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Keep Your Eye On U.S.-China Summit

Published 05/04/2017, 06:21 am
Updated 09/07/2023, 08:31 pm
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By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

It was turnaround Tuesday in the financial markets with the dollar, stocks and Treasury yields recovering early losses. Stronger-than-expected U.S. data took the market's focus off this week's meeting between U.S. President Trump and Chinese President Xi. The meeting is not until Thursday and for the time being it appears that investors are more focused on Wednesday's U.S. economic reports and FOMC minutes as Wednesday's data will help shape expectations for Friday's nonfarm payrolls report. If non-manufacturing ISM is weak or ADP misses, USD/JPY could make another run for 110. However the minutes from the last FOMC meeting should be optimistic with policymakers justifying the recent rate rise and plan for further tightening.

Of course, politics can easily trump economics as the world watches the first official meeting between the leaders of the 2 largest economies in the world. Even before the summit, President Trump set the tone saying it will be a difficult meeting. There are also many political issues at hand like the one-China policy and North Korea, but Trump has not been shy about his views on China's unfair currency and trade policies. This should make investors nervous but judging from Tuesday's price action, there is a hope that nothing significant will come out of the meeting. The best-case scenario is that both leaders will shake hands, smile and talk about a stronger relationship. Unfortunately, they are walking into the summit with a strained relationship as Trump rarely misses the opportunity to point fingers at China for its unfair trade practices having once described China as the world champion of currency manipulation and devaluation. Yet since the beginning of the year, the Chinese yuan has steadily increased in value, contributing in part to China's unexpected February trade deficit unlike the U.S., which reported its smallest trade deficit since the election.

FX traders should be nervous because Trump is unpredictable and it is not clear how hard he will press Xi. If the meeting ends with the same awkward press conference as the one held with German Chancellor Merkel, the markets won't be happy and risk appetite could suffer. Which would mean further losses for high-beta currency pairs like AUD/USD, EUR/USD and possibly even USD/JPY. Thankfully, with the 19th party congress set for November, Chinese President Xi needs to secure and not jeopardize U.S.-Chinese relations, so he'll have a vested interest in steering the meeting in the right direction. At the same time, he cannot leave the meeting embarrassed or bullied by Trump. With that in mind, this meeting could set the tone for Chinese-U.S. relations for the years to come and FX traders should be anything but complacent.

Tuesday's worst-performing currencies were the Australian and New Zealand dollars although all of the losses happened during the European trading session. AUD and NZD held steady throughout the NY session, ticking slightly higher as stocks stabilized. The Australian dollar sold off sharply after the Reserve Bank of Australia's monetary policy announcement. As expected the RBA left interest rates unchanged and while it was optimistic about global trade, lending and industrial output, investors latched on to the central bank's acknowledgement of recent softness in the labor market. The corresponding sell-off took AUD/USD to the 200-day SMA. While the currency pair could bounce off this level, we view rallies as an opportunity to sell at higher levels. The New Zealand dollar followed the Aussie lower though the 1.6% rise in dairy prices, which was only slightly less than the increase seen at the last auction, limited the sell-off. The Canadian dollar, on the other hand, shrugged off a surprisingly weak trade balance. None of the economists surveyed expected Canada to report a deficit but with the recovery slowing, exports fell 2.4%, causing the country's 420 million surplus to turn into a -970 million deficit in February. The report should have sent USD/CAD sharply higher but the recovery in oil allowed investors to look beyond the deterioration in trade.

The euro continued to trade in a tight range around 1.0650. Limiting the move was ECB President Draghi, who did not talk about the economy or monetary policy in Tuesday's speech. Stronger-than-expected Eurozone retail sales helped prevent steeper losses on a day when the U.S. dollar rose. Sterling, on the other hand, tumbled on the back of slower construction-sector growth. PMI services are scheduled for release on Wednesday and if service-sector activity eases alongside manufacturing and construction, GBP/USD could break 1.24 and hit a new 2-week low below 1.2377.

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