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VIX collapses to long-term mean indicates return of market bulls

VIX virtually collapsed on Tuesday, dropping by 17.28%, indicating how quickly the volatility sellers took up their usual business, betting on halt of the storm in the US stock market. Why invent something new if there is statistical arbitrage and mean-reverse strategies that still work? Now the index is close to 15 level long-term mean level, hovering near 17 points.  The relief came after the release of corporate earnings data in the US banking sector (beating forecasts) and the industrial US figures where expansion continued in September.

The three major Wall Street indices won back almost 2 percent on Tuesday, after the largest banks in the United States reported an increase in profit ahead of expectations. The profitability of the banking sector is now on the rise due to increasing interest rates, which allows to hike borrowing costs for the firms, while some liabilities have been benefiting from past low interest rates. As a result, bank profits are growing.

Data on industrial production in the United States indicated an increase in output for the fourth month in a row. Rumors have been swirling around the input costs, mainly rising oil prices, as well as tariff cap on export prices. The growth led by manufacturing and mining industries, but the growth momentum waned in 4Q. In October, the growth came at 0.3% after rising 0.4% in September. Export prices for US industrial products remained relatively flat in September, while oil imports advanced by 3.5% in the same month. Here we see the direct link between compression of corporate margins of “energy-intensive” industries and widening gap between export and import prices and the inability of producers to transfer inflation to final prices for external consumers.

September Fed minutes are due today later, which will once again help to assess the trajectory of the interest rate. Dollar and other relevant assets’ response is likely to be muted, because after Powell’s remarks on the pace of rate liftoff, a soft tone in the protocol, to put it mildly, would be inappropriate. Because of the Fed’s confidence in its policy course, the search for bearish hints will most likely be unsuccessful. The chances of a rate hike in December remain at a fairly high level, about 80%, so for the recent pullback in the US market it is difficult to find a more elegant interpretation than a “brief loss of consciousness”.

There is another view which says that the market has a vision of US economy growth diverging with the Fed’s one, but this view should rely on something, at least on fundamental data. While the key parameters of the American economy and corporate reporting does not give cause for disappointment.

UK wage growth data helped the Pound to strengthen yesterday, but today it can give up the territory if consumer inflation goes below the forecast. Although the effect of inflation can be interpreted in two ways: on the one hand, weak inflation and strong wages give rise to a combination of increased consumption, on the other hand, we should expect the Bank of England to delay the increase in interest rates in order to support expansion. Consensus view on the impact of the data is not completely clear. It will be useful to look at retail, production and import prices to clarify the prospects of consumption.

Regarding the European currency, its further movement can be determined with the release of consumer inflation in the Eurozone for September today. This will be the final data, which will most likely indicate a lack of change, with a key indicator at 0.9%. Together with fuel prices, inflation can accelerate to 2.1%, which of course has a negative effect on European manufacturers. Unlike US companies, they can only count on external demand, as domestic consumption remains weak. After yesterday’s weak indicators of optimism from ZEW, it is difficult to expect a positive surprise from consumer inflation. Therefore, in my opinion, short positions in European currency remain preferable.

Gold prices extinguish a jump in panic, as the rollback of US stock indices, stable expectations at the Fed rate, raise the issue of the asset returns. Yesterday, gold was supported by the comments of the Chinese Central Bank, which stated that the Chinese economy is in “good shape.” Prospects for the growth of defensive assets, including gold, remain unclear, especially against the background of a rapid recovery of sentiment in the stock market, therefore shorts with a target of $ 1,210 – $ 1,215 are preferable.

 

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Oil prices fall as Saudi Arabia assumes a dominant role in energy market

 

Sanctions on Iranian oil and the risks of political isolation of Saudi Arabia after the murder of a journalist have created a ground for reflection about the supply shortage as a new, permanent reality. On Tuesday, Saudi Arabia once again tried to halt the development of such rumors, saying that it completely feels and acts as a stabiliser on the oil market. Moreover, according to the oil minister, the kingdom is about to increase its exports of crude oil in response to a decline in Iranian supplies and will continue to expand its reserve capacity.

 

Oil prices dropped on the statement, with two major grades depreciating unevenly: WTI dropped 1.6% at the time of writing, while Brent lost much more, about 2.4%.

 

Different amplitude of decline allows to establish cause-effect connection between comments of the largest producer of OPEC and the reaction of the market to them.

 

Washington’s sanctions against Iranian oil enter into force on November 4th. Several US allies in Asia, for example, South Korea and Japan, have already struck Iran out of the list of energy suppliers. Already in September, the import of oil from Iran to South Korea was 0, showed the data of the national oil corporation of the country.

 

The Halliburton report, a company serving oil companies, pointed to disturbing trends that are developing in the American oil market. According to the report, in the fourth quarter production volumes on the mainland will go down due to congestion of pipelines in the Permian basin. Due to physical constraints, the pace of production will remain insensitive to price fluctuations, including favourable price moves for producers. The demand for Halliburton services as well as the Schlumberger, according to their own forecasts, will remain moderate, reflected in profit forecasts that didn’t met expectations.

 

Oil production in the United States faced limits in the summer of this year, when the hydrocarbon production pace reached a record level of 11 million barrels. The introduction of new production capacity is slow, firstly, because the US oil companies have accumulated large debts during the low oil prices for 2014-2016 and need to pay them off, and secondly, it is unknown how long will continue the phase of expansion of the world economy (which will provide a stable demand) Thirdly, the strategy of the main competitor (i.e. OPEC) may change from stabilisation measures in favour of the regular competition for a market share, since production quotas have already done their job.

As can be seen from the outlook of production in the US, 50% of which is shale production, it is already less actively overcoming past highs, fluctuating around the level of 11 million barrels.

 

It is interesting to trace the change in the futures curve as a result of sanctions on Iranian oil and lagging growth of OPEC production needed to compensate for the decline. Most of the cartel’s contracts are on spot market, and the shortage because of Iran should ideally have a greater impact on spot or near-term contracts. Recall that Trump reintroduced sanctions against Iran in early May.

