The market now has a wise owl

Summary

• Trade update — A patchy phase one deal.

• Fed update — Repoing what you sew.

• ECB update — Lagarde, the self-proclaimed wise owl.

• The UK election — Swift Brexit is in the cards.

• The week ahead — Uncertainty begone.

The US and China both agreed to rollback tariffs scheduled for December 15, although the details remain hazy, and the market remains skeptical.The phase one deal reduces tariffs on Chinese products and includes and agreement for China to purchase more agricultural products. It's important to note that the majority of the goods that are taxed will continue to be taxed. The 25 percent levy on US$ 250 billion remains, while the 15 percent tax on US$ 120 billion will be cut in half. In terms of agricultural purchases, China has committed to buying US$ 32 billion more in farm purchases over the next two years. That's an ambitious amount, given that the current amount sits below US$ 10 billion. The chart below shows the number of agricultural exports to China from the US.

As for intellectual property rights, the new deal doesn't address any of the issues directly, but Lighthizer, the Trade Representative for the US, mentioned that more effort would be put towards these issues. The market reaction reflected the lack of specifics around the deal. Bond yields spiked higher by nearly ten basis points, and stocks rise by almost 1 percent initially but ultimately pulled back during Friday's session. The reality is, the lack of transparency does little to reassure CEO's, which makes it unlikely that a deal will kickstart business investment. Without business investment, it's doubtful that we will see better data. For Goldman Sachs, the "skinnier" than expected deal essentially puts a cap on how high bond yields can go. With in mind, a "skinny" deal is better than no deal, and the developments surrounding the USMCA (new NAFTA) coupled with this deal are helping improve sentiment in the market. 

The Fed kept rates on hold by unanimous decision at their last policy meeting for the year, with the Fed dots suggesting policy will remain steady through 2020.The decision was consistent with Powell's notion of the economy being in a "good place" with policy remaining "appropriate to support the expansion." The labor market remains strong, and the economy continues to expand at a decent clip. The US consumer continues to wade the geopolitical storm of uncertainty, while business investment and exports remain weak. There aren't many inflation pressures to speak of, placing little urgency for the Fed to raise rates. Indeed, the latest inflation print came in above expectations for the second consecutive month but, with limited pressure from core inflation (inflation without food and energy) and average hourly earnings, the release will likely not impact the decision calculus of the Fed. Realistically, the Fed will have less to worry about with the main external risk (trade tensions) expected to simmer in the coming days. The biggest concern going into year-end will be overnight funding markets, where many analysts expect a similar, if not worse, event to the one witnessed in mid-September, where the Fed temporarily lost control of the overnight market. Regulations are at the heart of the problem, with banks brushing up against their capital requirements, making them unable to lend in the market. Many analysts are concerned that the current measures the Fed has put in place will not be enough for the market to remain within the Fed's target range. We should begin to see these pressures surface come Monday as businesses clean up their books going into the year-end balance sheet snapshot. 

As expected, the ECB left rates unchanged this week in a press conference that marks the beginning of the era of Christine Lagarde as the President of the ECB. The press conference was characterized by careful communication and, for the most part, was viewed as a freebee for Lagarde. The real challenge will come in the new year, where Lagarde will have to contend with a divided governing council amid a rethink of the ECB strategy (the first review since 2003). Although the details were far and few, it appears that the strategy review will take a broader approach, with an emphasis on incorporating the views of members of parliament. That suggests that Lagarde may very well be attempting to continue Mario Draghi's plea for fiscal policy to shoulder some of the burdens of lower growth. Many analysts equated the European macro environment to that of Japan 20 years ago, arguing that Europe is on its way to Japanesque growth. That does not entirely convince me, nor has it persuaded Lagarde, especially if she manages to work over officials and get fiscal stimulus in the bloc. Lagarde was also quick to flag widespread structural issues such as climate change, inequality, and technological change, which will invariably have broad implications for monetary policy going forward. As an example, understanding how financial markets will behave during extreme weather events will be critical to how the economy absorbs these shocks. Likewise, the effects of climate change on the labor force behave similarly to technological change in that climate change has displaced workers. Given that we don't have concrete tools designed to help displaced workers (apart from unemployment insurance) likely means that this problem will become worse in the future. All in all, Lagard's first press conference went, although she did refer to her self as neither a hawk nor a dove but rather a wise owl. Now that’s something the market was missing. 

The UK election resulted in a landslide victory for Boris Johnson, looking to be on course to score the most significant parliamentary majority since 2001. The victory all but ensures that Johnson's Brexit deal will be passed before the deadline on January 31. The lower political uncertainty should help boost equities while the British Pound has surged over 3 percent since the start of December. Clarity on the nature of Britain's exit from the UK should unlock pent up business investment. Of course, negotiations with the EU will continue and will mark the second phase of uncertainty. That likely means that the Bank of England will remain on hold until the long-term stance between the UK and Europe is locked in. A big question going forward will be who will take Governor Mark Carney's place when he leaves at the end of January and what policy stance will they make going forward.

With uncertainty surrounding Brexit and trade reduced, markets will now focus on the incoming data to get a grasp of how things are developing. In the US, eyes will be on the final Q3 GDP estimate along with some housing data and manufacturing surveys. The latest economic data for the US has been robust, but fears persist that the slowdown that engulfed the global economy has made landfall in the US. In other news, Canada will release inflation, retail sales, and employment data. Given the latest dip in employment data, market participants will be looking for signs of further deterioration in employment. The Bank of England is up this week and is expected to keep rates unchanged. GDP estimates for the UK will also be out and will likely show decent growth. In Europe, Eurozone, German, and French manufacturing survey data will be in the limelight and will help shed some light on whether growth has truely bottomed in Europe. 

Tiago Figueiredo