The Trade Week Ahead - Counting the Cost

There is no greater example of the cost to global trade than the fallout from the US trade representative (USTR) Robert Lighthizer’s communique around the possible US$200 billion of additional tariffs on Chinese goods.

The 205-page document covered almost every Chinese export to the US that could potentially slap with a 10% tariff as early as September and showed that the trade war is now entering into a much more volatile stage.

Just look at reactions in the AUD and any commodity denoted currency for that matter showed that risk was to be dumped and for safe-haven buying to ramp up. US 10-year yields fell off the back of the news and the spread between the 2and 10 years narrowed again – further risk.

The risk-off trade has spread through FX markets rapidly of late and one expects this to continue in particular the decline in the EUR, AUD, NZD, and CNH showing just how reactive markets are to the White House’s current policy stance.

There is no winner from an economic perspective around protectionism, it has one outcome – higher pricing, lower consumption and therefore lower growth and it’s the impact on growth that is most regrettable considering the globe has finally recovered from the GFC.

The cost of the trade war has been highly prevalent in industrial metal pricing. The 15% decline in copper over the past month as the tit-for-tat rhetoric ramped up shows just how destructive this has been and could get. When you factor in that the underlying fundamentals have changed very little in the past 30 days the collapse in the price of both the LME and CME copper futures have you asking, is there a genuine issue here?

Part of that question should be answered this week as the synchronized global growth story will likely be seen in the China data of the week.

Now, the enacted tariffs will not feed into Chinese retrospective actuals for upwards of 12 months; however, China’s core activity indicators in retail sales, fixed asset investment, and industrial production may show signs of pressure. All of which is due for release on Tuesday.

Simultaneously to the activity indicators, China Q2 GDP is to be released. Now GDP will always remain the best economic gauge of a nation and consensus for Tuesday’s GDP release is for year-on-year (YoY) growth remain slightly ahead of the official estimates of ‘around 6.5%’ with the latest Reuters poll seeing YoY growth coming in at 6.7% is a slight decline from the previous quarter 6.8%.

However, if we deconstruct China’s GDP into the sub-categories (seen in the chart below) FX and indices trades are likely to be more attuned to the aforementioned activity indicators than the GDP release for the following reasons.

The granular level of GDP has shown a strong switch from ‘investment’ to ‘consumption’ which is why consumption indicators are becoming key. Retail sales in China are forecasted to come in at 9% year-on-year for the month of June a key fed for the AUD this week and would be a jump up from the previous few months. However, as the chart below show retail sales have been lax of late

However, it’s the industrial production figure in the top right pane of the chart above that is f most interest as it is one of the best indicators of Chinese growth and likely to drive FX trading this week.

Industrial production is a measure of all industrial output from China and is almost a pseudo-indicator for global consumption considering the worlds thrust for Chinese goods.

Industrial production, having bottomed out in late 2015 (excluding the GFC) has bounced solidly since this low and has truly ramped up as the synchronized global growth story of 2017 and early 2018 hit actuals. This has lead risk higher and can partly explain why emerging market currencies and the AUD have managed to remain elevated despite other macro backdrops namely US rate rises and US economic strength.

However, in the past two months, the synchronized growth story has begun to show signs of weakness and Chinese industrial production will be one of the first metrics to show strain.

The consensus for Tuesday’s release has industrial production falling to 6.5% from 6.8% and would be the low read of 2018. I see this as more influential to how the AUD trades this week and into the future than say the GDP release at the same time. Going forward as the trade war escalates industrial production will be coming even more influential to understanding risk trading and FX positions.

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