 

From the chart, we can see that the futures delivery in July was about $ 72 a barrel, and in October, the futures for the same delivery was just over $ 80. Moving to more distant terms of deliveries it is clear that the difference between the purple red line is getting smaller and is quite insignificant on the futures with delivery in 73 months.

 

From this, we can conclude that despite the various political backgrounds in purchasing / refusing to buy Iranian oil, sanctions against Iran really “work” and supply has really diminished. At the same time, OPEC is in no hurry (or cannot) increase supplies with the same pace to compensate for Iranian barrels. Today’s announcement by Saudi Arabia of its intention to stabilize the market has, of course, become an unpleasant news for those who have made a bet on widening market deficit.

Looking at the Commitment of Traders data, the link between speculators’ bullish bets and real growth in oil prices disappeared at the end of the second quarter of this year, which is rather unusual.

 

From September last year until April 2018, the recovery of prices corresponded to an increase in long positions of speculators (brown lines). However, starting from April-May this year, speculators cut long positions, possibly wagering on falling prices, but the market continued to grow. The net long position of traders for the period under consideration decreased from more than 700K to less than 500K. That is, it turns out that prices could pull up not on speculative pressure, but due to fundamental shifts, while high uncertainty could make speculators even mistaken.

 

Now focus is on Saudi Arabia’s policy of increasing production. If the increase in production is less than necessary to compensate withdrawal of Iran from the market, then oil will have all the chances to extend gains, despite the weak start this week.

 

 

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China offers little help to solve bad bonds problem, aiming at deflation of the credit bubble

Respite on the Chinese stock market has quickly run out of steam after a pledge by the Chinese authorities to solve the trouble with bad private bonds.Respite on the Chinese stock market has quickly run out of steam after a pledge by the Chinese authorities to solve the trouble with bad private bonds. According to the latest data, they are relatively reluctant to directly participate in the rescue of firms, although in 2016 everything was different.

On Monday, a “recommendation” to private funds was followed to take part in the bailout of troubled shares that companies used as collateral for loans. 11 brokerage firms have agreed to allocate 21 billion yuan to buy shares, which is basically a drop in the ocean of 3 trillion. yuan of toxic loans, which are now collateralized by a falling stock market.

The government was not ready for anything more than putting some straw in the landing spot, what is surprising, as the private sector provides 50% of taxes, more than 60% of GDP, more than 80% of urban employment and 90% of new jobs created.

Perhaps the government bets on recovery of credit system with manageable credit bubble deflation (“defaults will start from most inefficient and high-risk which is good”) but at some point, may meddle with the process is something goes wrong.

But repairing consumer and corporate sentiments after the downturn of economic expectations is usually much more expensive and longer.

The situation is very similar to the 2008 crisis in the US, but instead of “share”, put the word “housing market”. The Fed has come to the rescue in the US, but in China, PBOC will only have to start carrying the can. While the Central Bank is focused on the banking system and the support of the manufacturing sector, which is rapidly losing pace of growth due to disrupted trade ties with the United States.

China, though, can’t fully deploy the mechanism of increased consumption to support the economy, despite the growth rate of imports overtaking production. Weakening yuan worsens the outlook for accelerating imports.

Here is the data that gives some clue on pledges shares problem in China:

·       724 out of 734 technology companies of ChiNext resorted to equity financing practices. The market capitalization of companies is about $580 billion. Since the end of May, the index has lost more than a third – from 1876 points to 1205 points.

·       16 percent of the “A” class shares are pledged as collateral for loans. In 2015, this share was 10.3 percent.

·       In the broad market, 148 companies out of 3,571 have pledged more than 50% of their own equity loans, despite a 50% legal limit, thanks to shadow banking. (data from a national Chinese depositary).

·       On October 9, value erosion of shares is close to margin call for 780 companies. Positions of 594 companies are approaching forced liquidation, i.e. the time when it comes to paying for loans.

Comparing the drop of the Shanghai Composite Index and ChiNext, the difference in the fall may be precisely the difference of risks from using financial leverage, which is higher in the technology index companies.

ShComp keeps solid footing after a bullish Monday, although closed today in a modest plus. A sweeping fall below 2,500 is unlikely to happen for some time, the index will mark time at the crucial round level. It is impossible for now to mention any essential drivers for upside correction though.

A few words about the past US treasury bond auction. With a progressive increase in placement ($26 billion per one auction in January against $38 billion at the moment), demand for paper remains high, the bid-to-cover ratio was at 2.671, against 2.437 at the last auction, slightly below the 6-month average at 2.75.

What’s really curious is a sharp surplus in favour of indirect bid. Their share amounted to 52.6% in the auction, the largest since December 2017, against 40% last month. Direct buyers, something “scared off” this time their share fell to 5.5% versus 13.4% last month.

Recall that indirect applications are mainly represented by foreign buyers acting through US intermediaries.

The main idea here is that demand for a risk-free security asset has increased from foreign demand. Definitely this trend is guided by the expectations of serious market turbulence ahead.

 

 

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What is a buyback blackout period? Can anything bring the US stock market back to life?

Photo 1.

The blue line signifies the yearly change in the balance sheets of world central banks. In other words, the waves on the chart are injections of money supply into the economy, i.e. cyclical swings from easing to tightening. Amazingly, every time the yearly change reached zero, central banks resumed buying assets in response to economic challenges.

Now that the Fed is in the midst of tightening policies, the ECB is suspending paper purchases, and the Central Bank of Japan is looking for ways out of the vicious circle of deflation, the world economy may again begin to dictate the need for soft policies, and the first signals for this have already been given. Take, for example correction in the US stock market.

10 years of relentless rally turned into a bloodbath in October. Now only 20% of global assets left investors with positive gains. The rest became uneconomic investment:

Photo 2.

This chart well explains the current strengthening of the dollar, as a humdrum surge in demand for liquidity. That is, now, assuming an overreaction in the stock market in response to the high pace of tightening by the Fed, which goes beyond the fundamentally justified level, there is a certain “panic” bias in favor of liquidity (i.e., the dollar). It can be eliminated as quickly as it appeared with the first signs of calm returning to the stock market. We have to keep this fact in mind, and on the basis of this, shape appropriate expectations for a rally of the American currency.

