- In the short term the market focus will be on Italy’s budget submission, potential credit downgrades and the Brexit negotiations
- At the end of the month there is the US’s largest weekly SOMA roll-off to date and an update to the UST’s funding needs
- November sees Iran sanctions in full effect and a potentially interesting G20 summit, with the US/China trade in full view
There is an undeniable correlation between geopolitics, market sentiment and the macro trading environment. In an era when a single tweet could trigger a geopolitical escalation, developed markets are beginning to behave more like emerging markets – politics has become a major driver.
Our risk radar identifies some of the event risks we are watching to navigate increasingly politically-driven markets. There are five key themes in the markets now:
- The China slowdown vs US outperformance in and among trade wars.
- The Italian budget talks leading to a potential “vicious circle” of higher yields, lower growth, worse deficits and therefore higher yields.
- Emerging markets continuing to underperform (and now DM).
- Improved Brexit sentiment, but with political pitfalls along the way and
- What the end of global QE and higher yields mean for the world economy and markets.
In the short term, there are some events to watch:
By 15 October – US Treasury semi-annual FX report: China’s current account surplus remains significantly smaller than the 3% of GDP criteria. Therefore, China still does not fit the current US Treasury FX manipulator criteria.
15 October – EU budget submission: The negotiations between Italy and the European Commission, when Italy’s draft 2019 budget is submitted for review, could be very difficult, as the fiscal deficit number indicated in the update to the
document of economy and finance (2.4% in 2019) would result in a violation of the EU budget rules.
18/19 October: Brexit negotiations and the “meaningful vote”: “Nothing is agreed until everything is agreed” is the line from UK ministers on the state of the Brexit negotiations. We also assign a 20% probability to a second referendum on the final deal, and we expect that to feature in market discussions closer to the time. The reason we assign such a high probability to this is that public sentiment seems to be shifting against Brexit. If this continues, watch for remain MPs (the majority) moving to capitalise on the shift in public perceptions (see Brexit FAQs).
4 November: Iran sanctions come into effect: The market’s focus may return to the impact of the nuclear deal around the end of the 180-day wind-down period (see here for FAQs). There is likely to be a significant reduction in oil purchases in the EU from Iran, but the European Commission said it would launch the process of activating a law that bans European companies and courts from complying with US sanctions against Iran, along with a proposal for EU governments to make direct euro-denominated payments for Iranian oil to Iran’s central bank, bypassing the US financial system.
China’s easing cycle is different for this round: Beijing has shifted its policy stance towards clear credit easing and fiscal stimulus. This raises the question of whether this is a case of déjà vu all over again. Our answer is no, and we tend to believe Beijing’s stimulus to be narrower, slower and less strong than in previous easing cycles. The reasons behind our call include: 1) less policy room and more constraints on easing; 2) given the unfolding trade conflict with the US, Beijing needs to reserve some stimulus measures for rainy days; 3) a significant change in policymakers’ mentality, with financial stability now being increasingly preferred over growth stability; and 4) a lack of consensus on best strategies. In the coming months, we expect growth to drop further, before staging a modest rebound with infrastructure investment the major driver. Easing measures and stimulus are likely to be rolled out in stages. Deleveraging will continue to be put on hold until Beijing feels the imminent risk of financial and growth instability is cleared, but will be more cautious in adding too much leverage again. More spending will be funded by the central government and its agencies, underpinned by faster issuance of central government bonds and policy bank bonds
Read the full Risk Radar here.