Oil, China Dominate Dollar Proceedings

Monday May 16: Five things the markets are talking about

Investors are beginning this holiday shortened trading week trying to avoid making any major moves given a lack of fresh trading cues.

Markets are closed in Germany, Denmark, Austria, Switzerland and Norway (Whit Monday). While bank holidays are been observed in a number of others (France included).

This week’s capital market direction should be dictated again by central banks. The Reserve Bank of Australia (RBA), European Central Bank (ECB) and the Fed will all publish minutes from their most recent policy meetings.

Yen traders will be focusing on Japan’s Q1 GDP print Tuesday evening, while sterling traders will have a plethora of data to plough through over the next few sessions – consumer and producer price indexes, retail sales and employment data.

At the end of the week, G7 finance ministers and their respective central bank governors meet (May 20/21) as a prelude to the G7 summit to be hosted in Japan (May 26/27).

1. China data disappoints

Chinese data continues to be the “elephant in the room.” A number of recent sub-par market releases have not been able to dent global market sentiment significantly of late. Why not? Investors seem to be clinging to the positive rhetoric and reassurances given by the People’s Bank of China (PBoC).

On the APAC open, the PBoC released a statement assuring that Friday’s disappointing New Loans (six-month low) and M2 Money Supply (10-month low) would be reversed.

On the weekend, China retail sales fell to a new 11-month low (+10.1% vs. +10.6%E; YTD Y/Y: +10.3% vs. +10.4%E), while industrial output was much lower than expected at +6.0% vs. +6.5%e.

2. Crude glut disappeared?

In the commodity space, crude prices again lead the pack ahead of the open stateside. In overnight trade, June WTI crude oil has rallied +1.5% to $47 a barrel to match last week’s highs.

In a note penned by Goldman Sachs analysts’ over the weekend, they indicate that the market supply has reversed course and entered “deficit” territory. The global “supply glut” that bear speculators have been relying on seems to have been soaked up by supply disruptions and sustained demand.

Traders are continuing to monitor a number of event risks that are having a material impact on global supply. There is political upheaval in Venezuela as well as oil delta sabotage in Nigeria and wildfires in Canada.

Collectively, they have persuaded Goldman’s analysts to raise their price of U.S. crude price to $50 a barrel for H2 from their March estimate of $45 a barrel.

3. U.S Treasury flatteners dominate fixed income trading

The flattening-yield-curve trade is again picking up momentum after last Friday’s U.S retail sales (+1.3%) and consumer-confidence (95.8) data points to resilience of U.S economic growth.

A stronger headline print on both accounts has some FI dealers believing that the Fed might raise rates more than the market to date has been pricing in.

Last week, the Fed’s Rosengren (Boston) warned that the market was behind the curve on Fed rate action.

Investors are seen selling short-term debt and moving further down the curve into longer-term bonds, a typical setup to prepare for Fed tightening – 2’s/10-year spread has tightened to 95.4. December Fed-fund futures show slightly higher odds for a rate hike by year-end (48% vs. 43% before Friday’s retail sales.

Note: A flattening U.S curve also reflects concerns that U.S growth momentum would slow because of Fed policy.

4. Gold rush

Despite playing second fiddle to silver ($17.31) in returns in the precious metal category, gold ($1,281, +1%) continues to see strong interest amid rising concern over negative rates in Europe and Japan and whether the Federal Reserve will be able to tighten further. Even the fear of currency wars and an uptick in market volatility is encouraging safe haven demand for the metal.

Note: Silver (YTD +24%) leapfrogged gold (YTD +21%) in mid-April as the best-performing precious metal as data signaled a resilient U.S. expansion and a stabilizing Chinese economy.

Demand for gold has jumped to the second-highest level ever in Q1 (World Gold Council). According to Bloomberg, holdings in ETF’s have swelled by +25% as investors take advantage of lower prices over the past fortnight (prices lost -1.6%, ETFs swelled 63.2 tons rising every day). The holdings have increased to 1,822.3 metric tons – the most in three-years.

5. Are Brexit fears priced in?

Between now and the U.K’s June 23 referendum, more polls and surrounding noise is expected to have a material impact on the pound (£1.4338).

Some analysts suggest that that even a 25% chance of Brexit suggests GBP could trade some 3%-4% weaker before the U.K.’s June 23 referendum on EU membership. Currently, opinion polls are not far from 50:50 among decided voters.

The bookie odd’s are only a 25%-30% probability of Brexit occurring. With the pound following the bookmakers, this would suggest that little Brexit risk has been priced in so far.

Bank of England’s (BoE) Governor Carney did not hold back last week on the risks to the U.K. economy over Brexit. A vote to leave could lead to a “materially lower path for growth and a notably higher path for inflation”, sterling might fall “sharply” and BoE policy makers would face a “challenging trade-off.” In translation, the U.K would be facing a recession.

The IMF seems to be in agreement with the Governor. They warn that a U.K. vote to exit the EU could hurt the economy, causing it to shrink by between -1% and -9% over the long-term.

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