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What Does US-China Phase 1 Deal Mean?

Published 11/10/2019, 21:34
Updated 09/07/2023, 11:31
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Kathy Lien, Managing Director Of FX Strategy For BK Asset Management

Daily FX Market Roundup October 11, 2019

The sentiment in the markets shifted from gloom to hope this week on the prospect of breakthroughs in US-China trade and Brexit negotiations.

Currencies and equities surged as policymaker tease the possibility of a deal and by the end of the week, USD/JPY rose to its strongest level in 2 months and GBP/USD rose to its highest level since June. On Friday President Trump announced a “Phase 1 Deal” with China and stocks extended their gains. However dollar bulls were not impressed. USD/JPY failed to extend higher because the “substantial deal,” has “not been put in writing” according to Trump and it may take up to 5 weeks to get the deal written. We know that China agreed to purchase $40-$50B in agricultural goods but there’s nothing about intellectual property, which means that in a nutshell, there’s not much meat to this agreement.

US China Phase 1 Deal Highlights

1️⃣ October 15 tariffs delayed, no mention of Dec.

2️⃣ Phase 1 deal still needs to be written, takes 5 weeks

3️⃣ China agrees to $40-50B more AG purchases

4️⃣ Agreement on FX Transparency

5️⃣ Trump says deal could still fall apart

What a Phase 1 deal means is that Trump gets validation from the markets and China gets their October tariffs delayed. The next 5 weeks is really critical because this is the fourth time that the US has offered relief to China and trade relations soured quickly after. There are also questions about whether the tariffs in December will be pushed off as well. China has extended an invitation to US officials for further talks next month. As the negotiations continue, investors will be watching the headlines closely to see if the trade truce stays but for the time being, the phase 1 deal eliminates near-term risks for China.

Meanwhile the UK is closer than ever to a Brexit deal and the nearly 2% rally in sterling reflects the market’s optimism that an agreement can be reached by October 31. Minimally the EU may have an idea on the table different enough to allow negotiations to proceed. On an intraday basis, the pound saw its strongest 1-day move in more than a decade following positive language out of Brussels. The two darkest clouds this year have been trade and Brexit and while Brexit negotiators are still working on areas of agreement, this is the closest they’ve come to amenable terms since Theresa May was Prime Minister. The EU’s Michel Barnier described his talk with Brexit Secretary Steve Barclay as “constructive” because Britain has accepted that any solution to replace the backstop cannot involve a customs border on the island of Ireland. However one viable option would be to do the customs checks in the Irish Sea. We are finally seeing the light at the end of the tunnel and the rally in sterling reflects the possibility of a breakthrough in the weeks ahead. The EU wants to avoid a no-deal Brexit and with less than 3 weeks to go, the intense negotiations in the days ahead could finally break the gridlock. There are many pieces of market moving UK data on next week’s calendar including retail sales, CPI and the jobs report but nothing will impact sterling more than Brexit headlines. A deal is close and we look for GBP/USD to trade above 1.28.

Risk appetite also helped euro climb to its strongest level in 3 weeks. Short covering has been the primary catalyst for the currency’s move above 1.10. The account of the last ECB meeting revealed how far apart EZ policymakers are on stimulus. Some members wanted a deeper cut while others didn’t feel that lower rates were needed. This division raises the bar for further easing and suggests that not everyone in the ECB believes that the region’s outlook is grim. The German ZEW survey is scheduled for release next week along with EZ CPI and trade but we are more interested in the comments from the long list of ECB officials set to speak. Technically, 1.1050 is an important level for EUR/USD. If it breaks it in a meaningful way, the next stop should be 1.1160.

All three of the commodity currencies traded higher last week and the best performer was the Canadian dollar. Although sterling clocked in as the strongest currency, Canada earns the title of the strongest economy. Friday’s labor-market numbers were exceptionally robust with more than 53K jobs created in September, a figure that was seven times better than expected. Full-time jobs increased 70K, the strongest in 5 months and the second-best reading this year. The unemployment rate also dropped to 5.5% from 5.7%. Unlike many other central banks, Canada did not lower interest rates this year and they have no need to after Friday’s report. USD/CAD fell sharply on the back of the release and further losses are likely but the loonie’s biggest gains should be against other currencies like EUR, JPY, CHF, and NZD. There’s a very good chance that next week’s CPI reports will reinforce the positive outlook for the currency.

Inflation numbers are also scheduled for release from New Zealand while AUD/USD traders look forward to the RBA minutes and latest employment report. Unlike Canada, the labor market in Australia is weakening but having lowered rates three times this year, we don’t see another cut by the RBA in 2019, so the impact on AUD could be limited. The data could also surprise to the upside as the manufacturing and construction sectors report stronger labor-market conditions.

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