Will The US Break The Hong Kong USD Peg?

Okay, very good morning. It's Wednesday the 8th of July. Really, 3 things I'm going to talk about in the briefing today. One is trade war, in particular focus on the Hong Kong dollar peg. Second is COVID-19, a quick update on that front. And then third, focus on the UK with Brexit talks and an upcoming important speech on fiscal stimulus from the Chancellor Rishi Sunak. So I hope everyone is doing well and ready for the day ahead. Don't forget as well that myself and the team are going to be doing a live webinar this evening starting at 5 PM London time. All you need to do is go on the link in the red in the description of this video and you'll be able to register for that. I'm going to be talking about risk management, a couple of examples, common mistakes, ways in which we try to get our traders to counteract that type of activity in order to have more consistent success with their trading strategies. So yeah, look forward to seeing some of you online later on this evening. But let's have a look at what's going on in markets. And from an overall cross-asset point of view, a little bit of moderate risk-off being observed going into the close on Wall Street last night and then holding kind of in a sense in the Asia-Pacific session. We'll talk about the, the dollar peg information or news in a little bit more detail shortly, but at the moment you can see that gold having been elevated on that pop back through $1,800 yesterday has held on to that in a fairly tight range in the overnight Asia-Pacific session, kind of restricted by yesterday's R2 and the overnight low at $1,804 at the moment. So we are down about $5 there, but as I said, still vaulting that 1800 once again in the futures at least. Comes with equity index futures lower close on Wall Street last night. Actually, the Shanghai Composite climbed for the 7th session in a row. Elsewhere though, in other parts of the Asia-Pac region, generally equities were a little bit softer following on from that US lead. So still a bit of this kind of irrational exuberance perhaps on the side of the state media pump that we saw getting that retail market kind of galvanized in the local market in mainland China still at play to some degree, and the market not being too fazed beyond that, the local market in Hong Kong, about some of this latest trade rhetoric coming out of the reports about the, the currency peg. So equity index futures are lower. The DAX then playing a bit of catch-up and down about 118 here in the center left. You can see this morning WTI crude is lower by about 22 cents. Not much in the way of a dramatic reaction, um, to, to crude after the API oil inventories last night. And, you know, from a longer-term daily continuation chart I'm looking at here, we continue to monitor the price quite intently as we, we are getting kind of squeezed in to around this $41 price point, which we've tested now multiple times. And that would be that level we were trading before the aggressive gap down upon OPEC's inability to strike an accord at the beginning of March. So it feels like oil at the moment just requires that catalyst to then get us through that level to break either way. And obviously the key components we'll be looking out for here really are dependent on COVID on the demand side and then OPEC on the supply side. That will be quite telling things to monitor going forward. Oil inventory, obviously data coming from the DOE later, whether or not that could be the catalyst perhaps, but it's got to be pretty spectacular because last night's figures weren't that dramatic. You had a build of 2 million, and if anything, that goes against the notion of then breaking that upside level that we were just looking at on that daily chart in oil. Expectations were for a draw, so a bit bearish on the headline. The gasoline number, slightly deeper draw, and just does a drawdown of 850,000 there. So So yeah, that was the oil picture, but generally it's following the sentiment, at least this morning, of being a touch lower with the equity movement being seen. And overall, a bit of a reversal, as you can see here in the NASDAQ on the center chart, of what has been a relatively seesaw week. Pushed higher on Monday, came back, pushed up to record highs again, and then a lot of people looking at those, those Bostic comments that we covered in yesterday's briefing. About how he's kind of, if anything, more typically a leaning hawk, but sounding quite dovish about the prospects of the US economy on the notion of second waves and the delayment of reopening of the economy. We've come back down again. And so that was why I really started with calendar as a main focal point to kick off this session, because if you remember back on Monday when I did the kind of look ahead for the week, this was one of my main parts of my routine that really is fundamentally key to the way I look at markets from what I do. And that is on Sunday, my forward-looking preparation for the week ahead, where I like to kind of visualize what that week might entail. And so I kind of plot in the key fundamental events. So not looking at every single data point like this calendar would suggest here, but looking at like, okay, what are the key 4 or 5 data points? What are the key meetings on, say, the Brexit front or the trade war? Or COVID and these types of things. And it gives me an idea then about the type of week that I can be expecting. And from a calendar perspective, this week is really dull, really quiet. And I think that leads to then this kind of a little bit of indecision which we've been seeing in these types of markets. So I think already before the week begins, you can kind of manage, if you like, your kind of approach, your expectation to try and harness then not overtrading, not not being too aggressive, not buying into these kind of trends that are going to be particularly sustainable given the market. If anything, I'd say we're probably due a little bit of a period of