More tax reform wobbles and squabbles ahead?
The market certainly had its Jekyll-and Hyde moments last week as the torrent of inter-party lobbying suggests we are nearing a now or never moment for US tax reform.
Digesting tax reform banter is an unsavoury business as even the ambient noise is triggering unusual moves across asset classes which has traders scurrying looking for answers. But when usual correlations break down it creates conflicting messages, producing a scrambled picture and price discovery becomes virtually impossible. Indeed, this partly explains some of the dangerous market schizophrenia over the last weeks, however in this low volatility environment with investors overly optimistic views likely stretched, even the smallest shock can help trigger an outsized move. Besides with Christmas just around the corner, investors will be more inclined to book year-end profits adding to sell-off momentum.
Similarly, currency traders, especially dollar bulls, will look to bank profits early this year given that most of the optimistic USD drivers have run their course. Indeed if this week’s US CPI print fails to trigger more Fed tightening expectations into 2018 and given the much of the Tax Reform USD positivity is factored in, we should expect a deeper USD correction.
Speaking of possible meltdowns: As the enormity of the budgetary implications surrounding Tax Reform sets in, bondholders are getting increasingly jittery just thinking about the volumes of new issues that would be required to fund this massive budget shortfall. If we compound this with a possible, but at this stage unlikely, uptick in US inflation we could see a sharper Bond Market sell-off in weeks to come. But in fact, Friday’s main market mover was the far-reaching sell-off in global Sovereign Bonds ahead of this week's key inflation data in perhaps a foreshadowing of things to come.
Speaking of actual meltdowns: Given just how boringly predictable gold markets have become lately, I guess a $10 dollar move lower is considered a deep plunge (referring to Friday’s mystery $4 million ounce seller). But with the cascade of political noise, backroom negotiations in full swing and some crankiness in US bond yields, someone is either taking a view on significant “big boys club” gold position, or it could be nothing more than hedge funds trimming longs which have been an ongoing trend the past 5-6 weeks. And while there doesn’t appear to be a powerful impetus for prices to move higher, there doesn’t seem to be a significant wavemaker to drive prices lower either.
Global equity markets traded lower on Friday influenced by higher bond yields and uncertainty over US tax reform. The exception was China where local stock markets were trading firmer after Friday’s announcement that China will be allowing Mainland financial firms greater access to foreign ownership of Chinese Financial Firms. While the timing may look suspiciously coordinated with President Trump visits, the fact is the announcement is an enthusiastic signal and symbolically significant that the government is genuine about the reforms discussed in the Party Congress.
The Chinese Yuan amid reforms
From a currency perspective, the markets will tread carefully knowing it will take time for something actionable to occur but this opening up of China’s financial markets to the rest of the world is a clear signal that China is looking to increase FDI. Ultimately this should lead to more capital inflow to counterbalance China’s capital outflow problem. Market reform will always be viewed in a positive light and should be yuan positive long-term.
The Japanese Yen
Price action around the tax reform headlines will be little more than a chop fest. But logic dictates lawmakers will pass tax reform in some form or another knowing the ensuing market meltdown is on their watch if they fail to do so. With that in mind, we should expect dips to remain supported, but with an increasing number of stops entering the picture just below 113, a break of this tipping point suggests things will get messy quickly. But given what lies ahead we should expect another discombobulated week for USDJPY trading as the interday tug of war between US yields and global equities is expected to intensify.
The Australian Dollar
Australia employment data is on tap this week as all data will be scoured over in the wake of the SOMP that gave little reason to buy the Aussie dollar. But unless there is a massive surprise in the data or an abrupt shift in RBA rhetoric, who appear sidelined indefinitely on tepid growth and apathetic inflation figures, the Aussie should remain pressured.
Iron ore futures drifted lower on Friday moved by China consumption fears which now leaves little more than US corp tax delay headlines holding the market back from assaulting the recent AUD lows.
RBA Assistant Governor Luci Ellis will talk on ‘Where is the Growth Going to Come From’ in Melbourne on Wednesday which should also be of interest to the markets given the obvious lack thereof when it comes to economic growth.
The New Zealand Dollar
An intense focus will remain on the Kiwi as the recent wave of post RBNZ NZD cross buying got hosed down on the back of Friday’s comments from Finance Minister Robertson when he said that the dual mandate could result in looser policy in specific situations. Any thought of RBNZ uncertainty fading into the background after the Central Bank struck an upbeat chord at last week's OCR quickly evaporated on Robertson's verbosity.
Strategically, with the RBNZ bringing forward both OCR and inflation forecast, it should lead to a higher NZD, but the market remains overly comfortable selling on the political risk narrative which suggests politics, not the monetary policy will continue to be the primary driver near term.
The Euro
No shortage of ECB Hawks flying into the picture as the ECB’s dovish taper is a distant memory. Indeed, the robust economic data out of the eurozone does suggest a more aggressive unwinding of easy-money policies than currently factored. With the USD all but stuck in the muck, the euro could trade firmer this week vs the USD.
But with USD CPI and Retail Sales on tap, not to mention tax headlines, the most obvious path for EUR appreciation would be via the Aussie dollar given the apparently dormant RBA.