A tough job in China

A tough job in China

This weekend’s intensification of the Hong Kong protests reminds us that the Chinese authorities have more pressing problems than the US-China trade dispute. Originally started in March of 2019 to protest against the Fugitive Offenders amendment bill by Hong Kong authorities—which would allow the extradition of persons detained in Hong Kong to Taiwan or China even though no extradition treaties exist—that many viewed as a back-door dilution of civil liberties by Chinese-controlled Hong Kong leadership. 

The protests started as a million strong, peaceful demonstration, but has since become more forceful, partly in response to Hong Kong police escalation. Yesterday’s protester occupation of the Hong Kong Polytechnic University is just the latest scene of chaotic images featuring tear gas and improvised firebombs. This presents a distinct quandary for mainland Chinese authorities, who can’t be seen bowing to protester pressure lest they find a dozen similar protests crop up on the mainland. At the same time, the current escalation has real economic costs to a city considered a bastion of capitalism and model for capitalist/communist economic cooperation. Increasing the use of force would likely alienate investors and represent a victory at too high of a cost. That’s a tough balancing act indeed.

Given their precarious position in Hong Kong, it's no wonder Chinese trade negotiators have avoided concessions with the US. The perception of weakness on trade would likely decrease their negotiating position on a range of other domestic issues. All the while, growth continues to slow at a faster pace than anticipated. Traditionally the People’s Bank of China—which has more direct control of lending activities than other central banks—has introduced countercyclical policy aimed at infrastructure investment in times of decreased economic activity. Recently, however, the PBOC has been more restrained in loan growth, electing to take the near-term hits to economic growth instead. There are no easy answers to any of these issues, but it's reassuring that the authorities seem to be a taking a long-term view rather than the more populist stance common in the west.

Bottom line: The PBoC has cut its overnight lending rate by a modest five basis points and is expected to follow up with a five-ten bps decrease to the loan prime rate (the central bank's main policy rate) later this month. This is likely the beginning of a subtle and incremental easing action in response to falling growth, but careful attention must be paid to the other lending terms it delivers to banks in addition to the lending rate, to ascertain the degree to which policy can ultimately be loosened.

The week ahead

GBP

Last week was a good one for the Sterling trade-weighted Index as it posted moderate gains against its counterparts. The Pound reached an interbank high of 1.2920 against the US Dollar on Friday as the pair currently trades at the upper end of its recent trading range; resistance remains at the 1.30 handle. Sterling also briefly breached the 1.17 mark against the Euro, extending its gains back into March/April’s trading range—1.18 will probably provide a source of significant resistance as this level has only been surpassed once in the past year. The focus will remain on the UK’s upcoming general election and its ramifications for Brexit.

  • It’s set to be a quiet week for UK data with no high-tier releases Monday-Thursday.
  • Friday will see the release of flash Markit Manufacturing PMI, which is expected to decline to 49.0 from last month’s 49.6. This would represent the seventh straight month of contraction in the UK’s manufacturing sector.
  • Also released on Friday, the UK’s flash Markit Services PMI is expected to dip into contraction. The consensus figure at the moment is 49.9 in contrast to last month’s 50.0. Services are the largest sector of the UK’s economy and have fluctuated between mild contraction and expansion throughout the past year.

USD

Positive sentiment that a partial or phase one US-China trade deal was being finalised meant that the Dollar softened through most of the past week. Markets stepped away from the safe-haven appeal of the Greenback, in favour of more risky assets. The trade-weighted Dollar Index has extended below the 50 and 100-day moving averages and is currently trading just above the 200-day. A break below this level could see a run towards the lows of mid-June/late-July.

  • The week begins on a quiet note, with no important data on Monday or Tuesday. Instead, markets will look for hints on upcoming monetary policy when Federal Reserve members, Loretta Mester and John Williams speak on each respective day.
  • The Federal Open Market Committee will release its meeting minutes on Wednesday, which are likely to provide an in-depth insight into last month’s policy decision and the rationale behind cutting rates. It will also provide clues as to the outlook for this month and the Fed’s reasoning behind its probable pause in altering rates.
  • Philly Fed manufacturing is due out on Thursday, and is forecast to increase from 5.6 to 7.0 and Fed members, Mester and Neel Kashkari will both speak.
  • On Friday, Markit will release the flash US Services and Manufacturing PMI’s. Services are expected to climb to 51.2 from 50.6 and the Manufacturing PMI is predicted to post a small increase to 51.5 from 51.3.

EUR

The common currency’s trade-weighted index began and ended the week at roughly the same level but briefly moved to its lowest since late September. This weakness took the Euro back below 1.10 against the Greenback for the first time in about a month. To shine some positivity on the outlook, the combination of Dollar weakness and a Euro rebound towards the end of the week took the pair back above the 50-day moving average, meaning a further move higher isn’t out of the question.

  • Once more, it’s a quiet start to the week with only European Central Bank speakers and no high-level data for Monday through Wednesday. The ECB’s Chief Economist, Philip Lane will speak Monday and Wednesday. ECB Vice-President Luis de Guindos will also speak on Monday.
  • On Thursday, the ECB’s monetary policy meeting minutes will be released. Like the US central bank minutes, markets will look for clues for future changes in monetary policy. Flash Consumer Confidence is also due on the same day, and is expected to marginally improve.
  • A slew of European PMI releases are scheduled for release on Friday; the most important to note are flash French and German Services and Manufacturing ecostats. The composite services figure for Europe is pegged to increase from 52.2 to 52.5, indicating expansion in the sector. The manufacturing number is predicted to increase from 45.9 to 46.4 but remain in contraction.