consolidation, particularly in the US equity market, after we've been quite rampant, obviously coming back up from very depressed levels. Um, but look, let's get our teeth into some of the main stories, and I'm going to kick off with the first one, which is— let me be clear here, It's not moving global markets right now. Would be quite interesting when the US come in because this is a big talking point, of course. But what I wanted to do here was just break down some of the key elements of this particular subject about the dollar peg and the fact that Trump aides are supposedly weighing proposals to undermine Hong Kong's dollar peg. And obviously this comes as the kind of evolution of the trade war. This is just another element, but potentially a very important one if we were to ever get to this point. Importantly though, as I said, if you look at global markets, they are little fazed. And I'm gonna show you a sequence of charts as well, domestically looking at a couple of different things in the options market, but also locally in the Hang Seng about why probably the likelihood of this actually materializing is very little. So I'll give my overall assessment after I actually explain the situation. So what have we got here? What is going on? Well, first of all, I guess, For those who are new to markets, you've got to understand that what is the purpose of a dollar peg in the first place? Like, why would someone like Hong Kong or China in fact want to have this? Well, a dollar peg is used to essentially stabilize an exchange rate between two key trading partners. A country that pegs its currency to the US dollar seeks to keep its currency value low, and that would make sense, right? For a country like China, which historically has always been an exporter and their biggest client or customer in this sense would be that of the United States of America, who are importing a lot of these goods. So what it does then, it gives people clarity, confirmation, a definitive level of which then they know that they can trade upon in terms of actual physical trade. And so that's why it exists. Um, what's happening here is the idea of striking against the Hong Kong dollar peg perhaps by limiting the ability of Hong Kong banks basically to buy US dollars. That's been raised as part of a broader discussion among advisors to the Secretary of State Pompeo and hasn't been elevated yet though to senior levels of the White House, which Bloomberg— a lot of this is coming from sources, so it's not official commentary— they're suggesting it hasn't really gained too much traction yet. It's just one of the options on the table as part, part of the course of the negotiation ongoing between the US and China. Apparently, the proposal faces very strong opposition from others in the administration who worry that such a move would only hurt Hong Kong banks and the US in itself, and not so much China. Again, don't forget that by having a stable exchange rate, the US is highly dependent on importing goods as well from China. So that could be almost self-harming in a way. Another person had cautioned that the idea of attacking the dollar peg is lower on the list of possible options now under discussion. Those ideas include things like canceling the US-Hong Kong extradition treaty, ending cooperation with Hong Kong's police, as well as another thing that's on the agenda. And to give you a bit of context in terms of numbers, the dollar peg is underpinned by about $440 billion US dollars of foreign exchange reserves, and Hong Kong has had its currency pegged to the US dollar since the year I was born, in 1983. So, a very memorable year, of course. One possible way for Trump to attack the peg, and this was an interesting snippet I saw from an analyst who was commenting on this this morning. So one possible way for Trump to attack the peg would be for the US Treasury to limit American banks from providing dollar funding to Hong Kong and Chinese banks, which would drive the cost for such funding higher. But this analyst went on to say it's unlikely because China could retaliate by essentially taking action against US assets. And obviously China is a phenomenally large holder and buyer of US Treasuries and also US stocks. Stocks, and it could also reverberate and destabilize pegs elsewhere, especially those maintained by the US allies in the Middle East. So you disrupt one, it's going to potentially have ramifications for all these other trade partners that they have, in particular those in the Middle East where they purchase obviously a lot of crude oil, for example, which is again very important for the United States of America. So a couple things here visually that I think are quite telling. Um, this is not something that I would typically look at, um, day to day. I don't really look at the options market a great deal, but what was quite interesting with this graphic was, look, we're encapsulating a period of time here, and we have the summer of last year up to the summer of this year. So we're looking essentially at the last 12 months, and what this is looking at is Hong Kong dollar risk reversals, which is basically a gauge of trader sentiment in the options market. And what you can see here is it's really little, little changed. I mean, it's pretty flat, reflecting a way lower probability of a peg break than during the height. The reason why this was so elevated and the risk reversal indicative of potential for large price currency swings— we're nowhere near that level. And that was promoted, if you like, this increase, by the ongoing unrest we were seeing with those escalation in Hong Kong protests at the time. So comparatively, what the options market would tell you here is that they're fairly comfortable that although this is being put on the table as a potential discussion point, that it is very far away from actually being at the point of being implemented. And, and before I give you my view and why I think that is a particularly important point, let me just show you two other