History knows only two times with similar observed “lack” of yielding assets: during stagflation in the United States in 1970 and the financial crisis in 2008. That is, in conditions which were much worse than the current ones. Then, from the historical point of view, the irrationality of the depth of current selloff is the most plausible version of what is happening. On the other hand, if mushrooms grow after rain, no matter how fertile the soil is, it is pointless to wait for them without rain.

Cheap credit has long dominated the minds of investors, and after parting with it, the vacant place is not so easy to fill.

However, there are several suitable candidates for nomination. The first is a stock repurchase. In one of my September notes I mentioned that in October, companies should have to face time constraints in stock repurchase transactions (buyback blackout period). It was introduced as a measure to counteract the asymmetry of information between managers and shareholders, which reaches its peak a week or a few days before earnings data is released.

A party with more access to sensitive information, i.e. managers, is reasonably in a better position when it comes to buying/selling shares before reporting day. For example, a company, knowing that earnings will beat estimates, may urge investors to sell their shares of the firm, thus putting investors in an unfair position. Conversely, if managers believe that reporting will upset investors, they may try to get rid of stocks at a still high price before the data hit the wires.

Blackout period has passed its peak and companies will most likely resume purchases, which have been fueling growth of the stock market to considerable extent:

Photo 3.

Conventional wisdom is that growth catalysts which are clear and understandable to investors should be well covered in the press and also stir attention among investors. It does makes sense and let me show you an example. Here is a growing buzz in media and some data from Google Trends:

Photo 4, 5.

Now, about candidate number two. This is of course the aggregate demand in the American economy and all the indicators relating to it. You can pay attention to the Friday row of economic data, including Core PCE, consumer optimism and producer prices. The main conclusion is that imbalances in the US economy are likely to become more evident:

Photo 6.

Consumption and GDP growth outpaced forecasts for the third quarter, but inflation, measured through personal spending, stubbornly remains low. Its growth in the third quarter was only 1.6%. In conventional economic model, an increase in output is usually accompanied by an increase in prices, but the data indicates the opposite.

The only explanation that comes to my mind is a combination of the effects of monetary and fiscal policy. Tax reform better targets the consumer, giving him not just the opportunity to get a cheap credit (as in the case of monetary easing), but a real increase in disposable income. This caused an increase in consumption with some inertia, which we observe.

At the same time, the tightening of the Fed effectively restrains inflation by holding back plans to expand output. The survey indicator of future capital spending in the US manufacturing sector has been declining 6 months in advance since the beginning of this year:

Photo 7.

So does growth really keep solely on tax maneuver? Candidate number “two” for supporting stock market rally should be considered transitory?

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

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Mid-term elections keep global markets in suspense

The index of economic activity in US manufacturing and services sectors came at 60.3 points in October, beating the expectations of 59 points. In September, the indicator hit the local peak at 61.6 points showing that companies are facing a surplus of new orders, as well as a shortage in labor force. The leading nature of the data generated through surveys suggests that companies will likely increase output, as well as maintain high employment rates in November.

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The dollar is trading in a narrow range against major opponents on Tuesday, as caution dominates the mood and risk appetite with the midterm elections in the US being held today. The American nation will decide whether they like the combination of huge tax cuts and the hostile trade policy of the current administration. The average market outlook assumes that Democrats will take control of the House of Representatives, and the Republicans will remain with the Congress.

Trump’s policy largely explains the strong dollar that we are seeing now, so the outcome of the elections will likely be interpreted by investors as follows: if the Republicans succeed in defending the House of Representatives, it will be a big bullish surprise for the dollar and it will have to shoot up; if the Democrats gain control of the House of Representatives, then the dollar will be traded in the red zone for a while.

The loss of control over the House of Representatives will make it difficult for Trump to carry out large-scale reforms, including the tax reform “for the middle class”, which may further increase the budget deficit by $2 trillion for 10 years. The confrontation with China may also lose some color, as supporters of liberal trade Democrats will not allow the increase of protectionism, for example, through the introduction of duties on all imports from China.

The European currency remains under pressure, as the EU’s appeals to add modesty to Italy’s budget expenditures for the next year did not bring results. The deadline for a deal is set for the next week, but the absence of leverage on populists allows us to expect that the decision will be either postponed or come at the expense of concessions from the EU. Unfortunately, European diplomats cannot object to the manipulation of EU membership by Italy, so they will probably be forced to accept their conditions.

The Australian Reserve Bank made the widely expected decision to keep the rate unchanged (1.5%). Most investors believe that the cost of borrowing will remain at 1.5% at least until the middle of 2019. AUD responded weakly to the decision and even strengthened slightly against the dollar. The RBA has no incentive to raise the rate now, as in the real estate market, a problem issue for the Central Bank, there has been some cooling, so the course to stimulus is likely to be maintained without any particular risks.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

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Strengthening of the Democrats sends relief waves over the US stock market

 

US Congress elections were deemed as the main source of “headwinds” for Trump’s somewhat reckless policies, so the market was in no hurry to make guesses on the long-term consequences of the president’s threats and initiatives, betting on the temporary freedom of White House’s power. The division of power in the United States between the two rival parties happened according to the baseline scenario: The Democrats won the House of Representatives, while the Republicans retained control of the Senate.

The strengthening of power in the hands of the Democrats identified a bearish outlook for the dollar, which has been extending a signal for rally from the contradictory chain of relationships between US tariffs and the Fed’s actions over the course of the last three months. Today, the US dollar index lost about 0.2% after a short rally in Tuesday’s session.

Restoring the balance of power clearly promises to delay the war with China, as Trump will have to overcome the additional resistance of opponents and spend more time on the next steps to escalate the conflict.

The dollar could be supported by the Fed on Thursday. Tomorrow, Powell will announce the interest rate decision, but it is likely that during the press conference he will repeat the mantra about the benefits of raising rates to preserve the historically rare state of the economy (low inflation & low unemployment). It will be curious to see the opinion of the regulator about the recent market correction, in particular, how positive feedback can influence the Central Bank’s plans to raise the rate.

In my opinion, since the plans for the long-term bear market have failed and the S&P 500 is targeting the main resistance at 2800, the chances for the Fed to slow down become even smaller. According to some estimates, the fall to 2400 could be a trigger for the Central Bank, but with a distance from dangerous levels, one should be inclined to favor a bullish interpretation of the decision on Thursday.

