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Trade Wars Progress Falters, Seasonal Volatility Return, Who is Devaluing? - DFX key themes



A Habit of Cutting Down Progress Towards Ending Trade Wars 

This past week, optimism was dangled in front of the markets and violently snatched away before it became too established. We have been dealing with the escalation of explicit competition in trade policies for the since March, and each hint of progress in turning the major players back from economic stalemate has been consummately dashed. This past week, there were two fronts on which it seemed we were heading for an important breakthrough. The first upswing would come from the NAFTA negotiations. After US and Mexican officials seemed to come to an understanding on bilateral conditions, it was reported that Canada was coming back to the table to see if it could hash out its own understanding with the United States. With a soft ‘deadline’ presented for this past Friday it seemed there was the will and momentum to secure a trilateral agreement that could provide stability in the relationships between these major economies. Instead, Canada’s Foreign Minister announced they had not come to an agreement. In a now-familiar style of reaction, President Trump said the US was ready to go without Canada and said Congress should not interfere in the negotiation. 

The US President would also dash building confidence that the US and EU would head off a more threatening economic standoff between the two largest economies in the world. EU Trade Minister Malmstrom made remarks earlier in the week saying the Union could cut tariffs on US auto imports to zero if the US would do the same for European cars coming into their country. That was seemingly what the President was looking for in previous remarks, but rather than voice pleasure that talks had taken a favorable turn, Trump stated it was ‘not enough’. These developed world trade threats are ominous for global growth and the healthy flow of capital across the world’s financial centers. However, they are not as yet as intense as the impasse between the US and China. There was no material sign of improvement from which we could garner a fresh sense of disappointment this past week. The previous restart of talks between the two superpowers notably led to little traction according to US leaders. There has been little in the way of encouraging rhetoric from either side in the meantime. 

Furthermore, there are reports that President Trump is intent on pushing through the next, more onerous round of tariffs on the largest foreign holder of its sovereign debt. The open period for the public to weigh in on a proposed additional $200 billion in taxes on Chinese imports was original set for August 30, but was supposedly pushed back to September 5. Either way, the ultimate decision by the administration is likely soon – with some administrators believing news could come as soon as next week. This begs the question: at what level of total taxes or number of active trade war participants will global investors turn their fear over ill effects into action?

What to Watch for as We Turn to Fall Trading

Summer in the Northern Hemisphere doesn’t officially end until September 22; but for most intents and purposes, it came to a close this past Friday. Historically, August is the last month of the doldrums and the week preceding the US Labor Day holiday weekend is the final true week of passive drift. There is not a definitive flick of the switch from Friday August 31st to Tuesday September 4th where markets turn from listless chop back into full-fledged trend. That said, same seasonal factors the market abided by to overlook pressing issues such as trade wars, growing political risks and central bank commitment to normalize monetary policy will transition into active trade for a month that historically averages the only loss in the calendar year for the benchmark S&P 500 and is one of the top standings for volatility according to the VIX. 

It is possible that anticipation has been building up to this cyclical pivot and the weight of all of the aforementioned risks will come crashing down on the complacent market. More likely, we will see the ill-effects of eroding fundamentals slowly wear away at the speculative resolve that has promoted a situation where the S&P 500 is at record highs while the Vanguard’s World Index ex US fund (VEU) and Emerging Market ETF (EEM) are carving out multi-month bear trends. Important with monitoring the balance of the markets moving forward are the measures of general speculative activity and the relationship across favorite risk assets. Volume is almost certainly to increase over the coming month, and there is a long-standing correlation between turnover and volatility. For those keeping count, volatility has an inverse relationship with risk-leaning assets such as equities and carry trade. Open interest – essentially participation – will also be important to monitor. 

Are bulls significantly adding to the S&P 500 via cumulative shares, the SPY and eminis as it traverses new records or is stagnating (perhaps even declining)? As markets deepen and volatility increases, the discrepancy between risky assets (and typical havens) will demand reconciliation. If a broad appetite behind speculative benchmarks does not return, the incongruity will draw increasing unwanted attention from those looking to honestly evaluate the risks of their portfolios. 

Who is Devaluing their Currency and Why

Not long ago, President Trump lobbed accusations against Chinese and European authorities for devaluing their respective currencies to afford unfair trade advantages. This was likely a means to add further justification for pursuing aggressive confrontational trade policies against these major economies that draw painful retaliations against American consumers and businesses in the process. It could also be the pretext for the US exacting its own FX policies that would categorically touch off a financial crisis as the market re-assesses pricing, reserves and economic relations wholesale (something we’ve discussed before). With big questions ahead of us, it is worth assessing who is utilizing policy currently that can fit classification of currency manipulation or may have in the recent past. The most frequently accused world player is China. And, there is obvious policy adopted just recently that qualifies it for the label. One of the country’s primary FX administrators (the People’s Bank of China or PBoC) announced a change to its pricing method that was clearly aimed at reducing volatility – and not so subtly meant to prevent the continued decline in the offshore Reminibi. That was a move that was likely taken in part to take the wind out of Trump’s manipulation claims sails as well as to head off concerns that there was a building wave of capital flight. These are moves that can be labeled efforts to curb political stress and prevent a financial crisis, but they are most definitely manipulation. And, distortions imposed long enough eventually lead to crises. 

As for the allegation directed at the Euro, the 2014 monetary policy connection the ECB made to EURUSD at 1.4000 was rather egregious. However, the application of rate cuts to zero and expansion of its balance sheet afterwards didn’t deviate far from many other large central banks – they were just late to the game and thereby less effective. Keeping up the argument recently finds much less weight as the Euro rallied in 2017 despite the Fed’s persistent hike pace while the European bank itself has signaled it plans to normalize in the foreseeable future. If the British Pound has purposefully been devalued to afford it trade advantage in this world of plateauing growth, using Brexit to afford this advantage would have to be the worst possible route. Japan has a long history of outright intervention on behalf of its currency owing to its dependence on trade, but both the Finance Ministry’s direct Yen selling and the Bank of Japan’s (BoJ) indirect monetary policy effort have seen their effectiveness fade after so many successive rounds. Both the RBA and RBNZ have attempted to ‘jawbone’ (talk down) their currencies, but that is something nearly every major central bank has done and it is just as ineffective for all. We could label the groups’ passive monetary policies as moving them out of favor as carry currencies, but that would be a poor plan as well as they will not attract foreign capital to help establish financial stability. 

The SNB clearly enacted a program meant to devalue its currency with negative rates and a hard EURCHF floor, but that effort failed spectacularly and the central bank now has to deal with the fallout from a lack of credibility. And, then there is the US Dollar. Was the Fed’s piloting the QE program after the financial crisis evidence of an effort to gain trade advantage? Perhaps expanding to a QE 2 and QE 3 even though the economy and financial system was no longer in crisis was the evidence? Or perhaps the Trump administration’s efforts to play down the long-held ‘Strong Dollar’ policy or the President’s ruminations over Fed policy and accusations against other trade partners? In some way, everyone is engaged. 

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