things. This is the Hang Seng, the local stock index, of course, trading in Hong Kong, and it's been very volatile on the back of this, but net-net hasn't seen a great deal of movement. One bank in particular that has seen a bit of downside and worth keeping on— keeping an eye on at the cash open in the FTSE in the UK is HSBC. They do draw more than two-thirds of their pre-tax income from Hong Kong, of course, And they were down about 3% in local trade there domestically in the overnight session, so worth keeping an eye on them at the open. Um, the other thing then was, yeah, these bank stocks. So they have come— Standard Chartered is another one which has a high proportion of exposure in that region and would be more sensitive than other banking stocks, than most. So those would be two to keep an eye on as well at the UK open. But overall, um, you know, the point here is, as I was kind of alluding to, um, the likelihood of this happening is relatively small. And for me, this is more of that kind of political gamesmanship, the posturing of suggesting the kind of a more nuclear option, which is highly unlikely to be deployed. But from a Trump administration strategy It's one of those things where you just want to plant the seed that this is— look, sending a message to China that we would consider this, and that's almost serving its purpose in itself. I highly see this as unlikely that this would materialize, at least at this point in time or anytime soon. We'd need to see much more dramatic escalation at this point. And to be quite frank, going into a US election year, I think disrupting that dollar peg and the ramifications it would have on trade and on other dollar peg relationships around the world, as we were just mentioning about Middle East, I think this would be completely self-harming at a completely inappropriate time for Donald Trump. So I think for all the headline buzz that this is creating, I think it's all a lot of noise, quite frankly, at this point in time. I think that's why largely markets have been fairly sanguine about the issue for the time being. On the notion of China, I'm not sure if you guys caught it, but Eddie wasn't able to do a video on Sunday, so he kindly did one yesterday where he talked about TikTok. Now, I for one, probably a reflection of my age, I've never used TikTok, and quite frankly, I don't even know what it is until I— or was until I watched Eddie's video. But away from the social media and the comedic side of that platform, uh, Eddie did a really great video actually, and it was quite interesting hearing him explain how this kind of idea perhaps about the surveillance of China using that technology to watch them and obtain data and information, particularly on Americans as well as people based in, in Western Europe, and how this becomes a suspiciously time point of the year going into a US election, of course, and those connotations still lingering about Russia involvement in 2016 and, and so on. So check that out. If you go on the Amplify YouTube channel, you just basically need to scroll down. Eddie's got his own playlists where he explains these market concepts, and TikTok is his latest one, and it's definitely worth a watch. Very interesting. Um, elsewhere then, other headlines, you've got Brexit updates. So basically, Boris Johnson's warned Angela Merkel, the German Chancellor, that, look, we're ready to walk without a trade deal if the EU wasn't prepared to compromise. Now, I think this again, you know, I've quite enjoyed in a way how much more prevalent politics has become in financial markets. It certainly wasn't like this when I started back in kind of '06. And I enjoy it because I have to start thinking with a different kind of mindset where, you know, what politicians say, what they do, are very different things. And what they're trying to do is create a narrative and try to create a certain response from the public, from a popularity point of view more than anything. And so, you know, it's really interesting here with, with the pound and how it's been behaving. Yesterday, actually, the pound was outperforming forming. And obviously a lot of people scratching their heads about, you know, what's going on. There's still a lot of uncertainty. But, you know, for me, the, the passage of what was then a kind of major milestone, which was whether or not the UK would request an extension, which obviously they haven't done— for me, there's a little bit of breathing room here at the moment for these negotiations to go on. They're obviously continuing in earnest at the moment, and and talks are being accelerated. But in terms of milestones, it's really more the kind of autumn time when we're looking for a potential deal to be struck. So if I was Dominic Cummings, I'm not even gonna mention Boris Johnson, if I was Dominic Cummings, I'd be absolutely, let's play hardball. Let's say, look, we're ready to walk, and we go almost right back to the beginning again in the aggressive, assertive tone You know, a negotiation does tend, like any, to go in an ebb and flow. It looked like there were compromises being made, and now we go back to the hardball. And given a little bit of room to maneuver with that rhetoric, because the pound is trading quite, quite solid at the moment, if anything, despite the economic underlying situation, negotiations are still stuck on the same points really: fishing rights, the future influence of EU courts and UK law, how far Britain will be able to loosen its rules in order to better have access to the European single market. So nothing really has changed too much. The UK, what's being tabled is they'd be ready to leave the transition period, so the end of this year, on what's been classified as Australian terms if an agreement cannot be reached. And what Australian terms basically means is Australia do not have a comprehensive trade deal with the EU. So basically, much of EU trade goes through the main tariff rates of the WTO. However, there are some specific agreements tied to