Over the last week, cross-asset markets moved broadly risk-on as positive news related to several key areas of risks emerged.
First, the US administration averted a potential debt ceiling crisis by reaching an agreement with congressional leaders to suspend the debt limit through July 2021, which significantly reduces policy uncertainty and the risk of a sequester-driven decline in fiscal spending.
Second, we saw some positive developments in Sino-US relations. In his meeting with CEOs of US technology companies on 22 July, Trump agreed to requests for “timely” export waivers on Huawei, which suggests we will hear more on the easing of Huawei’s supply restrictions ahead.
The Chinese also recently made enquiries on the purchase of US soybeans and other agricultural goods, and we understand that the companies involved have applied for tariffs exclusions from Chinese custom officials. Given the direct impact this issue has on his rural support base, President Trump has been eager for the Chinese to resume purchases of US agricultural goods, which will be taken as a firm gesture of goodwill if they did so.
Sino-US trade talks also took another step forward as US negotiators head to Beijing this week to restart face-to-face discussions. While we see broad underlying tensions between the two superpowers to be the long-term status quo, our baseline expectations are that Trump is unlikely to impose the final round of US tariffs on the remaining US$300b of Chinese imports as long as direct negotiations are ongoing, and that he will likely acquiesce to a partial trade agreement before the 2020 US presidential elections.
Third, by formally signaling a dovish bias at its meeting last week, the ECB has paved the way for delivering a monetary easing package in September which will likely comprise a rate cut, a tiering system for reserve remuneration and a new QE program. This dovetails with expectations that the Fed’s anticipated rate cut this week will set off a global easing cycle as other central banks follow suit in easing policy over the next few months.
Our baseline scenario is that the Fed will cut rates by 25bps later this week (a 50bps cut is also possible but less likely), and we see the subsequent series of synchronized monetary easing by global central banks being supportive of risk asset prices and further spurring yield-seeking behavior.
Of course, one major wildcard is economic growth. The risk is that the global outlook would suffer an increasing drag from the weakening manufacturing sector, but we see good odds that easing financial conditions from looser monetary policies will help stabilize business sentiment and capital expenditure ahead. Notably, there are some tentative signs in US June business spending indicators which hint at modest stabilization, for instance, durable goods orders rose 2% month-on-month, but it is too early to determine if this is signal or noise.
Uncertainty over corporate profitability also weighed on investors as we head into the earnings season this month following a significant downgrade in expectations. In particular, S&P 500 consensus estimates reflects a 2% year-on-year decline in 2Q earnings per share (EPS) but at this juncture this seems overly pessimistic: Over a third of S&P500 companies have reported earnings so far and, out of this sample, EPS growth is up 7% year-on-year.Disclaimer applicable to recommendation
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