Philip Wee, FX Strategist
Eugene Leow, Rates Strategist
DBS Group Research
FX: US-China trade talks
Marketa remain optimistic for a possible US-China trade deal. Having relented on the US government shutdown, President Donald Trump needs to show a win on trade at his State of the Union address on 5 February. But this morning’s indictments by the US Department of Justice against China’s Huawei, its chief financial officer, and two bank affiliates illustrate the risks attached to the US-China relationship.
The actions by the DOJ show that it would not be enough for China to buy more US goods. America wants China to make structural reforms especially on its intellectual property practices. From America’s perspective, progress on the talks is contingent on China agreeing to verification measures on its commitment to reforms. If there is a breakthrough in talks, there will be another round of talks before the March 1 deadline for the US to decide on whether to resume its tariff war. Until then, the risk for the yuan to depreciate past 7 this year cannot be totally discounted.
Rates: Fed pause & easier financial conditions
US financial conditions have eased in line with the improvement in sentiment over the past month. Most of this appears to have been triggered by Powell’s less hawkish stance that suggests that a Fed pause is likely for the immediate few months. In the interest rates space, the interaction between IG spreads, HY spreads and govvie yields bears watching. Notably, while the Fed tightened in earnest in 2017, there was hardly any passthrough to borrowing costs. This changed in the early part of 2018 when UST yields headed meaningfully higher, dragging IG yields along, and created the first wobble in risky assets. Shortly after the third hike was delivered in 2018 (and Powell still sounded hawkish), risk aversion started kicking in, driving credit spreads sharply wider, tightening financial conditions more than what the Fed intended.
While stress in the credit space has eased somewhat, there is little doubt that the Fed would reiterate patience at the FOMC meeting this week (outcome due 31st Jan, SG time). The global growth backdrop is slowing and there are still considerable uncertainties regarding the China-US trade tensions and the temporary reopening of the government (another shutdown takes place on 15thFebruary unless an agreement over Trump’s border wall is reached). It would be interesting to see the Fed’s take on the pace of balance sheet runoff, which could have exacerbated the selloff in risky assets. We think that the supply of excess reserves is already getting low and that the Fed would slow or pause the balance sheet run off relatively soon (see here).