Tomorrow there will be a whole series of data on China’s foreign trade (export / import / trade balance), which will probably confirm the recent decline in production rates and a slowdown in export activity.

Since the economy has clearly entered a phase of slowdown, the data will probably be interpreted on a scale from “neutral” to “negative”. Unfortunately, there is no chance to talk about positive economic reports now, as structural imbalances in the economy do not have the possibility for a quick elimination and the indisposition may be prolonged. Data on foreign direct investment will probably be able to save the mood. If external support from investors beats expectations, we can expect the leveling effect of this indicator on foreign trade readings.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

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Consumption slack adds to Chinese problems; industrial data beats estimates on fiscal support

The data on Chinese economy released today offered a mixed impression about the government’s attempts to fix inefficiencies and ease recession risks. Slowing retail sales was unexpectedly countered by uptick in industrial output and investment in fixed assets which is quite surprising and worrying at the same time.

Together with the data on loans that were released yesterday, Wednesday figures suggest that economy conditions will continue to degrade at least until the end of 2018, since the government was a bit late to come up with stimulus measures.

The authorities have increased fiscal support for the manufacturing sector and the population (through taxes), while reducing monetary support, thus avoiding direct pressure on interest rates and weakening the yuan, which in turn leads to capital outflows. The number of fresh loans issued by the banks fell to 697 billion yuan in October, from 1,380 billion in September, i.e., almost halved. The tightening of credit conditions was priced in the market, but at a less rapid pace, at about 904 billion yuan.

The growth rate of money supply (aggregate M1) slowed down to 2.7% in annual terms against a 4.2% forecast. The solid signal about shrinking money supply failed to provide substantial support to the yuan, which oscillates in a narrow range around the level of 6.94 per dollar. However, the intensity of the outflow of capital seems to have weakened, since the clear impulses upward in the intraday movement have not been traced since the beginning of this week.

One of the key prospective pillars of the Chinese economy is a huge untapped potential for consumption, while it does not allow the authorities to rely on it yet, since it functions poorly in “stressing conditions”. Domestic consumption, which has grown at an accelerated pace since recent times, slowed in October. Retail sales, a less elastic economic indicator to the decline in household income, (unlike, for example, durable goods), slowed down from 9.2% to 8.6% in October, the lowest since May of this year. The prolonged decline in car sales in China has put the world’s largest car market on the verge of downturn for the first time since 1990. Sales of garments reached a two-year low, indicating a decline in consumer optimism.

Reduction in consumer spending could be explained by several reasons, such as mortgage debt, which requires an increasing proportion of income, falling welfare due to a decline in the stock market and declining return on investments. Tightening access to credit financing (as we see from the data on new loans) makes it difficult to smooth fluctuations in income.

The state’s fiscal support in the form of tax cuts on cars, imports, and an increase in income tax from 3,500 to 5,000 yuan may have arrived a little late, and deterioration in consumer confidence has led the population to save more and spend less.

The government has so far managed to “hold onto” the falling production, what we see from the data today. The pace of industrial output rose to 5.9% in October, contrary to forecasts of a slowdown to 5.8%. Positive economic figures are diluted into the fears of escalation of the trade war with the US. And recovery of the Chinese industrial sector is unlikely until the “war” with the US is not over. Recent data on US export orders for Chinese factories pointed to a 30% decline in annual terms.

The state is increasing its market participation as key client, focusing on infrastructure projects. For example, production of cement in October jumped by 13.1%.

The forward-looking indicator of investment in fixed assets rose unexpectedly in October, although it is unclear whether this indication came from the Administration (again, thanks to the “guarantees” in the form of infrastructure projects) or the corporate expectations really turned out to be more resilient than consumer ones. The main indicator rose by 5.7% in October against expectations of 5.5%, while investments in the private sector grew by 8.8% in annual terms.

SHCOMP was not impressed with the economic data, rolling back almost 1% on Wednesday to 2632 points.

In the UK, labor market data showed that the economy is recovering at a moderate pace. Salaries rose in line with expectations, while quarterly changes in unemployment were worse than expected. The pound is entirely absorbed by the events of the Brexit, with development being shrouded under a “three-layer fog” of speculations that benefit traders and algos. The political deadlock in which May’s conservative party found itself once again allowed GBPUSD to play below 1.29, but yesterday and today the pair is recovering in response to economic data and speculation about the progress in the negotiations.

One of the latest encouraging phrases of the Prime Minister was that “negotiations are in the endgame,” and the fact that the “Brexit draft has been agreed”, although it’s not the first time that such promises are coming out of the mouth of officials. GBPUSD is likely to linger at 1.30, as it is a convenient point to bet on a favorable Brexit outcome.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

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US Pence and Xi crash hope for peaceful resolution of US-Sino trade spat

 

For two consecutive days at the end of last week, the US stock market was in high spirits while expecting a thaw, which is likely to be the outcome of the upcoming meeting of Xi and Trump at the G-20 summit. The corresponding news background began to take shape after reports that the chief hawk in the White House, trade relations Robert Lightizer, does not expect new tariffs, and Trump may change his mind about introducing new ones, as Chinese colleagues sent a telegram with the planned concessions.

 

Hope was dispelled at the APEC summit in Papua New Guinea, where Chinese leader Xi and vice president of the United States, Mike Pence exchanged barbs, which only stressed that no country was going to give up the struggle for trade advantages.

 

The old wording of Xi, that the introduction of tariffs and thus the disruption of the global supply chains is a short-sighted decision and doomed for failure, caused applause among those present. Pence responded by saying that the United States would not retreat in a trade dispute with China and could even double tariffs if Beijing did not properly consider the issues that are the essence of the dispute, i.e. closeness of the economy and the theft of intellectual property.

 

As a result, Pence stated that there are no clear deadlines for resolving the dispute, dooming confrontation to an economic survival game.

 

Futures on the S&P 500 fell on Monday morning, indicating a weak start on Wall Street, as the market’s expectations of progress in the negotiations were not met. Markets put low expectations on Trump and Xi meeting in Buenos Aires, which need to be taken into account, because the positive outcome of the meeting can greatly encourage the market.

