8 June 2018
Brexit update: Theresa May’s biggest test yet?

The UK Prime Minister faces a series of challenging parliamentary votes on her plan to leave the customs union and single market after Brexit

The biggest test yet?

Almost exactly one year on from the her big election upset, Prime Minister Theresa May faces another mammoth challenge.

On Tuesday, the EU Withdrawal Bill – which would see all current EU rules enshrined into UK law in March 2019 - will return to the House of Commons. As part of this, parliament will debate and vote upon a series of controversial amendments that were passed by the House of Lords a few weeks ago. These votes will put pressure on the government to reconsider access to the customs union and EEA, as well as giving more clarity on parliament's so-called ‘meaningful vote’.

A loss on one or many of these amendments would come as a major – albeit perhaps not fatal – blow to PM May’s government.

Federal Reserve preview: Stepping on the gas

A rebound in US growth and rising inflation pressures mean the Fed will concentrate on domestic issues rather than be distracted by emerging market woes at the forthcoming meeting

Emerging markets favour policy restraint...

Brazil, Turkey, India and Argentina have all been in the spotlight as authorities try to stem volatility in FX markets. Domestic imbalances - widening fiscal and current account deficits - together with political uncertainty have been compounded by higher dollar borrowing costs and a stronger greenback. Consequently, there have been calls from some quarters for the Federal Reserve to consider the implications for the broader global economy when it sets interest rate policy on Wednesday. This was what happened under Alan Greenspan 20 years ago following the Russia/LTCM crisis and more recently in 2014 and 2016 in response to market volatility.

ECB preview: Praet’s pivot pirouette

Despite growing uncertainties around the strength of the eurozone recovery, little underlying inflationary pressure and possible further market turmoil, the ECB seems determined to demonstrate its focus on long-term trends. After Praet's remarkable speech, we expect a very exciting meeting on 14 June 

Until recently, the ECB had remained tight-lipped about its next steps for monetary policy, particularly quantitative easing (QE) beyond September this year. 

Remember after the April meeting, when the ECB president Mario Draghi went as far as saying the ECB had not discussed next steps for monetary policy at all. This approach seems to have changed. The latest speech by the ECB chief economist Peter Praet suggested the discussion on an end to quantitative easing (QE) could gain lots of traction at next week’s meeting. Even ECB doves seem to be fine with a gradual end to QE this year.

Whether the ECB is getting cold feet and wants to unwind QE before it gets too late or whether it simply wants to prove that it is entirely focused on macro facts is still unclear

In his speech, Peter Praet signalled the ECB’s criteria for assessing whether there is a sustained adjustment in the path of inflation towards target: convergence, confidence, and resilience - were almost fulfilled. Contrary to earlier statements by many ECB officials and even the minutes of recent ECB meetings, Praet no longer mentioned doubts about inflation really picking up. Praet also stressed the underlying strength of the eurozone economy, suggesting the ECB considers the recent weakness in the eurozone data transitory.

Copper back above $7k as the curve flirts with backwardation

The start of labour negotiations at the world’s largest copper mine, Escondida, have restored volatility to the copper market. We are keeping a close eye on the tightening spreads which could restore fund flows but also seem dependent on stock holdings

Labour negotiations back to the fore

At the beginning of 2018, we cautioned bulls were likely pricing in a high amount of mine disruptions too early which only risked disappointment. With the retreat of prices, open interest and money manager positions through Q1, this seemed to play out as we expected. 

2018 is indeed an extreme year for the number of labour negotiations in Chile and Peru, but until now all talks have gone without any hit to supply. Only two mines including Los Pelambres and Chiquicamata/Radimoro Tomic saw negotiations go down to the wire.

Now labour is back in focus as talks have now begun at the world’s largest mine Escondida. A record 44-day strike here cost c.200kt of supply in 2017, and the rebound (+ concentrator expansion) is expected to add c.300kt this year making it the largest contribution to supply growth.

As we stressed in our 2018 copper outlook, counting on a higher supply disruption rate than usual for 2018 was a tough sell because fewer greenfield mines are ramping up and prone to delays. Given the smooth start to the labour negotiations in the first five months, it would take a very prolonged strike at Escondida to now surpass the 5% disruption allowance in our models and swing the market into a price driving, curve flipping, refined deficit. At the historical disruption rate, copper concentrate looks set for a shortfall of around 100kt, but the refined market looks effectively balanced.

Our base case doesn’t see prices break much higher than $7k

However, never say never. Both sides appear to be far apart since early mediations broke down and the union is demanding the largest one-time bonus ever for Chilean mining. More worryingly, the union has said they have the cash to potentially sustain a strike for up to a year. Those possibilities have sent the speculators bidding up copper prices, but we would still urge caution. Last year’s lengthy strike was extreme and if not the workers, then certainly BHP, would have little appetite to withstand such a lengthy outage.

