Trade deal can is kicked, as European elections start to bite the pound

The US-China trade negotiations failed to produce a deal last week, the US implemented a further $200bn of tariffs on Chinese goods coming into the US, and President Trump upped his level of rhetoric by stating that it was all Beijing’s fault; no wonder it was the worst week for US stocks since the start of 2019. 

Can a US/ China trade deal be salvaged? 

However, traders managed to look on the bright side, and at the start of the week there is a chance that stocks could see some limited upside in the short-term. Late on Sunday, Trump’s top economic advisor Larry Kudlow said that there was a strong possibility that the US President would meet with the Chinese President to rescue the trade deal at next month’s G20- summit. The possibility of an 11thhour trade deal is still possible, and this is reflected in the performance of the safe haven yen, which is the main barometer of market nerves.  At the market open late on Sunday, USD/JPY has picked up sharply, rising from a low of 109.50 on Friday back to 110.00. Interestingly, the move above 110.00 attracted some selling interest, at the time of writing USD/JPY is sitting on the 109.95 level, which suggests that the ambiguity of the trade relationship between China and the US may cause residual nerves in the market. We shall have to wait until Europe and the US open later today to see if nerves can settle further and push USD/JPY back above the psychologically important 110.00 level. In the medium term, even if USD/JPY does get back above this level, Minerva believes that the upside for this pair is likely to be limited, and until the trade deal is signed, sealed and delivered 111.00 could be stiff resistance. However, downside could also be limited, now that the focus is on the G20 summit, we believe that it will take a significant souring of US/China relations for the yen to rise substantially higher, with Friday’s low at 109.50 a major support level. 

Stocks stuck in the doldrums 

Investors had little faith in US stocks last week, as trade fears started to bite. Not even strong growth, accommodative Fed and strong corporate earnings - the most recent results saw earnings growth beat expectations by a decent 6.6% - could halt last week’s gyrations in the stock market. The S&P 500 fell to early April levels, as global recession fears knocked investor confidence. Thus, in the absence of a deal, we expect the upside for stocks to be limited. The current twilight zone status of the trade talks makes it more likely that the S&P 500 will range trade between 2,700-2,950, with a move above the key 3,000 level now shelved until a deal can be reached. 

Why commodity currencies could be in for a bounce 

Commodities and commodity currencies are also vulnerable to the trade war theme. Commodity currencies had a strong positive correlation to the trade war stories last week. Now that fears have died down a bit, we could be near the lows for the Aussie and the Kiwi, the latter was also hit by a surprise RBNZ rate cut last week that sent NZD/USD to a 6-month low. Gold is also vulnerable to a further sell off this week, as trade tensions ease. $1,288 is key resistance, with the first major support level to watch at $1,280, last week’s low. 

For the euro, fundamentals are back in focus

Economic data comes back into focus for the market this week with Eurozone inflation, UK employment data, German GDP, US retail sales and Australian employment data all taking centre stage. German GDP for Q1 will be worth watching on Wednesday. It is expected to show that Europe’s largest economy rose by 0.7%, which is significantly better than the 0% growth in Q4 2018. A better than expected reading could trigger a break above $1.1260, which has stymied the euro bulls since mid-April. A move above this level opens the way to $1.1320. 

UK: Why the European elections matter 

The pound has taken a knock early this week, with GBP/USD back below $1.30. The decline is mostly due to the political headlines from the Sunday papers. The latest European election polls suggest a new round of pressure on support for the Conservatives, more demands for Theresa May to step down as Prime Minister and surging support for the Brexit party. This adds to the uncertainty and confusion over the direction of British politics in this pre-Brexit era that we find ourselves in. The European elections on 23rdMay, don’t usually matter for     UK asset prices, however this time they do because they are expected to show the number of people who put leaving the EU above everything else, including the economy. Thus, if the Brexit party wins big on the 23rdMay then pressure will grow for the UK to leave the EU without a deal as soon as possible, which is a significant negative for the pound in the medium term. It may also fuel fears in that Labour could win the next General Election, since they are likely to be less friendly to the finance community, this could also be bad news for UK asset prices. In trading terns, this means that the pound may struggle as we lead up to the EU elections. From a technical perspective, GBP/USD is close to the 61.8% Fib retracement of the 25thApril low to 3rdMay high at 1.2986. A break below this level would be negative for the pound and may accelerate a move back towards the 1.2860 low from April.