 

Dollar positions were somewhat discouraged on Friday after several Fed officials warned of risks to the Fed’s tightening policy. Richard Clarida and the President of the New York Federal Reserve Bank John Williams began to enter the discussion “from a distance”, expressing concerns about growth in Europe and China, but avoiding mentioning any warning signs related to the domestic demand. According to them, the external economic situation is of great importance in the US growth forecast.

 

US 10Yr Treasuries rebounded on the comments, the dollar is looking for a point to renew growth, but without success.

 

This week, the completed draft Brexit will be presented to colleagues in Brussels (deadline is 25 of November), but Prime Minister May faces strong resistance from both party colleagues and Labour Party, whose support is only growing. May warned that leaving the EU could be postponed again. Pound price action will depend on the verdict of European diplomats, but the final trend is likely to be determined only next week.

 

Remarks of the BoE officials tomorrow may also have an impact on the Pound, but it is unlikely that they can say anything definite when the status of England in the EU remains in question. Neutral language is the most likely scenario, so you could expect the Pound to remain dependent on political headlines.

 

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

 

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Why Bitcoin is likely doomed to fail

 

The cryptocurrencies’ market cap fell by $60 billion in less than a week, after another Bitcoin mini-crash gave start to widespread rout.

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The rapid liquidation of cryptocurrency portfolios has resulted in other major assets, such as ETH, LTC and XRP, falling in price to the lowest level since December 2017. At the time it was suggested that behind the world’s bet on revolutionary technologies there was only a cascade of speculative transactions and hunt for easy profit.

Last night, the BTC fell to $ 4,237, its lowest level in the last 13 months, then stabilized at about $ 4,500 on Wednesday. From the point of view of basic technical analysis, the main support for Bitcoin can be found at the weekly 200-moving average (200-sma) at the level of $ 3130.

The level of $ 3,130 may be the last big fortress for bulls to fight back. But if it fails, it will become clear that the speculative bubble has passed into the terminal stage and long-term shorts will likely be the major play.

Low BTC volatility, prompt calls on the dips and various rally attempts have created the impression for a stable market for a relatively long time, however, the looming storm was indicated by the market capitalization that does not include Bitcoin.

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Since May, the market has steadily lost in volume, and over the past two months, the pace has slowed down, which has restrained gloomy sentiments. In addition, large stock exchanges such as Binance cut off the connection with fiat currencies, therefore Bitcoin served as a kind of internal fiat (protective asset) and at times of rout of other digital assets it naturally strengthened in price.

It’s funny, but such a restriction created a transactional demand for bitcoin (demand as means of payment), while other cryptocurrencies performed like goods in our ordinary economy. The only problem is that over time awareness has grown that most of them have neither consumer nor investment value. But the idea or the forced measure to close the cryptocurrency system and make it a real and independent digital economy, with its goods, extended its life for some time.

Cold calculation

Interestingly, despite the stabilization of the price of Bitcoin in the summer at around $ 6,000, the complexity of mining continued to grow. There is evidenced that the hashrate began to decline only in October of this year. In other words, mining efforts increased, while increasing the natural supply of Bitcoin, albeit at a falling rate.

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Since mining has operational costs (electricity, air conditioning, etc.), with BTC price stuck in tight ranges and increasing complexity, mining should remain profitable until marginal revenue equals marginal costs. That is, until the moment when the next mined and sold bitcoin will not cover the costs of it.

As envisioned by Satoshi, the mining infrastructure of the miners was to become the technological basis for processing the transactions for which the miners would charge a commission. But the only miscalculation was that Bitcoin won’t be widely adopted as a means of payment, so mining remained mostly speculative all this time and the share of revenue from commissions was low, except for the really active period last year (again speculative).

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As I said above, the difficulty of mining is directly proportional to the computational efforts (and electricity!) spent on it. With the fall of the difficulty, the natural increase in supply will slow down, easing the pressure on prices. This is one of the few positive factors. But following the simple reasoning above, the remaining capacity will continue to supply new BTC to the market, trying to pay off or take the last profit.

A speculative supply among other factors will likely lead to the next downward spike in demand. The next portion of capacity will go to junk, which does not pay for itself. Thus, the system sets itself to self-destruction, miners in the struggle for a shrinking profit rate lose the infrastructure necessary for processing transactions. And new ones will likely not be built, while old ones could be sold first.

And here is the sad evidence of what is happening:

https://twitter.com/DoveyWan/status/1064878600594305025

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

 

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What is the Euro Currently up to?

 

In the daily chart, the rate of the European currency seems to be staying next to the level of 1.1301. Euro could approach the support level 1.1301 and pull back away from it. In this case, reverse head and shoulders may form. Here we should rely on the candlestick patterns:

1-17-1024x488.png

 

A flat and very wide uptrend seems to have formed on the daily chart of American stock index S&P500. The asset will likely pull back from uptrend although it may break it through as well. Such a breakout can lead to a quick and a very strong drop. It will be very important to consider additional signals like Japanese candles, for example:

2-13-1024x488.png

 

Cross rate of EUR/GBP is currently testing the broken uptrend therefore it could soon pull back down. It can also pull back to the resistance level 0.9098 that represents a month’s long maximum for this pair:

 

3-11-1024x488.png

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Divided UK parliament creates risks for fragile Brexit agreements

 

Asian stocks sank on Friday, because despite the enabling environment for a meaningful dialogue between the leaders of China and the US in Argentina, the escalation of trade war remains on top of the risk list for the markets. Weak corporate reporting in Europe heightened concerns about the growth of the Eurozone, but progress in Brexit does not allow pessimism to outweigh market sentiments.

 

American markets were closed yesterday on the occasion of Thanksgiving, so trading activity was thin. After opening, Chinese markets pulled local indices down as blue-chip stocks in China declined by more than 2% today.