certain areas. So it's kind of a lesser— well, it's much more of a broad agreement where they've isolated a couple points rather than the more encompassing agreement that currently exists between the UK and the EU. So yeah, overall I would not be thinking short-term intraday that this is a real definable change in tone and that would make me want to be massively short the pound. That's not the case. This is just strategic political negotiation that's happening at the moment. The other thing, of course, that's happening today is, uh, Rishi Sunak is going to come out. He's going to take center stage. He's going to unveil a couple of new ways in order to promote growth in our country and obviously get ahead of the problem that things like the government's propping up of furlough schemes cannot last forever. So there's a couple of different things to be aware of that are likely to be announced today from the UK Chancellor, and one is a £2 billion program to pay wages for more than 200,000 young workers. Basically, it's going to be the centerpiece of a 3-point plan to protect, support, and create jobs. So, you know, the marketing machine again, that is Dominic Cummings in full flow with these keywords: protect, support, create. Um, is likely to resonate to a certain degree. Other things Sunak will announce is potentially a stamp duty holiday is being discussed for homes costing up to £500,000. That's being reported in The Sun this morning. The FT has reported considering a temporary cut to VAT to help boost the hospitality sector. However, there's been a little bit of mixed reporting about the timing around that specific point. And over the past week, to put this in context, the Treasury has outlined more than £4 billion of measures to promote jobs, skills, and energy efficiency. Johnson has also brought forward that £5 billion in accelerated infrastructure spending. The government has also outlined £1.6 billion bailout earlier this week to help struggling theaters and music venues which haven't been yet able to open because of social distancing. So there's a— again, a lot of just getting the checkbook out in order to really do two things: one, promote an economic recovery, and two, appear that you're being proactive in trying to do whatever is necessary to support the economy and people's jobs. So Yeah, more of that to come from, from Sunak today. All of this, of course, does mean that the Office of Budget Responsibility in the UK, the OBR, estimate that Sunak's efforts to support businesses and workers through this crisis will cost more than essentially £130 billion. That's already pushed national debt in our country to the size of the country's GDP, or above the size of the country's GDP, for the first time since basically the 1960s. So again, national debt above GDP for the first time, you know, in 50, 60 years. Although that's bad, remember how markets function. Markets, as intelligent as the people that may operate in the markets, you know, human irrationality suggests that we must confront and deal with the first and foremost debt danger, and that is we're in an economic plight at the moment. So as much as things like an overstretched budget, which is pushing national debt ever higher, is somewhat troublesome, maybe in the long term, in the short term, you know, the more they throw at it, the better is the short-term response if you're trading intraday markets or short-term price movement. How much of this announcement from Sunak is really going to move the market. I would say very little. The way that these types of events tend to unfold is, look, I've just listed you everything that's going to happen today, so we already know about it. And if there was any move to happen, it's already happened. So perhaps then some of the bump up that we had in cable was a little bit of a reflection of that. So if that were the case, then, you know, he's got to now deliver on what these press speculation has, has reported. On the COVID side, What's going on? Well, there's not really too many differences. Australia continues to be quite a focal point in terms of the rapid escalation that we've seen coming out of Melbourne. Uh, US still increasing, UK decreasing, and Europe fairly flat. So from a statewide level, yeah, it continues to paint the same picture, but equally so, there's the, you know, the kind of intensity around the kind of obsession with COVID has dissipated, I would say, to a certain degree, and it's almost like the markets have become more comfortable and started to price in the fact that, look, this isn't spooking us as it was only a few weeks ago, literally 1.5, 2 weeks ago. So these, these need to be monitored still, and I guess we're getting to the point like what we saw in this first official initial acceleration phase to eventual peak. Where does this second wave start to peak and when will be, will be quite key. So keep an eye out for those in the afternoon. But again, I think unlikely to be a real game changer as far as the intraday is concerned. So calendar for today, it is very quiet, as I've mentioned for the entire week really. Today and tomorrow, very quiet indeed on the fixed data front. So there's nothing really coming up this morning. And then you've got the oil inventories this afternoon. That's pretty much it. Speaker-wise, obviously looking out for Sunak in his fiscal statement later. De Guindos speaking, Vice President of the ECB, at 9:45 London time, and then a bit later on this afternoon. And then you've got a $29 billion 10-year note auction coming out the US, or the Bobble auction in Germany as well, for any fixed income traders. But look, that's it from me. Hopefully I'll see you online later this evening for our webinar. I'm gonna be joined by Sam and a few of the other guys, so I look forward to talking to you all in, in real time and fielding your questions. Again, the link for that, if you want to register, is in the description of the video. Okay guys, that's it. Have a good day ahead. I'll see you tomorrow.