US and China finally sign off on ‘phase 1’ trade deal

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16 January 2020

thomasdodds

Investors breathed a sigh of relief on Thursday after the US and China finally signed off on their so-called ‘phase 1’ trade deal in Washington.

A
s mentioned yesterday, the news was, of course, widely expected and heavily priced into the market so there was no major reaction in the currencies to note. While both sides have acknowledged there is still some way to go before a full agreement can be struck, the development is undoubtedly a step in the right direction. As part of the deal, China will increase US imports by $200bn above 2017 levels, while also strengthening its intellectual property rules. Importantly for the markets, Trump has also agreed to halve some of the tariffs on Chinese products, although most will still remain in place.

General optimism surrounding US-Sino trade relations has already provided good support for emerging market currencies in the past few months, with many rallying off multi-month or, in some cases, record lows. A good gauge of how EM currencies are performing is MSCI’s emerging market currency index, which as you can see below has risen by around 5% since September alone (Figure 1).

Figure 1: MSCI Emerging Market Currency Index (2018 – 2020)

Currency traders will be hoping that the phase 1 deal ensures no additional tariffs are slapped on China by the US President this year. Risk of an escalation in tension do remain, however, particularly should China not be able to fulfill its pledge to increase US imported goods by the sizable extent laid out in the deal.

ECB to release December meeting accounts

The euro rallied by around 30 pips against the dollar yesterday afternoon, in part due to trade optimism.

Investors actually largely overlooked data out in the Euro Area yesterday, which was broadly negative. Industrial production fell short of expectations, remaining deep in negative territory year-on-year. Real GDP growth in Germany was also confirmed to have reached a six-year low in 2019 at just 0.6%, considerably lower than the 1.5% and 2.5% registered in the two years previous. We think that this is largely a reflection of the trade uncertainty and growth in Europe’s largest economy should, therefore, start to pick up steam in 2020.

All attention in the market will now turn to this afternoon’s speech from President of the European Central Bank Christine Lagarde. In the meantime, the ECB will be releasing the accounts from its latest meeting (12:30 GMT, 13:30 CET). We don’t expect too many fireworks, with the message likely to be in line with Lagarde’s upbeat comments in December.

Soft UK inflation data ramps up BoE rate cut bets

The release of a disappointing set of UK inflation numbers on Wednesday heaped added pressure on the Bank of England to cut interest rates when it meets at the end of the month.

Headline inflation slowed to just 1.3% year-on-year in December, 0.2 p.p. below the November reading and its lowest level in three years. Unsurprisingly, expectations for Bank of England easing have risen again, with the market now pricing in around a 60% chance of a cut at the bank’s 30th January meeting.

Given recent comments from BoE members, we think that next week’s PMI numbers will now be key. Another slowdown here may well be the final nail in the coffin for a rate cut, although an upside surprise may be enough to tip the balance in favour of the hawks on the MPC.