 

Shares of Chinese companies seem to be “stuck” in a downtrend, as US tariffs and high debt burdening the corporate sector have become a painful combination of risks for shareholders, causing flight to safer assets, i.e. cash. The growing number of corporate defaults in China suggests that the authorities are yet to find a balance between stability and efficiency and the strengthening of one of the parameters inevitably leads to a deterioration of the other. In the trade confrontation with the United States, the Chinese economy still suffers larger losses than the US, for example, activity indices in the manufacturing sector in China (manufacturing PMI) indicate a decrease in production volumes and a drop in export orders. The October reading showed that the manufacturing sector in China is hardly above the line which divides growth from a downturn.

 

Seoul’s Kospi fell by 0.6%, Hang Seng, following mainland China, was trading in negative territory. Australian stocks rose 0.5%, but in the weekly perspective they are in the red zone for the second week in a row.

 

On Thursday, European stocks were under attack as corporate reporting disappointed the market, indicating that, in addition to domestic demand, companies also had problems with external demand. US tariffs have created imbalances in the supply chain and European companies have a harder time selling their products to foreign consumers. Domestic demand continues to be in a dormant state, as the ECB’s easing program has not achieved significant results in stimulating household lending.

 

A draft on future relations, prepared by British and European diplomats, should have become a sign that the parties are making progress in the process of England’s exit from the EU, but May’s inner-party opposition does not allow any progress in foreign policy to be considered reliable. Especially if there is no political consensus inside the country.

 

In the foreign exchange market, the pound stabilized slightly above 1.2850, jumping 1 percent on Thursday, amid news that England and the EU presented a draft agreement that describes future relations between the two countries. It became the second document after the draft of Brexit, which brings Britain closer to the exit from the block, a process which has been going on for more than two years. But the documents must be approved in the British Parliament, which is divided into camps and where there are Euro-skeptics and pro-European parties and various opportunists seem to be ready to exchange a voice for a benefit.

 

Voting in the British Parliament will take place in the second week of December, so until that time the pound is left to wave the volatility, as now there is a fertile environment for rumors.

 

US stock futures indicate a weak start on Wall Street today.

 

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

 

 

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British Parliament seems ready to agree on one Brexit option – No “Soft” Brexit

 

Asian markets kicked off the week with moderate growth, futures for US indices also show a little optimism, as investors are preparing for the meeting of Xi and Trump in Argentina, preferring to dodge possible unwelcome outcomses in the safe heavens. A little support is provided by expectations of solid consumer sales in the US during the holiday season, as a counter-argument we can mention the lackluster survey data from U. Michigan, which showed that rush in optimism was probably left in the past.

 

The meeting between the leaders of China and the United States in Buenos Aires, which will be held this week, and the Fed meeting in December remain the two major market-moving events for December.

 

The broad MSCI index, which includes Pacific stock indices, rose by 0.7%. Hong Kong and Taiwan led gains, while the Japanese Nikkei gained 0.8%. In China, the Shanghai Composite Index started the week from strengthening, but closed Monday in a small loss trying to defend the psychologically important level of 2500.

 

During the Asian session, futures for the S&P 500 pulled up by 0.4%, as traders gradually adjust valuation estimates according to potential economic impetus from Black Friday sales.

 

The S&P 500 fell by 0.66% on Friday or by 10.2% from the annual peak reached on September 20th, amid oil prices falling, which hit the US energy sector. On Friday, the price of WTI approached $50 per barrel – the lowest since October last year. Today, the prices are likely to hold a session in the technical correction; during the Asian session, prices rose by almost 2%. It is expected that with the decline in prices, American oil firms will have to slow down the rate of production, while, Saudi Arabia may make adjustments to its plans to restrict production in December, which it has evasively discussed. Based on this, the news background can gradually be filled with positive rumors and news, and trying to short the oil is very risky, because you can get into a global reversal.

 

It is noteworthy that the pace of decline in oil prices is comparable to 2008 (almost 21% in just 1 month), so winter will probably be accompanied by a global “cooling down” of inflation, which should be reflected in the speeches of officials of large central banks. In particular, energy prices were an important component of inflation in the eurozone, and the ECB President Mario Draghi had already promised to curb QE, but at the last meeting he gave a signal that the ECB could change its mind.

 

US President Donald Trump and his Chinese counterpart Xi Jingping are expected to hold informal talks at the G20 summit in Argentina later this month. In my opinion, the leaders of the two countries will still be able to agree on what we can probably find out through easing Trump’s rhetoric on Twitter and more positive messages in Chinese state media. Now that the effect of tax reform is dwindling, the Fed is not going to slow down the pace of rate increases, and the stock market is depressed, the new wave of tariffs will not pass unnoticed by the American economy, and Trump probably understands this. Peter Navarro, the main “hater” of China in the White House, was excluded from the list of those who will attend the meeting, which was an indicative step on the part of the United States that they would try to circumvent sharp corners in negotiations with their Chinese colleagues.

 

Eurozone activity indices from Markit showed on Friday that services and production slowed down significantly in November. The euro responded with a decline of 0.6% on Friday, stabilizing around 1.1360 on Monday. German bond yields have declined, indicating a growing risk aversion in the market.

 

The British Pound barely responded to the news that the European Union agreed with the British “best possible” options for Brexit at the summit of EU leaders on Sunday. The market will closely monitor whether the deal will go through the split British Parliament, which will vote on this issue on December 13-14.

 

Jeremy Powell’s speech at the New York Economic Club is scheduled for Wednesday.

 

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

 

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Where is the dollar heading to? A review of major catalysts for the next week

 

The weighted average dollar index DXY has been trending upwards from the end of September and a fair question is where the end of the rally is. I am not a big fan of technical patterns but applying a quick sketch of channel lines on the chart we can see a rather clear resistance point, at least from where bidding on further rally may be a mentally hard decision. Of course, it makes sense if we assume that the medium-term trend, we are talking about has some inertia. Such resistance could be expected at around 98.00 points.28.11-1-1024x589.png

What led the dollar here and what drivers are there for the American currency to grow further? Considering the situation with a “bird’s-eye view”, discrepancies in the fundamental picture of the market arise when assessing the three next points: the economic outlook for the United States abroad, the state of the American economy, and the Fed’s policies related to it. The collapse of oil prices by more than 20% from $80 per barrel to $50 steals the so-welcomed inflationary impulse from developed economies. This is especially clearly seen in the Eurozone and Japan and may contradict the commonplace view that lower oil will help firms to save up on costs.

