LCG: US-China talks resume, Fed prepares to cut rates and UK sets the stage for a no-deal exit.

July 29, 2019

Asian equities kicked off the week on a negative note as Hong Kong protests paralyzed the city for the eighth consecutive week. Hang Seng index (-1.20%) led losses in Asia.

Japanese yen and Swiss franc were the leading gainers versus the US dollar. Gold rebounded to $1424 an ounce as the US 10-year yield tested the 2.06% level on the downside. Investors could increase their gold hedges heading into an event-full week with more company earnings, Federal Reserve (Fed), Bank of Japan (BoJ) and Bank of England (BoE) decisions and the US payrolls data.

Nikkei (-0.47%) and Topix (-0.40%) fell on the back of stronger yen and weak company earnings. Investors are fully focused on how the BoJ will react on Tuesday to the imminent interest rate cut from the Fed, and more policy easing from the European Central Bank (ECB). At the latest policy meeting, BoJ’s Kuroda had remained silent about a further easing, but weak results from Japanese companies and increased pressure on exporters could encourage BoJ’s policymakers to join the doves’ camp at this week’s meeting.

US equity futures eased after the S&P500 and Nasdaq advanced to fresh record highs on Friday. Investors will remain focused on company earnings and the Fed decision.

The FOMC meeting will be the highlight of this week. The Fed is heading toward an interest rate cut for the first time in a decade with a fifty-year low unemployment rate and above 2% GDP growth in hand. Moreover, nearly half of S&P500 companies released their second quarter results this far and their earnings surprised by 5.27% on the upside, meaning that the trade tensions did not hit the company earnings as badly as investors expected. Under these circumstances, a 25-basis-point cut from the Fed could be that reasonable ‘preventive measure’ to support the economy and to avoid a further slowdown in growth numbers amid ongoing US-China trade tensions, while a larger cut would be unnecessary at this point and could perturb the market. The pricing in US sovereign bond markets suggests no more than 17% chances for a 50-basis-point cut at this week’s monetary policy meeting. With the dovish prospects in control, the Fed could easily meet the market expectations on Wednesday. The US yields and the dollar could remain under pressure depending on the dovishness of the Fed’s policy outlook. Moving forward, the Fed is expected to proceed with at least two more interest rate cuts over the next nine months.

Meanwhile, US officials travel to Shanghai for the first face-to-face meeting with Chinese officials since negotiations abruptly stopped in May. Two-day talks will start on Tuesday. Whether the US and China will resume trade negotiations is the first and the key question at this week’s talks. And if so, the trade tariffs will be brought back on the table. But investors also hope to hear more about Huawei sanctions and China’s intention to increase purchases of US farm products. The fact that the two countries have agreed to resume talks is a good sign, but the probability of a comprehensive deal between the two countries remain slim as neither side seems eager to agree.

Technology stocks (+0.49%) are slightly stronger in Shanghai on hopes that this week’s US-China talks could ease restrictions on Huawei.

Also, Apple’s latest results, due on Tuesday, should give a better insight on if the US-China tensions had a significant impact on its profit and earnings, and if yes, by how much.

Pound burns investors’ hands

Britain’s political scene is a hot mess and things are getting worse by the day. The pound slumped to 1.2364 on rising prospects of a no-deal Brexit, as the British government intensifies efforts to leave the European Union by ‘any means necessary’ by October 31st deadline. Lawmakers on the other hand will do whatever is in their power to block a forced no-deal exit, which could hammer Britain’s economy for the coming years.

The net speculative positions in pound sterling dived to the lowest levels since September 2018 and the selling pressure in sterling will likely persist as the downside risks persist and increase. Decent put option expiries will now pressure the pound-US dollar below the 1.24 mark. Unfortunately, there is not much to cheer up the pound markets at this point.

It is under growing Brexit tensions that the Bank of England (BoE) will meet on Thursday. The BoE is expected to maintain its policy unchanged, but the bank will likely soften its policy stance as the UK’s economy may need a decent support if the country leaves the EU without a deal in hand.

But the FTSE remains supported by a strong global appetite for stocks and the cheaper pound. The FTSE 100 is expected to open 6 points higher at 7555p.

Opening calls

FTSE is expected to open 6 points higher at 7555

DAX is expected to open 20 points lower at 12400