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More Gains Ahead for New Zealand and Aussie Dollars if China Trade Talks "Accelerate to a Deal": State Street

Chinese economy Shanghai Cityscape

Image © Yevgen Belich, Adobe Images

- Currencies sensitive to China could rise in 2019

- Trade war to be resolved quickly, supporting China

- Outlook for global growth only slightly below trend

Global markets are notably bullish ahead of the weekend, with hopes of a potential breakthrough in U.S.-China trade talks helping drive optimism throughout both Asian and European sessions.

Stock markets are rising and so are the Australian and New Zealand Dollars which tends to benefit from good news relating to China, the number one export destination for the two antipodean countries.

Currencies that are sensitive to the Chinese economy, such as the Australian and New Zealand Dollars, as well as emerging market (EM) currencies, are likely to perform well, “in the next few months”, says Rick Lacaille, chief investment officer at State Street Global Advisors, especially versus the U.S. Dollar, as trade tensions ease and the global economy stays resilient.

The slowdown in China - and in the U.S. - will make both countries more motivated to “accelerate towards a deal” says Lacaille, and this will keep investor risk appetite buoyant and help support the Aussie, New Zealand (Kiwi) and most EM FX sphere too.

Fears about slowing global growth are a little exaggerated, as the world will still maintain a relatively strong 3.5% growth rate in 2019, which is only marginally below trend, says the CIO. This is likely to support global risk appetite and both EM and other risk-related FX.

“The trade dispute between U.S. and China hangs over emerging markets because Chinese growth is so central for the prospects for emerging markets and so many from a market-weight perspective are in Asia,” says Lacaille in an interview with Bloomberg News. “If, as we suspect, we will get a deal from President Trump and Xi in the next several months, that would provide a relief rally fuelled by the Dollar weakening a little bit.”

Last Wednesday, the People's Bank of China (Pboc) announced an $83bn ‘emergency’ ‘open market operation’ - the largest cash injection into the real economy ever recorded by the Bank. Far from soothing investor fears, however, the sheer scale of the stimulus splurge triggered concerns amongst investors who saw it as a sign the economy was faltering. Not surprisingly, China-sensitive FX, including the Aussie and Kiwi Dollars also fell on the news.

The vulnerability in the Chinese economy indicated by the huge Pboc intervention is likely to make Chinese negotiators more willing to “accelerate towards a deal” according to State Street’s Lacaille, who sees a risk of ‘irreversible damage’ to the economy if they dither.

“The challenge they (the Chinese) may face if the trade dispute goes on for longer may not easily be fixed by fiscal policy, although their scope for that is much greater than in the European Union or the U.S. But I think the scale of the problem and threat to employment growth is substantial and it is the reason why there may be an acceleration on both sides to a deal.”

His view differs somewhat from that of Stefanie Miller, senior vice president of capital markets at Height Capital, who sees the U.S. taking a tougher line in negotiations, making them more drawn out.

“The president wrote a book, ‘The art of the deal’ we have to remember this gentleman prides himself on his negotiating tactics.” Says Miller, who thinks Trump will use the knowledge that the Pboc has had to take emergency action to liquidate the economy and use it as a weapon to squeeze the Chinese into making concessions.

The tariff standoff was like “pouring gasoline on a fire” for the already struggling capital markets in China, adds Miller.

The market is probably too optimistic about a quick resolution and there is probably more likely to be an “extended pause” with no definitive conclusion in sight. Although talks are trending in a positive direction, “they are not done” yet.

Another factor which could delay a detente is the character of the U.S’s chief negotiator Robert Lighthizer, who “is a protectionist and his instincts are not to cave and so the best case outcome in our view will be a continuation of the pause past March 1, because we do not think they will reach an agreement by then,” says Miller in an interview with Bloomberg News.

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