If we chart together the yield on German 10-year bonds and the oil price, it is evident that energy prices somewhat lead the yield movement in the Europe’s fixed income market.

28.11-2-1024x585.png

What led the dollar here and what drivers are there for the American currency to grow further? Considering the situation with a “bird’s-eye view”, discrepancies in the fundamental picture of the market arise when assessing the three next points: the economic outlook for the United States abroad, the state of the American economy, and the Fed’s policies related to it. The collapse of oil prices by more than 20% from $80 per barrel to $50 steals the so-welcomed inflationary impulse from developed economies. This is especially clearly seen in the Eurozone and Japan and may contradict the commonplace view that lower oil will help firms to save up on costs.

If we chart together the yield on German 10-year bonds and the oil price, it is evident that energy prices somewhat lead the yield movement in the Europe’s fixed income market.

 

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Fed-fueled rally fades as markets concentrate on Trump-Xi meeting

 

In continuation of my Thursday discussion about the stock market rally, volatility responded curiously to Powell’s speech on Wednesday. Usually, the VIX and S&P 500 move just the opposite (although with different amplitudes), but on Wednesday there was a moment when the 9-day expected volatility (VXST) rose despite the 2% gains of S&P 500 which is very unusual.

1.jpg 

Usually, the VIX and the S&P 500 move in different directions, since, roughly speaking, panic and the accompanying increase in volatility is inherent in a rather bear market (“market goes up by stairs and down by elevator”). Interestingly, this movement has not been observed on the market since 2011.

The dots on the chart indicate the daily changes in VXST (9-day volatility), in those days when the S&P 500 grew by more than 2% per day. On average, VXST fell by -17%.

 

One of the possible explanations for what happened is that some market participants did not buy at the rally initiated by Powell, as they are waiting for the results of the Trump-Xi meeting, which I wrote about yesterday.

 

Despite the increase in fiscal and monetary support in recent months, the activity of the manufacturing sector in China fell to 2016 low and is on the verge of contraction. The main indicator was 50 points in November – the value of separating recovery and recession.

 

The service sector in China is also not yet able to take on the burden of growth – activity in it slowed to 53.4 points in November against expectations of 53.8 points.

 

The weakness of debt-addicted economy cannot be eradicated even after a fresh stimulus package- income tax cuts, credit support for financial organizations in order to pour this money into enterprises through stocks and bonds. The size and position in China in the global economy will guarantee the recession echoes will feed into the PMI data of other countries, primarily in the EU and the US. Their PMI gauges is expected to be released next week.

 

The minutes of the Fed meeting, which appeared yesterday, could seem irrelevant knowledge to the markets in the light of Powell’s communication on Wednesday, but the statement language convinces that concerns about growth in 2019 has been already gaining momentum at the beginning of this month.

 

First, the officials urged to be more attentive to the incoming economic data. They said that in the upcoming meetings, in the content of the statement and the wording, it may be appropriate to place more emphasis on economic data in economic assessments and policy forecasts.

 

That old and well-known “data dependence” narrative which pervaded Yellen’s comments and which Draghi cannot yet get rid of. This is the exact caution motive which may serve as fundamental ground for expectations of only one rate increase next year (in fact, to the lower limit of the neutral rate estimates by the Fed).

 

Secondly, after a series of previous statements about strong, robust growth, first signs of Fed concerns about the economy were concentrated around slowdown in “some rate-sensitive sectors” in the November statement. Most likely this is the real estate market and possibly the construction sector related to it, the data for which were absolutely not impressive this year. Since March 2016, the 30-year mortgage rate has risen from 3.6 to 5.2%.

 

Stock markets reacted slightly, the dollar changed was flat. Futures on the interest rate point to the same probability of a rate increase in December, while we are waiting for the results of the Trump-Xi meeting.

 

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

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Huawei – the new bone of contention between China and US

 

Despite the catchy headlines of the reports covering the OPEC meeting, the oil market preferred to read between the lines, making frowning conclusion from the statements: the cartel members could not move further from the mere awareness that the threat of oversupply exists.

The meeting of Saudi Arabia, other members of the cartel and Russia ultimately produced only a recommendation to curb production, without a formal agreement on how much oil should leave the market.

Representatives of the OPEC countries hit the wires with comments on Wednesday on how important it is to cut production now, and the Russian representative confirmed that the meeting was constructive, but the result will be announced at a meeting in Vienna today. As a result, relying on positive rhetoric, oil prices may spend the day in positive territory, waiting for fruitful decisions.

Most likely the participants will agree on the extension of the existing production quotas. But some of the Russian producers have already expressed doubts about the possibility of cutting production due to seasonal difficulties, for example, Lukoil.

After the statements from Oman delegates that decline in production could be as low as 1 million barrels, prices fell. This may indicate that the market expects more serious concessions from OPEC.

The growth of commercial inventories in the United States so far effectively prevents the growth of positive sentiment in the oil market, which, moreover, is gradually accepting the hypothesis of a global slowdown in demand. In such conditions, output cut is an obvious necessity for OPEC, but the whole question is how much the members of the cartel are willing to sacrifice in order not to infringe upon their national economic interests.

Yesterday there were reports that Huawei CFO was detained in Canada on request of the US. The part of the market that has relied on the rapprochement of China and the United States after the meeting in Argentina is likely to start correcting its wrong hopes, this can now be seen from the fall of US stock futures. SPX, with ease, punctured the 2,700 mark down, Wall Street is likely to hold in sales today.

A top manager of a Chinese company is awaiting extradition to the US after being detained on the first of December, that is, before Trump and Xi meeting. Most likely, the reason for the arrest was the involvement in the sale of HP equipment, to the sanctioned Iran. It is unlikely that Trump did not know about this and did not authorize the detention, so he won’t be able to portray a surprise. And if he knew, the reaction of the markets was easy to predict, the fragile expectations due to the uncertainty with the tariffs only increases the amplitude of the negative reaction. The costs of creating additional tensions with China are high, so the reason is serious, and the dust will not be settled down quickly. The short trade of the S&P 500 now looks like an easy bet as the truce in a trade war can easily be broken.

