The latest testimonies of both the incoming and outgoing Fed chairs suggest that the FOMC's approach would be more the less the same after February next year. At his confirmation hearing before the Senate, Jerome Powell affirmed that future monetary policy would remain...
Although the selloff the euro as a result of a breakdown of Germany's coalition talks appeared short-lived, political instability in the country and the EU would remain in play for some time. We see four possibilities are present in the aftermath of FDP's walkout from the 4-week exploratory talks: 1 New election, 2. Grand coalition (a CDU/CSU+SPD Government), 3. Restart of the Jamaica talks (CDU/CSU + FDP+ Greens) or 4. Formation of a minority government by CDU/CSU with either the Greens or FDP. It appears that none of the above options is easier to be achieved as each has its own limitations and constraints. This report would analyze each of the four scenarios. Yet, assessing the likelihood of the scenarios at this stage appears premature as the developments remain fluid.
The House of Representatives passed its version of tax reform bill with a 227-205 vote. The outcome had been widely anticipated as Republicans control 240 out of 435 seats there. Despite the passage of the bill, there were 13 Republicans voted against it due to the dissatisfaction with the proposal to eliminate the deduction for state and local income taxes, although the deduction for property tax up to US$ 10 000 is preserved. Dissenters were mainly from high-tax states with 5 GOPs from New York, 4 from New Jersey, 3 from California and 1 from North Carolina voting against the bill. The House is presumably the easier hurdle for the tax reform bill due to the larger Republican majority.
Once again securing a super majority (two-third of seats) in the snap election on October 22, Japan's LDP/ Komeito coalition would continue to lead the lower house, possibly until 2021. The landslide victory indicates that PM Shinzo Abe would likely be re-elected for a third presidential term in the LDP next year, allowing him to push forward his political and economic policies with a stronger mandate. There are several reasons for the rally in Nikkei and USDJPY after the election outcome. Just like the previous elections we have seen before, the stock market and currency of a country usually weaken amidst of political uncertainty. Re-election of the ruling party has removed of uncertainty at least in the near-term. This bodes well for the stock market and currency. Unlike other currencies which tend to rise on lessened uncertainty, Japanese yen fell on diminished demand for safe-haven asset. Another reason for the rise in Japanese stock market and yen was expectations of lengthy monetary easing by BOJ. Meanwhile, widening US-Japan yield spread would also continue to support USDJPY in the medium term.
With no single party being able to secure over half of the seats in the parliament in last month's election, the right-wing, populist NZ First party has become a kingmaker. Its leader Winston Peters has just announced that his party would form a government with the Labour Party. Kiwi's sell off after the announcement as the outcome has not been quite priced in. NZ First had cooperated with both National and Labour previously (National/ NZ First from 1996 to 1998, and Labour/ NZ First from 2005 to 2008).
British pound's post-BOE rally has more than evaporated over the past two weeks. Political uncertainties and the lack of progress in Brexit negotiations are the key reasons driving sterling lower. Despite mounting pressure on PM Theresa May to step down, we believe it would be hard to materialize as there lacks charismatic leaders within the Conservative Party and the move might trigger a snap election and a Labor government. Progress of Brexit talks has remained slow. The next round of talk in Phase I would begin this week, amidst EU Parliament's overwhelming vote that previous talks has not brought sufficient progress. EU member states are due to vote next week to decide whether the talk can progress to the next phase. It is getting likely that BOE would increase the Bank rate by +25 bps in November. However, we do not consider this as the beginning of a tightening cycle as UK's macroeconomic developments remains fragile.
Volatility in Japanese financial markets is set to intensify as the snap election for the parliament (Lower House), scheduled on October 22, approaches. Our base case is that PM Shinzo Abe's LDP would remain the biggest party. He would continue to be the leader of the LDP/Komeito coalition in the new term. However, the rapid rise of the new party Kibo no To (Party of Hope), led by Tokyo Governor Yuriko Koike, might result in a decrease in number of seats for LDP. This, together with the decline in Abe's approval rating, has created much uncertainty in the upcoming election.
Despite government's violent intervention, Catalonia's referendum took place and resulted in an overwhelmingly "yes" to seceding the region from the rest of Spain. European financial markets' reactions are rather negative to the outcome. Euro's selloff accelerated in the European morning with EURUSD falling -0.7% at the time of writing this report. Spanish equities fell with the benchmark IBEX index losing over -1% in the morning session. Treasuries fell, sending yields higher. The 10-year Spanish government bond yields soared to a 2.5-month high of 1.68%. Spread between Spanish-German 10 yields rose to the highest in 3 weeks.
Despite the general perception that the German election would be a boring game, the outcomes contain several surprises and should drag the process of deeper EU integration. Angela Merkel's CDU and its sister party CSU have secured 246, out of 709 seats in the new Bundestag, marking a decline of -65 seats from the 2013 term. With CDU remaining the biggest party, Merkel will no doubt be the Chancellor for a fourth term. However, it is challenging for her to form a coalition government this time. Back in 2013, the CDU/CSU formed a Grand Coalition government, with SPD as its junior partner. This time, with SPD's number of seats sharply falling to 153 (down -40 seats from 2014), the party has pledged that it would head into opposition this time. Indeed, the SPD during the election period had been complaining about the loss of popularity after forming coalition with CDU/CSU. Yet, Merkel has asked Martin Schulz, SPD's leader, to re-think. The Grand Coalition is expected to be the best for the financial markets, providing the least uncertainty and most favorable for deeper EU integration.