In short, supply disruptions are expected and will happen this year, but only a very extreme Escondida strike can swing the balance. But Escondida will not be the last strike either. The year has started smoothly, but plenty of labour negotiations remain (c.4.4Mt of annualised production). Some look less risky because they concern supervisors, but many of these mines have also had strike action in just the last few years.

G7 Summit: Trump needs to back off to secure his wins

So far President Trump's 'maximum pressure' strategy has worked, but the results are now at risk because China has threatened to take back concessions and the EU, Canada and Mexico have also announced retaliatory measures. At the G7 summit, this Friday President Trump will be pressured to scale down his demands to preserve his gains thus far

Smart tactics

President Trump has said trade wars are good and easy to win. Economists have been keen to point out that trade wars are not good and everyone loses out. Who is right? To answer this, we need to understand what a trade war is.  

When economists refer to a trade war, they are referring to countries slapping tariffs on each other. It's easy to explain why everybody loses out in such a situation because the benefits for the domestic industries that are protected by higher tariffs are countered by losses of exports that face higher tariffs as well when retaliation kicks in. Add to this, the loss of purchasing power, because tariffs lead to higher prices and there you go: the net effect on welfare for the two countries is negative. Essentially, a lose-lose situation.

But the trade conflict that President Trump has started is not a real war yet, because retaliation has been limited, at least until last week. Trump has so far practised a 'maximum pressure' strategy that has been quite successful. In March, Trump imposed higher import tariffs on steel and aluminium for all countries and said exemptions would be granted in return for better US trade conditions.

In the past, Donald Trump is the one who has said that deals work best when each side gets something it wants from the other. 

Countries like South Korea, Brazil, and Argentina, gave in and ‘voluntarily’ restrained their exports to the US, accompanied by other concessions too. To avoid tariffs on 1333 of their export goods, China has also promised to lower their import tariffs on cars and loosen restrictions on foreign investments in the financial sector, automotive, transport, and the energy sector. The US has given nothing in return, except an exemption for the sanctions on the Chinese company ZTE that was about to be punished for doing business with North Korea and Iran (and even that isn’t a sure thing).

Once the concessions of the trade partners kick in, these bargaining results will not only lead to more domestic sales for US steel and aluminium companies (substitution of imports) but also more exports of US companies in industries like automotive, agriculture and energy. This pushes up US national income and stimulates employment. The welfare loss for the US buyers of steel and aluminium due to the higher price they have to pay has to be taken into account as well, but this will be partly offset by the tariff income for the US government. A precise calculation, using various empirical findings on price sensitivities of demand for imported products, is warranted to derive the effect on US economy as a whole. But the effect will at least be positive for the steel and aluminium industry at the expense of the welfare in the countries that have granted Trump these favours.

More important for the President than the net benefit for the US economy as a whole is the fact that with these bargaining results he lives up to the promises he made to specific industries and their workers.

US housing: Still going strong but for how long?

A mixed month for US housing data, but the overall direction remains upwards. The question is, how long will this trend continue?

Sales are down

Several key data for the US housing market pointed downwards in April. Sales of both new and existing homes fell relative to March, and by somewhat more than consensus expectations. New home sales in previous months were also revised down. Pending homes sales also fell by 1.3% month on month, again well below consensus, indicating sales are likely to slip further over the next couple of months.

One key reason for slowing sales is the dearth of houses on the market. The supply of homes for sale relative to the current pace of sales keeps falling and with less than four months of supply available is now at the lowest level since the 1990s. That makes it difficult for buyers to find a home they want to buy. Rising mortgage rates also make it harder for buyers, and to some extent could discourage potential sellers from moving house if it means they may end up with a more expensive mortgage.

China: Why the central bank won’t cut reserve requirements

China's central bank is supporting the onshore bond market by expanding collateral for the medium-term lending facility (MLF). This will reduce contagion risks though standalone default cases could continue. Still, we think it's unlikely the central bank will cut its reserve requirements ratio (RRR) for banks in June. Here's why

Central bank expands collateral of medium-term lending facility

Since 1 June, the central bank (PBoC) has expanded the collateral of its medium-term lending facility (MLF), which is a lending facility for banks. 

MLF collateral expands to:

  1. AA-rated bonds issued by financial institutions for small and micro enterprises, green financing and agricultural financing.
  2. AA+, AA-rated corporate bonds (priority to accept bonds involving small and micro enterprises, green economy).
  3. High-quality micro-enterprise loans and green loans.

Before this expansion, the central bank only accepted sovereign bonds, central bank notes, China Development Bank and other policy bank bonds, local government bonds and AAA corporate bonds as collaterals for MLF. The interest rate on MLF is now at 3.3%.

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In case you missed it: Big week ahead

The Swiss vote on 'Vollgeld', Theresa May faces her biggest challenge yet, the Fed and the ECB meet - one might hike while the other will be talking QE, but first, all eyes on the G7 summit and whether Trump can be talked out of his protectionist agenda? 

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