The Fed released the Beige Book on Wednesday with pretty rich content for even polar interpretations. On the one hand, the number of references to the word “tariffs” decreased from a peak of 51 to 39 in December, on the other hand, the number of references to the word “slow” rose to the highest level in 2018. The frequency approach to analyzing the content of the Beige Book is justified by the fact that the Fed gathers anecdotal feedback of company managers, economists, market experts from different US districts about economy situation in the country.  The citation of some actual words allows us to assess the general mood of the respondents.

11.jpg

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

 

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A short guide: How to use data on the T-bills to estimate future Fed rate hikes?

 

Amid growing jittery that the Fed made a mistake picking up the quarterly pace of rate hikes and reluctantly admits its flaw, the US term structure of interest rates earns back the status of a “reliable predictor” of a looming slowdown. Recently, I wrote about how the spread between 10-year and two-year bonds portrayed extreme distrust of the Fed’s policy in the medium term, but today I would like to speculate about the even shorter timeframe of the Fed’s actions.

With the December meeting approaching and keeping in mind the quarterly pace of rate increases by the Fed, it is curious to see how the yield of 1-month and 3-month Treasury bonds behave together. If we assume that inflationary expectations in the short-term interval are roughly equal (i.e. only Fed decisions affect their yield then), comparing their yields, we can put forward a guess what the bond market thinks about the Fed meeting in March, which corresponds to the supposed quarterly increase in the rate.

The last auction of 3-month bonds in the amount of 39 billion was held this Monday, while the auction for the 1-month ones was held on Thursday. It is noteworthy that the yield to maturity of both terms was about the same.

1-4-1024x458.png

Since the market is highly likely to expect a rate hike in December, convergence in yields of 1-month bonds with 3-month (which YTM basically focuses on the March decision) means that the expectations for a rate increase in March gradually leave the market. After all, if the opposite were true, the demand for three-month bonds would have to fall, which would be expressed in the increase in YTM (yield-to-maturity).

Of course, you may not bother with the details of yield movements and just look at the probability distribution of futures on the rate hike.

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The chances of a rate increase in March to the level of 250-275 dropped to 33%, although only a month ago the probability of the increase was 50%.

And certainly, what will not leave the Fed indifferent is the inflation expectations (albeit measured through inflation-linked bonds), which did not last long at the desired level of 2% and began to dive.

3-3-1024x825.png

The latest data shows that inflation expectations, measured “through the consumer” (for example, from W. Michigan), also slightly slowed down. The problem is that they are more likely to be lagging (considering that the consumer is less aware of the trend in economy) than the leading inflation expectations measured through the demand for bonds. On the other hand, we can’t rule out that the market reaction to what is happening in the economy can be irrational (for example, to the effects of tariffs), which then spreads to other agents (firms, consumers), and positive loop feedback only enhances the effect. The Fed is now trying to stabilize expectations and particularly illustrative for this are the comments of the President of the Federal Reserve Bank John Williams, who said recently that the Central Bank cannot react to every whim of the markets.

In general, the following situation arises: the market prices in one incomplete rate increase in 2019 and the beginning of a new easing program (QE4) in 2020. Then the Fed will have to begin to soften credit conditions in the economy, as expectations of a new wave of recession rise due to fading fiscal impulse, the effects of trade tensions and a seemingly deadlock state in the oil market.

In the short-run, hopes to remain for wage growth, data on which will be released today. The monthly wage change is expected to be at the level of 0.3%, the number of jobs – 198K, unemployment – at the level of 3.7%.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

 

 

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November US CPI may follow lackluster wages, Fed to call off March rate hike

The Asian and European markets rose on Wednesday thanks to positive comments from the US president regarding the trade deal, freeing Huawei top manager Meng on bail. The major source of gloom remains the risk of ousting British Prime Minister May, what threatens to thwart Brexit plans.

In an interview with Reuters, Trump said that the US government is conducting trade negotiations with China over the phone, and the new tariffs will not be introduced until certain results on the deal appear.

Trump decided to intervene in the Huawei case, under with the provision that non-intervention poses a threat to national security. This moment has yet to be clarified, but even now it allows the markets to downplay the risk of an escalation of the conflict with China.

A Canadian court decided to release Meng on bail, although, according to tentative information, he refused to do so, given severity of the charges and difficulty of determining the correct amount of bail. Keeping Meng in custody forced the markets to include the consequences of China’s “stern response” in the asset prices, but now it allows them to count on positive developments, in particular, on the trade deal.

The news background has improved enough to allow global markets to start trading on Wednesday with a correction, after a weak start at the beginning of the week. The MSCI broad Asia-Pacific index added 1.2% on Wednesday, while the positive attitude was clearly visible on the Chinese stock market.

China has already shown the will to cooperate, considering the reduction of tariffs on car imports from 40 to 15%. On the other hand, it can hardly be called a serious concession, given that the authorities are trying to boost consumer demand in the context of weakening the main driver of growth – production.

Negative expectations regarding the trade deal are fueled by news that several state agencies in the US are going to publish a report on China’s wrongdoings in commercial espionage and hacking. On the other hand, the government already has this information, so without specific consequences (for example, sanctions or indictments) the publication of evidence is unlikely to lead to an escalation of the conflict.

In the foreign exchange market, the pound sterling is down to the lowest level for 20 months against the dollar amid speculation that the conservative party may put forward a vote of no confidence in May. The likelihood of such an outcome increased after May moved the vote on Brexit, fearing its failure. In the event that May loses her seat, a supporter of hard Brexit will probably come to power, who may even initiate a second referendum. The pound is significantly oversold and barely holds above 1.25 on negative expectations, so any news about the trade-off will allow the British currency to materially strengthen.

Consumer inflation data for November are due later today. There is a significant risk of a negative surprise, considering that the data on wage for the past month did not meet expectations. Wage growth increased by 0.2% in November against the forecast of 0.3%. The early weakening of pressure in prices will strengthen speculation that the Fed will postpone rate hikes in 2019. The chances for the March rate hike are low, currently staying nearly 26%.

Oil prices rose after the API data pointed to a significant (-10M) decline in US commercial reserves, suggesting that a sharp decline in prices forced producers to slow down production pace. WTI rose cautiously on Wednesday by half a percent.

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