FX5: Focus On Rhetoric Ahead Of G20 Summit

Thursday February 25: Five Things The Markets Are Talking About

Wednesday’s turnaround in U.S equities from a negative open to a positive close was in part attributed to a report citing the People’s Bank of China (PBoC) stats department is calling for an increase in the fiscal deficit to +4%/GDP vs. +3%/GDP currently targeted in 2016.

But it was China’s Finance Minister Min Zhu’s non-committal on fiscal stimulus that has rattled Asia’s equity markets again.

Investors have been lacking monetary guidance from Tier 1 Central Banks in the month of February – they are all back on line for March. Their absence this month has only made market moves that more volatile. Investors can expect Central Bank communication concerns to be addressed at this weekend’s G20 summit in Shanghai.

1. Chinese Stocks Tumble as Money Rates Rise

China’s equities plummeted overnight as concern increased that recent gains were overdone relative to the outlook for their economy.

The Shanghai Composite Index closed down -6.4%, the biggest decline since January 26, extending its losses this year to -23%. The overnight money rate (a gauge of liquidity in the financial system) climbed the most since the first-week of this month.

Not helping investor’s confidence is China’s manipulation of their exchange rate and this despite China’s Finance Minister stating that the upcoming G20 meeting (Shanghai February 26-27) will not feature a proposal to devalue CNY. In the overnight session, the PBoC continued to gradually nudge it lower, with this morning’s setting being the third consecutive weaker fix (¥6.5318 vs. ¥6.5302 prior) and the lowest since February 5.

2. Focus On Rhetoric Ahead Of G20 Summit

Investors are looking for assurances and a clear plan, but will they get it this weekend?

In an IMF staff report issued yesterday, in time for the G20 meet-up, indicated that G20 members needed to create a plan for coordinated demand support, otherwise know as further government fiscal spending. Relying too heavily on monetary policy will see the global economic situation likely to deteriorate further. NIRP (negative interest rate policy) can only do so much. Already, a number of Central Banks (ECB and BoJ in particular) are running out of innovative tools in their arsenal to combat the lack of inflation/deflation and sustainable growth in their respective countries.

U.S. Treasury Secretary Lew has reiterated their opposition to exchange rate misalignments and emphasized the importance of communication in exchange rates. He is also urging Chinese officials to follow through on economic reforms and clearly communicate their economic policies.

3. Oil Traders Have Many Moving Parts To Deal With

Both WTI and Brent trade under pressure from the continued influence of the no Saudi production cut/no Iran participation theme. Added pressure comes from the “huge” build seen in the API (American Petroleum Institute) weekly inventory report earlier this week. Crude ‘bulls’ have been taking some solace from yesterday’s DoE gas drawdowns that were less than expected.

West Texas Intermediate crude has declined -1.1% to $31.79 a barrel, after gaining +0.9% on Wednesday. Stockpiles of gasoline in the U.S. fell -2.24m barrels to +256.5m, as demand climbed on pump prices near a seven-year low. American crude inventories, however, rose by +3.5m barrels to an 86-year high of +507.6m last week, according to the EIA.

Crude has slumped -14% this year on speculation a global glut in the commodity will persist amid the outlook for increased shipments from Iran and brimming U.S. supplies.

4. Fed’s Bull’s More Cautious?

FOMC voter Bullard has added his voice to the recent Fed ‘speak’ with a slightly greater “caution” on proceeding with more rate hikes.

The normally ‘bullish’ member is indicating that the case for raising rates stateside is losing some of its urgency. He is also calling for reconsideration of how the Fed makes its forecasts in the dot plot, concluding that the markets’ expectations are not on the same page as the Fed’s outlook.

Seeing how U.S fixed income traders’ are pricing their rate curve suggests they are very much misaligned with the Fed’s expectations. Currently the curve odd’s are at only +30% for one more rate hike in 2016.

Nevertheless, Bullard remains upbeat on 2016, expecting growth to top last year and labor markets to continue to improve.

5. Cost Of FX Speculation Jumps

2016 thus far has recorded the highest currency-market volatility in more than four-years.

Volatility (vols.) helps determine the price of currency options and because of increased vols leads to higher prices; currency options are losing some of their appeal as a way to speculate in foreign exchange markets and none of this is expected to change anytime soon.

U.K’s Brexit uncertainty has seen demand spike for contracts that protect investors from a big move in GBP this summer (June 23 vote). Dealers note that the cost of some options have hit its most extreme levels since Europe’s sovereign debt crisis. Implied volatility (vols.) have rallied to +13.5% this week vs. +8.4% cost recorded two-months ago – do not expect a good deal anytime soon.

GBP sank to fresh seven-year lows mid-week after another round of very close poll numbers on the support for the UK’s continued membership in the European Union (YouGov poll, 37% of respondents were in favor of staying in EU versus 38% voting to leave). The current bookies odds are one-in-three chance of the U.K leaving the EU. Investors can expect a volatile four-months.

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