Flickering trade deal hopes; Fed's repo facility assuages funding concerns

Weak conviction on any trade deal keeps sentiment volatile. USD funding concerns assuaged by repo operations.
Philip Wee, Eugene Leow23 Sep 2019
    Photo credit: AFP Photo

    FX: China-US trade deal hopes not concrete

    We expect weak conviction to keep market sentiment volatile. Trade tensions remain the chief worry for the global economy. A China-US trade deal in October is still considered possible but improbable. There are no concrete signs that the US is ready for an interim trade deal that would lead to a tariff truce. Despite talks of progress by both sides ahead of the early October trade negotiations, US President Trump favoured a whole deal and signalled no urgency for a trade deal before the US presidential election in November 2020. Hence, it was not a surprise that the mid-rate for USDCNY has only edged, for the first time since August 26, below 7.08 last week.

    During the first wave of trade talks that failed in May, USDCNY was did not break below 6.70 because the US did not agree to China’s request to roll back tariffs for a trade deal. Since then, China has been labelled a currency manipulator in August followed by multiple US tariffs increases on all Chinese goods headed to the US. It does not appear that China would compromise into its 70th National Day on October 1. Chinese Premier Li Keqiang has already warned that it would be “very difficult” to keep China’s growth at/above 6%. We maintain the view for USDCNY to hold above 7 for the rest of this year, mindful that the global monetary policy stances still favour the USD on a relative basis.

    Rates: Fed’s repo facility in place until a more permanent solution is introduced    

    The Fed will offer its repo facility (of up to USD 75bn) daily through to October 10 to tide the financial system through the quarter-end funding squeeze. 14D term repos (amounting to USD 90bn) will also be offered this week. To recap, overnight USD rates (repo, SOFR and Fed funds effective rate) spiked last week as a combination of factors – tax payments, heavy issuances and bloated dealer balance sheets – tightened liquidity significantly. With the effective Fed funds rate temporarily pushing above the upper bound, it is clear that the Fed briefly lost control of interest rates. We think that the Fed has assuaged concerns and will likely take the next few weeks to outline a more permanent solution to the funding problem.

    Figuring out how much reserves / cash the financial system is needed is a nontrivial exercise. The amount of excess reserves (USD 1.3tn), as traditionally calculated, overstates the amount of liquidity in the banking system. Seasonal demand for cash can lead to outsized moves in overnight USD rates. The solution is to inject liquidity by expanding its balance sheet on a more permanent basis (last week’s operations only temporarily boosted the Fed’s balance sheet). By gauging the take-up rates of its facilities, the Fed will then have a basis on how much to expand its balance sheet by. It is quite likely that a small-scale asset purchase program (spanning 6-12 months and amounting to USD 100-200bn) would be mooted in October. 


    Philip Wee

    FX Strategist - G3 & Asia


    Eugene Leow

    Rates Strategist - G3 & Asia

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