While the final result would be formally announced on October 7 (due to the complex arithmetic of the mixed-member proportion system), the available information confirmed that the centre-right National Party remains the biggest party but would again be shy of being a majority government. Worse still, it would also be challenging for Nationals to form a minority government with consent of smaller parities. While many believe that the most likely result would be a Nationals+ NZ First coalition, it is not yet a done deal as it is still possible for NZ First form a coalition government with centre-left Labors and left-wing Greens. With plenty of uncertainties remains and the populist NZ First likely be a kingmaker in this term, New Zealand dollar got hit, losing over -1% against US dollar and Australian dollar.
Despite the comfortable lead of Chancellor Angela Merkel's Christian Democratic Union (CDU) and its sister party, the Christian Socialist Union (CSU), in polls, Germany, as well as the EU, would never be the same again after upcoming German election on September 24. Merkel is on the course to pursue her fourth, and the last term, as the Chancellor. Her party is unlikely to form a government without forming coalition other party(ies). While the Grand Coalition (CDU/CSU+SPD as the junior partner), just like the one we have had since 2013 and between 2005-2009, is the most favorable to the economy and the financial markets, it cannot be seen as a done deal.
The upcoming New Zealand election would be a tight race between the incumbent National Party and Labor Party. Polls of polls compiled by both RNZ and Stuff indicate that supports for both parties are at around 40%. Moreover, opinion polls have been suggesting that neither of the parties would be able to a government without forming coalition with smaller parties. This is such uncertainty that has increased the volatility of New Zealand dollar of late. This report compares the impacts of various scenarios on the economic growth outlook and the monetary policy, hence the exchange rate. We believe that maintain the status quo - a minority government led by Nationals- would be the most NZD-favorable, while a Labor + Green+ NZ First trio would lead to an immediate, but short-term selloff in the currency.
Korean peninsula tensions have escalated further as North Korea confirmed the sixth nuclear test on Sunday, following a missile launch over Japan on August 29. In response to the growing threat of its closest neighbor (and ethnic brother), South Korea has earlier today conducted a missile drill and pledged to implement contingency measures to stabilize the economy in case of drastic deterioration. In the US, Defense Secretary James Mattis warned of "massive military response" to North Korea's intimidation, echoing President Donald Trump's comment 'all options are on the table' following the rogue regime missile launch last week. While US' warnings imply that a military strike against North Korea cannot be ruled out, we believe the chance is low as it is the least preferred option for all major stakeholders.
US President Donald Trump's renewed threat to withdraw from the North America Free Trade Agreement (NAFTA) reminds us that renegotiation of this 23-year-old deal has begun. While the US has accused Canada of both lumber and dairy trades, its focus is more on Mexico with Trump keeping demanding its third trading partner to pay the bill for construction of the wall along the border. In our opinion, the core of NAFTA renegotiation is to narrow US' trade deficit. With US' trade deficit with Canada on the fall, it would put harder pressure on Mexico in the negotiations.
After breaking several technical levels, New Zealand dollar looks vulnerable to further fall against both Australian dollar and US dollar. We believe the selloff over the past few days is driven by several factors, including weakness in soft commodity prices, unwinding of net speculative long positions, government's GDP growth downgrade and uncertainty in the upcoming parliamentary election.
Brexit negotiations return to the driver's seat as the third round of talks in phase one (withdrawal terms) is set to begin in the week of August 28. Last week, the government, facing criticisms of its lacking preparation, released the policy papers on future customs arrangements, and Northern Ireland and the border with Ireland. The UK's positions, in particular the customs arrangements, triggered criticisms and are expected to delay the completion of the first phase negotiation, limiting the time for the second phase (trade issues). British pound has remained under pressure recently, with GBPUSD hovering around a one-month low and EURGBP firming around the highest levels in 10 months.
The broad-based selloff of Swiss franc of late has raised speculations of renewed SNB intervention. Yet, the latest release of FX reserve and sight deposit data suggest that it was unlikely the cause. We believe franc's depreciation, especially against the euro was mainly driven by yield differential as the ECB is approaching tapering of its asset purchase program while the SNB maintained the pledge to fight against deflation. EURUSD soared over +4% over the past two weeks while USDCHF gained about +3% during the period. The recent risk-on mode in the financial market has also raised franc's appeal as funding currency, thereby exacerbating its decline.
An increasingly provocative North Korea is testing the limit of US' patience. Following another test of ICBM missile last Thursday, US President Donald Trump has accelerated sanctions against the hermit Kingdom. He has also pledged to give China a difficult time on trade amidst the latter's lack of pressure against North Korea's nuclear developments. Although intensifying geopolitical tensions might increase volatility of the financial markets, we believe the chance of war remains remote as the provocations-sanctions-negotiations process is indeed a routine of the Korean Peninsula problem over the past decades.
With 98% of the vote declared, PM Theresa May's Conservative Party would remain the biggest party with over 300 seats in the Parliament. However, Tories would highly likely fall short of majority. The disastrous scenario in our previous report materializes: A hung parliament is now inevitable. Yet, unlike the situation in 2010, Tories would find it very challenging to form a coalition government with other parties. The snap election not only has resulted a reduction in number of seats for Tories, but also has scrapped their majority status in the Parliament. This would only make the Brexit negotiation with the EU more difficult, even if Tories managed to form a coalition government.
Geopolitical uncertainty in the Middle East lifted Australian dollar. A boycott over Qatar is expected to disrupt the country's exports, benefitting its rival, Australia, over LNG exports. Aussie, however, retreated on 'Tuesday, using RBA announcement as an excuse. The central bank reiterated that the global economy continued the "broad-based pick-up", suggested that the domestic economic transition from mining investment has "almost complete" and maintained a neutral tone on the monetary policy. Yet, it remained concerned that low household income growth would constrain consumption. We are skeptical over RBA's forecast that Australia's economy growth would reach+3% p.a. and cast doubt over how long it can refrain from cutting the policy rate further so as to prevent the property bubble.
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