OREX: China stimulus – Another false dawn or the real deal?

While I typically harbour skepticism toward China's grand stimulus declarations, the price action in FX markets speaks volumes. The uplift in Asian FX might seem promising, espeically the CNH, but I see these shifts as optimal moments to hedge against Trump's looming tariff threats. All this stimulus chatter should get under President-elect Trump's skin, who could interpret this as an even bigger opportunity to intensify trade pressures to mitigate China’s substantial trade surplus.

As we edge closer to China's highly anticipated Central Economic Work Conference (CEWC), market spectators are on high alert for any new details regarding the scale of policy stimulus planned for the upcoming year. Recent buzz suggests that the Chinese government may aim for a more expansive budget deficit of 3.0% to 4.0% of GDP next year, an uptick from this year's 3.0%.

Investors are particularly keen to see if the stimulus will extend beyond typical infrastructure spending to include fiscal measures that bolster personal consumption, helping to rebalance demand within China's economy. Such a move would be warmly received, as it could address the chronic deflation issue.

However, with bond yields in China already touching record lows, there's growing skepticism about the effectiveness of further monetary easing to spur growth. This upcoming conference could shed crucial light on China's economic strategy, significantly influencing global market sentiments.

I anticipate the dollar will maintain its resilience and rally after the December Fed cut, especially given the backdrop of looming tariffs, which could nudge U.S. yields higher. However, the surprising endurance of the recent bond rally has unexpectedly tempered the dollar’s ascent more than I had foreseen, adding an unusual twist to the usual interplay of trade war dynamics and currency valuations.

The Federal Reserve is in the “blackout “period before the critical rate decision scheduled for December 18th, putting the spotlight squarely on this week’s U.S. CPI data. Market consensus is leaning towards another stubbornly high 0.3% increase in core CPI month-on-month. Although this isn’t ideal, it's unlikely to sway the Fed from proceeding with a planned 25 basis point cut in December. However, a spike to 0.4% in the core CPI could dramatically shift perspectives, challenging the wisdom of rate reductions amidst escalating inflationary pressures, particularly with the impending tariff adjustments under the incoming Trump administration.

The yen's lack of momentum following the U.S. non-farm payroll data—which seemed weaker beneath the surface—was a significant red flag, as noted in our weekend report. Similarly, yesterday's tepid response to robust Japanese economic reports suggests caution is warranted, especially if US yields kick up. It seems the FX market is voting with the buy USDJPY button that the Bank of Japan is on hold this month.

As for the euro, all eyes are now on the aftermath of the ECB’s rate decision. Lagarde's upcoming press conference could hint at further easing, potentially setting a dovish stage for the EUR.

Yesterday's commodity rally, spurred by chatter around China's stimulus plans, initially sent commodity currencies like the Australian dollar and the South African rand soaring. However, the Australian dollar has since retraced most of its gains, diving sharply in Asia following the Reserve Bank of Australia's (RBA) latest policy meeting. This downturn saw the AUD/USD fall below the 0.6400 level after briefly reaching a high of 0.6471 yesterday.

The RBA opted to maintain its policy rate at 4.35%, a stance unchanged throughout the year, but the nuances in its updated policy statement captured market attention. The statement suggested that the Board is "gaining some confidence that inflationary pressures are declining," aligning with their latest forecasts from the November Statement on Monetary Policy. This shift in tone was enough to temper the initial enthusiasm for the Aussie as traders reassessed Australia's monetary policy trajectory in light of easing inflation concerns.