and will continue supporting sectors it sees as strategic – keeping the playing field tilted in its favour for now.

Somewhat-perversely, this cessation in hostilities could also reduce pressure on China to slow a deleveraging drive that has impacted global trade and capital flows over the past two years. With the threat of trade wars helping to push growth toward uncomfortably-weak levels, policymakers have taken steps to stabilize the economy in recent months, cutting taxes, reducing reserve requirements, stepping up liquidity injections, and allowing local governments to resume borrowing – efforts that may be reversed if the trade narrative shifts in a more positive direction.

From a foreign exchange perspective, this suggests that the impact could be staged out over time.

Investors will eventually look the gift reindeer in the mouth – valuations in many areas look overstretched, monetary tightening is likely to continue, and the global economy itself remains incredibly-fragile – so when skepticism sets in, unhedged currency exposures could be dangerous.

Until then, an optimistic view on markets should prevail – investors are already reducing odds on a recession hitting in the next year, and risk premia on the world’s most risk sensitive assets are beginning to evaporate. A rotation into commodity-linked and emerging market units has already gotten underway, with currencies like the Australian and Canadian dollars going nearly vertical at the Asian open last night.

As Judy the Elf once put it, “Seeing isn’t believing; believing is seeing”.

Have a great week!

Karl Schamotta
Chief Market Strategist

Counterparties: Background Reading

LPL Research: Recession Watch Dashboard
Bloomberg: Bitcoin’s Crash Looks Like a Real Currency Crisis
Federal Reserve: Does Oil Drive Inflation?
Wall Street Journal: Cheaper Oil Isn’t the Boon It Used to Be
Bloomberg: Sun Storms Could Hold the Secret to Natural Gas Prices
Antonio Fatas: Global Rebalancing
Federal Reserve: North American Divergence
Bloomberg: The Inside Story of How Mario Draghi Saved the Euro

Catalysts: Scheduled Data Releases

09:30  *        CAD RBC Manufacturing Purchasing Manager Index, November
09:45  *        USD Markit Manufacturing Purchasing Manager Index, November
10:00  **      USD Institute for Supply Management Manufacturing, November
12:30  *        GBP Bank of England Speech, Chief Economist Haldane
13:00  *        USD Federal Reserve Speech, Kaplan
22:30  **      AUD Reserve Bank of Australia, Rate Decision

04:15  ***    GBP Bank of England Parliamentary Speech, Governor Carney
13:00  *        GBP Bank of England Speech, Vlieghe
17:00  **      AUD CBA Australia Purchasing Manager Indices, November
19:30  **      JPY Nikkei Purchasing Manager Indices, November
19:30  **      AUD Gross Domestic Product, Q3
20:45  **      CNY Caixin China Purchasing Manager Indices, November

04:00  **      EUR Markit Eurozone Composite Purchasing Manager Indices, November
05:00  *        EUR Euro-Zone Retail Sales, October
08:15  *        USD ADP Employment, November
09:45  **      USD Markit Purchasing Manager Indices, November
10:00  ***    CAD Bank of Canada Rate Decision
10:00  ***    USD ISM Non-Manufacturing/Services Composite, November
10:15  ***    USD Federal Reserve Joint Economic Committee Testimony, Powell
10:30  **      USD Department of Energy Weekly Inventories
14:00  **      USD Federal Reserve Beige Book

02:00  **      EUR German Factory Orders, October
08:30  *        CAD International Merchandise Trade, October
08:30  **      USD Trade Balance, October
08:30  ***    USD Weekly Jobless Claims
10:00  **      USD Durable Goods Orders, October
12:15  *        USD Federal Reserve Speech, Bostic

05:00  ***    EUR Euro-Zone Gross Domestic Product, Q3
08:30  ***    CAD Unemployment, November
08:30  ***    USD Non-Farm Payrolls, November
09:00  **      MXN Consumer Price Indices, November
10:00  **      USD University of Michigan Consumer Sentiment, December
12:00  *        USD Federal Reserve Speech, Brainard
13:00  *        USD Baker Hughes Weekly Rig Count

00:00  **      CNY Trade Balance, November

Note: Asterisks indicate our preliminary estimate of the potential market impact associated with each event. One asterisk indicates an event with the lowest, two for a moderate impact, and three for the highest expected impact.

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