Market Response to De-escalation of Sino-American Trade Tensions: Meh

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The US dollar initially extended its recent run against the euro, yen, and sterling, as the divergence theme has re-emerged as an investor focus.  The market’s response to the agreement in principle between the US and China was mild at best, while Italian assets remain under pressure as a new government’s priorities are awaited, but the rhetoric takes a toll.  

There have been two major developments over the weekend.  First, the US and China appear to have struck an agreement in principle that will reduce the bilateral imbalance.  The precise details have yet to be worked out, but the progress has been sufficient for US Treasury Secretary Mnuchin to that the tariffs are on hold.

Asian stock markets were mixed, as exemplified by the rise of the Nikkei (~0.3%) and the decline in the Topix (~-0.1%).  China’s shares and Hong Kong’s Hang Seng advanced around 0.5%-0.6%, though the Shenzhen Composite was up 1%.  Taiwan and South Korean markets also advanced.  The entrepot, Singapore also rose.  Australia and India, and Indonesia eased.  Foreign liquidation of Malaysian shares continued, and the gradual but steady decline of the ringgit has continued (ninth session and only two advancing sessions since April 11 ( a month before the election).

Australian stocks slipped fractionally, but the Australian dollar is holding its own against the US dollar, which has risen to new highs for the year against the euro and sterling and its best level against the yen (~JPY111.40) since mid-January.  Over the past five sessions, the Aussie is among the strongest of the majors by being virtually flat against the dollar.  It has encountered offers near $0.7530 in Asia and Europe, ahead of the A$1.6 bln $0.7548 option that expires today.  Support is the $0.7480-$0.7500 band.

The second development has been more progress in Italy in forming a government between the Five Star Movement and the (Northern League).   Even though the call to leave the EU and/or EMU has been dropped, investors and other observers remain suspicious.  Many are warning of the risk of a Greece-like confrontation with the EU over fiscal issues.

Italian assets remain under pressure.  Italy’s 10-year bond yield has continued where it left after last week and has risen another four basis points to today to 2.25%.  The premium over Germany and Spain are widening.  Italy’s two-year premium is also marching higher.  However, note that absolute level:  Italy is able to borrow two-year money for a dozen basis points.

Italian stocks are underperforming.  The FTSE-Milan Index is off 0.4%.   It fell 1.5% before the weekend.  It has fallen for two-weeks, during which time it has pared this year’s gain by 2.7%.  Although May has been a tough month, the 6.9% year-to-date gain still allows it to hold on to the title of best performing G7 bourse this year, though France’s CAC (+6.5%) closing the gap.

The key uncertainty emanating from Italy is how much the new government, whose team has not yet been named (though the M5S head may be given the labor portfolio and the League head become the internal minister, is how confrontational it will be toward Europe.  Will it really seek to create a parallel currency?  Will it roll back the pension reforms?  Will it cut taxes and introduce a 15% and 20% rate across the board?  How aggressive will it address the refugee problem?

To be sure, the euro has been falling for weeks prior to the shift in stance toward the Italian election.  After all, the election took place in early March.   The euro has been begun falling for a sixth consecutive week.  It has risen in two sessions so far this month.  The euro dipped briefly below $1.1720 in early European turnover.  The $1.1700 area is technically significant.  A break of it could spur losses toward $1.1450-$1.1500 as the next target.  The $1.1760-$1.17870 area offers resistance, and there is a 962 mln euro option struck at $1.1760 that expire today.

The divergence of US policy remains a powerful driver.  Rising US rates has also kept the dollar bid against the yen.  The dollar has risen eight consecutive weeks against the yen and has begun week nine on firm footing. It is advancing against the yen for the sixth consecutive session. We pegged initial resistance today near JPY11.60, and so far the greenback saw JPY111.40.

Earlier Japan reported a larger than expected trade surplus for April, which was as seasonal patterns typically have it, smaller than March.  The April surplus stood at JPY626 bln, down from JPY797.3 bln in March and half again as good as the Reuters poll forecast (median JPY405.6 bln).  Exports rebounded to 7.8% from a year ago, after a 2.1% gain in March.  Imports rose 5.9%, after contracting 0.6% in March, which was the first drop in a couple of years.

Sterling is the weakest of the majors.  It is off 0.5% and is probing the bids below $1.34.  It is not trending as smoothly as the euro and yen, but last week’s decline was the fourth in five weeks.  The US two-year premium has risen to nearly 175 bp from about 140 bp at the end of last year.   The large double top pattern we have been monitoring projects into the $1.30-$1.31 area.

The US data week starts slowly, with only the Chicago Fed’s National Activity Index is on tap for today.  Recovery from the 10 reading in March is consistent with expectations of stronger growth in Q2.  The US is raising more than $250 bln this week.  It begins with around $150 bln in bills today, and then continues to $99 bln in fixed rates notes, with some of the largest offerings since 2010, and then a $16 bln two-year floating-rate note.

Last week’s NAFTA deadline passed, and there have been little recriminations. US Treasury Secretary Mnuchin seemed to indicate a willingness to continue to negotiate and if it is not so important if this Congress cannot vote on it and that responsibility falls to the next Congress.  Importantly, there was no new threat to withdraw.  Marginally softer than expected Canadian data (retail sales and CPI), weighed on the Canadian dollar before the weekend and saw expectations for a central bank hike pared.  The US dollar has risen in four of the past five weeks against the Canadian dollar.  The Canadian dollar is trading firmer today but within the pre-weekend range.  Initial US dollar support is seen near CAD1.2840.