China and Brexit negotiations, one long road to nowhere for financial markets
Economic data is thin on the ground as we head into the second half of this week, however, two major issues are dominating and have the potential to cause shock waves through major global financial markets: the US/ China trade negotiations and Brexit.
No-deal back on the table…
Looking at Brexit first, two major developments have occurred this week. Firstly, the cross party talks between the Conservatives and the Labour parties came to nothing on Tuesday. This means that Theresa May’s Brexit deal with the European Union is unlikely to get passed by the UK Parliament, so the UK and EU negotiators may as well start again. With the European aside unlikely to give any more ground in the negotiations, this makes a no-deal Brexit likely, even though the deadline has been moved to the end of October. Hence the sharp decline in the pound in the last two days. GBP/USD has fallen below the crucial $1.3050 level, and its ability to stay above $1.30 is now in doubt. A break below $1.30 would be a big signal to FX traders: not even a relatively hawkish BOE can stop the pound from sliding on the back of Brexit uncertainty.
So, what’s next for Brexit?
Below we list a few points that we think should make the Brexit mess “easier” to understand as traders try to negotiate the latest GBP trading conditions.
· Theresa May’s current Brexit deal is dead in the water and unlikely to get passed by Parliament.
· The UK government has set a new deadline of August 1stto reach a deal, this comes immediately after the UK government breaks for the summer, suggesting that the next three months will be fully focussed on Brexit, leading to news-driven and volatile trading conditions for the pound.
· The focus is back on when Theresa May will leave office. In our view, this is also bad news for the pound, as a leadership contest alongside Brexit negotiations would only increase uncertainty for traders and make the pound a less attractive option for traders (good news for exporters, however!)
· As we lead up to European elections later this month, the pound could also come under pressure. Although these elections are not a precursor to a general election, big losses for the Tories and Labour could add to the weight of uncertainty that is dominating British politics right now. If traders and investors can’t have faith in the political direction of a country then it is unlikely to invest in that country, which is bad news for domestic stocks and the pound in the long term.
Overall, we have a negative view on sterling for the foreseeable future largely because of political and Brexit risks. GBP/USD is slap bang in the middle of its long-term range between $1.3350 - $1.2800. At the time of writing, GBP/USD was bouncing back above the $1.30 level as buyers picked up cable on the dip. How long will this last? We don’t think GBP/USD is immune from another dip below $1.30, with $1.2950, then $1.2865- the low from April 25th, key support levels to watch on the way down. Any periods of strength are likely to be short term in nature, in our view.
China/ US trade talks disintegrate
The big sell off in stocks at the start of this week may be a dress rehearsal for what could happen if the US and China fail to agree a trade deal and the US imposes further higher tariffs on $200bn of Chinese imports this Friday. The US side has blamed Beijing for “reneging on prior commitments”, which has eroded hopes that a trade deal will be signed this week. China is sending a slimmed down negotiating team to Washington for trade talks on Thursday, although this initially calmed European markets, equity indices remain skittish as we lead up to the trade negotiations.
Could Trump be calling Beijing’s bluff?
The market is taking the US threats literally, although President Trump’s tweets, which first caused stocks to tumble on Monday, could be a negotiating tactic. Surely, it is to be expected that both sides will have differences in the days before a deal is signed. Financial markets are not willing to take any chances, and with the 2020 US election now in view, Trump may be taking a tougher line with China to extract even more concessions from Beijing before he will sign a trade deal.
Global superpowers at war, and the market reaction
Where does this leave the short-term direction for global asset prices? All major equity indices, emerging market currencies’, the yuan, global interest rates, precious metals and commodities could be impacted by the outcome of these negotiations. If the tariffs are imposed by the US, then growth in both the US and China could be knocked by more than 1% each, which would have a huge impact on global growth rates in the coming year. Thus, we expect markets to remain volatile until we hear the outcome of Thursday’s trade negotiations. Below we list the potential outcomes we see from this week’s US/ China meetings
· A deal is announced:risky assets would bounce back sharply, and US stocks would likely make fresh record highs.
· A delay is announced to a deal:the markets may dip initially, however, this is better than no-deal, so we may see a partial recovery in risky assets at the end of next week.
· No deal:this may lead to another leg lower in global risky assets, with fresh lows likely for stock indices, in particular. We could also see safe havens surge, including gold, which may rise back above the $1,300 level, and USD/JPY could sink below 109.