Three points on the week ahead are easy to predict. The Federal Reserve will hike rates. The People’s Bank of China will not. Trade tensions will persist.
What this means for the yuan — only recently back from the threshold of seven to the dollar — is harder to say. Pressure from both rate differentials and trade, though, will be for a weaker currency. Signs of a significant drop would have the PBOC delving into their toolkit to provide support.
If the Fed doesn’t hike interest rates for the eighth time in the current cycle at its meeting Wednesday, that would be a major surprise. Inflation is at the 2% target, unemployment is at 3.9%, and wage growth is at a post-financial crisis high. A 25-bp increase to a 2% to 2.25% target range is widely anticipated. Chief U.S. Economist Carl Riccadonna expects market reaction to focus on the update to economic and financial forecasts, which will be parsed for indications on the future trajectory of policy.
If all the U.S. indicators are flashing a green for go on rate hikes, in China the lights on the PBOC’s dashboard are flashing red for stop. Investment growth is running at a 20-year low. Retail sales have slumped. The Politburo has signaled that the priority has shifted from deleveraging to supporting growth. The PBOC already broke with past precedent in June, holding as the Fed hiked. In September, that pattern will very likely be repeated.
On trade, China is attempting to dial down the tensions. Bloomberg News reported Beijing is considering a broad cut in import tariffs — presumably including for the U.S. if the trade war is called off. We’ll see what the details look like, but it appears China is trying to beat a dignified retreat. Whether they succeed in creating conditions for a ceasefire, and ultimately cessation of hostilities, remains to be see. U.S. concerns go beyond tariff rates to China’s state-centric development model.
The combination of narrowing rate differentials and continued trade uncertainty means the yuan will face renewed pressure. It was the PBOC’s hold in June that was the trigger for the yuan’s recent drop toward seven to the dollar. The second time around, the element of surprise will be reduced. But signals on the future path for the Fed could still be a signal for further yuan weakness. On trade, hostilities resumed would be a signal for yuan weakness. But hostilities suspended on an expectation of more Chinese imports might be, too.
The wild card is the PBOC. China’s policy makers have a suite of options, from jawboning the market through tweaks to the yuan’s daily fixing and — ultimately — hardening of capital controls, that they can and do use to guide the currency. The more extreme options won’t be necessary. If the yuan resumes its slide toward seven, expect the more targeted interventions to come into play.
Highlights for the Asia week ahead:
China’s Caixin PMI was only narrowly in expansionary territory in August. We expect the PMI to edge down for a fourth straight month in September. We’ll be watching the export orders sub-index closely — it’s been below the 50 level that divides improving and deteriorating conditions for the five months through August. — Qian Wan
In Japan, the data to watch are industrial production. The main focus will be on the production forecasts for September and October. With the U.S.-China trade war likely to damp supply-chain demand, weak projections would suggest the Japan Inc. may be starting to feel the impact.
One of the world’s senior financial regulators is sounding the alarm about surging high-risk lending. The Bank for International Settlements warned that likely distress among indebted borrowers may spread into the wider economy as central banks raise interest rates. It’s not just the total debt, but the fact that investors seem less and less concerned about protecting themselves against losses, the BIS said.
The U.S. and China are hours away from a new round of tariffs on each other’s goods, with no improvement in relations between the two rivals in sight. China on Saturday called off planned trade talks with U.S. officials. The U.S. State Department’s sanctions against China’s defense agency and its director contributed to the decision, according to people familiar with the situation. There’s a growing consensus in Beijing that substantive talks will only be possible with the Trump administration after U.S. mid-term elections in November, the people said.
China reached into the U.S. heartland in its escalating trade war over President Trump’s tariffs, using an advertising supplement in Iowa’s largest newspaper to highlight the impact on the state’s soybean farmers as “the fruit of a president’s folly.’’ The section in Sunday’s Des Moines Register, which carried the label “paid for and prepared solely by China Daily, an official publication of the People’s Republic of China,” featured articles including one outlining how the trade dispute is forcing Chinese importers to turn to South America instead of the U.S. for soybeans.
A shock jump in Hong Kong’s currency is signaling a decade-long liquidity party is finally coming to an end. That may be bad news for the city’s housing market. The Hong Kong dollar posted its biggest gain 15 years Friday. While traders gave differing reasons for the move, the common theme was concern that the city’s borrowing costs will catch up with those in the U.S. as the Federal Reserve continues to hike rates. Home prices rose more than 170% in the past decade making the city the world’s least affordable. Citigroup Inc. and CLSA Ltd. are among those warning of a reversal on expectations that mortgage servicing costs will rise.
Producers in China are already under stress even ahead of implementation of U.S. tariffs, as indicated by an explosion in corporate borrowing that isn’t being captured by official government statistics, according to the China Beige Book.
“Manufacturing is under fire. The sector’s multi-year rally has given way to declining revenue and sharply declining profit growth,” CBB International said in a report. “Critically, manufacturing’s plight is occurring before any meaningful American tariffs have been imposed. Absent a fall trade deal, this situation will likely deteriorate. The pace of borrowing — at 41% of firms, the highest since 2012 — sure smells a lot like panic.”
AHEAD OF THE DATA
Singapore’s inflation may have ticked higher in August following a 0.6% y/y reading in July, reflecting firm oil prices. Oil prices were up 48% y/y in August, picking up from increases of 41% in July and 11% a year earlier.
What’s more, household spending has been supported by stronger employment and wage growth after inflation, as well as an ongoing recovery in the housing market.
Helping to keep price pressures in check: the central bank tightened monetary policy in April — returning to a stance of gradual appreciation in the exchange rate.The pace of appreciation in the trade-weighted exchange rate picked up to 0.9% year in August from 0.4% in July and 0.2% a year earlier.
The Monetary Authority of Singapore is unlikely to tighten policy further at the next semi-annual policy meeting in October. Risks to growth have increased with the escalation in the U.S.-China trade war. Also, inflation remains below 1%.
SPEAKERS AND EVENTS
A 10% U.S. tariff on about $200 billion in Chinese goods takes effect. China has retaliated by levying tariffs on $60 billion of U.S. goods.
Japan’s inflation picked up in August, and we expect the core gauge that excludes fresh food to edge up further to 1% in September — halfway to the BOJ’s target — writes BE’s Yuki Masujima. Beyond that though, it will be tough going for the BOJ.
The reasons why were partly evident in Friday’s data. Much of the impetus for the rise in headline inflation came from higher fresh food prices — a cost-push factor that also crimps household purchasing power. Higher prices of energy and accommodation, and a smaller drop in mobile phone service charges, helped propel the core reading. None of those are sustainable drivers of inflation.
The good news though, is that the basic underlying drivers of inflation remain intact — the economy is running above potential, wage growth is rising, and the yen is weak. PM Shinzo Abe’s win in his party’s leadership race is also positive for reflation. The big downside risk remains U.S. protectionism, especially ahead of November’s U.S. mid-term elections — a hit to exports would be bad news for growth.
An early indicator shows the outlook for underlying price pressures remains solid in September. The 30-day moving average of the CPINow daily inflation index (T-Index) registered a rise of 0.32% y/y as of Sept. 19, accelerating from a gain of 0.14% at end-August. This points to upward pressure on prices of daily necessities, including fresh food, in September.
When it comes to U.S. Treasuries, Japanese investors may be ready to throw caution to the wind in their hunt for superior yields, write BN’s Masaki Kondo and Chikako Mogi. Prohibitive currency-hedging costs make Treasuries unattractive for many Japanese fixed income buyers, even as U.S. yields approach a seven-year high. But with the yen falling at the same time, the temptation is building to ditch protection against an adverse exchange rate move.
“Investors may not think too much about the currency hedge costs right now and chase the U.S. yield when it is above 3%,” said Satoshi Shimamura, head of rates and markets for investment strategy at MassMutual Life Insurance. “With the yen unlikely to strengthen sharply against the dollar, it is a period where hedging incentives fade as yields rise.”
While the U.S. 10-year rate climbed to 3.09% last week, that would be whittled down to less than 0.5% for Japanese investors taking protection against a weaker dollar. That compares with the 0.65% on offer for currency-hedged 10-year German bunds.
But a yield premium of 2.94 ppts over similar-maturity Japanese debt may be sufficient to attract unhedged buying of Treasuries. With dollar-yen closing at 112.49 on Thursday, such an approach would be profitable as long as the exchange rate stays stronger than around 109. The dollar may end this year at 111 yen, according to the median estimate of economists compiled by Bloomberg.
Such an approach would mark a turnaround. Japanese investors have sold a net 5.3 trillion yen ($47 billion) worth of dollar-denominated bonds so far this year while boosting holdings of euro debt by a similar degree, according to BOJ data. The prospects of the Fed further raising interest rates have increased the cost of hedging against dollar weakness, damping Japanese demand for Treasuries.
In their own individual ways, the leaders of the U.S. and China are products of a moment when free-market capitalism imploded and Chinese-style “state capitalism” shored up the global economy. The 2008 financial crisis helped make both Donald Trump and Xi Jinping. What observers don’t yet seem to appreciate is how difficult that makes it for them to resolve their spiraling trade war, writes Bloomberg Opinion’s Andrew Browne.
Financial markets wobble every time Trump imposes new tariffs on China and then perk up on hopes of talks, as though this was a classic tit-for-tat trade war. It’s far from that. White House complaints about lopsided trade and Chinese theft of intellectual property are the pretext for a wider struggle. What we’re seeing are the opening stages of a strategic competition spurred by a sense of vulnerability in the U.S. and, in China, of national destiny.
Under Trump, China has gone from economic threat to “strategic competitor.” Trade is the leading edge of resistance.
Chinese leaders have lost hope of a quick trade deal from a U.S. president they pegged, wrongly, as a pragmatic businessman. Instead, they now interpret his moves as “containment” — and they’re not far off the mark. Though this is not exactly a replay of the Cold War, trade hostilities infect just about every area of the relationship, from the military and security realms to scientific and technological collaboration.
The best the U.S. and China can probably hope for is some form of peaceful-if-awkward coexistence. A Cold War-style relationship would imply at least a limited decoupling of the world’s two biggest economies, with the U.S. and China agreeing to cooperate where possible on commercial matters and to limit the scope of their strategic competition. If they can’t work out a managed separation of this kind, the legacy of 2008 may well be a hard split, with Trump and Xi ripping apart the global economy.