Monday’s Open: Trade Wars Status Quo That Really Isn’t 

The G-20 Summit has passed and by the accounts of the key players, the results were encouraging. I guess no new fronts have been added to the global economic conflict after the two-day meeting, so that is a silver lining we can hold onto if we wanted to be optimistic to the point of true enthusiasm.  According to President Trump’s account of his meeting with his Chinese counterpart Xi Jinping, their discussion was a success as it reportedly signaled the restart of negotiations between the two countries. To be sated by this news would mean ignoring the fact that they had supposedly never officially broke off talks and being on speaking terms is about as low as the bar can be set. The genuine improvement in circumstance after this summit was the fact that the White House’s threat to put another $300 billion in Chinese imports under the 25 percent tariff. The US President also announced that he was lifting the ban on US firms selling products to banned Chinese telecom Huawei – though the company remains blacklisted and cannot export its wares to the United States. 

The real question heading into the new trading week is how this news is leveraged: by bulls or bears, to charge conviction or short circuit intended trends. If we do see the market buy into the optimistic perspective of the US-Chinese negotiations, it will prove very difficult to develop any meaningful trend. This outcome is tuned more towards a relief rally. That being the case, there was never a significant discount established in the broader markets. These past weeks have seen speculative assets rise with the S&P 500 and Dow in particular anchored to record highs. That would suggest that the markets may in fact have been pricing in a more significant improvement of circumstances which could completely drown out any low-grade rally that could arise. Further, in this conflicted backdrop, it would be very difficult to sustain a troubled risk-on rally with liquidity under pressure owing to the US Independence holiday on Thursday July 4th. A middling risk rally would very unlikely override shallow markets.
 
Alternatively, a bearish take on the after-action would likely trigger deeper misgivings in the markets and potentially tip a selloff that can override thinned conditions. This scenario could start as a retrenchment as the excess premium afforded to an assumed reversal in one of the most abstract and wide-reaching fundamental threats registered in years (trade wars). It could further grow into an appreciation of the economic pain that is slowly compounding as the efforts put into place thus far build upon the burden in economic activity. That is recognition of true fundamental struggle that contradicts superficial speculative ambitions that have placed greater emphasis on the expectations around the likes of the Fed rather than the tangibility of GDP. While generating enough conviction to carry risk aversion through the liquidity drain this week, it is far more likely to happen in a fit of panic rather than greed; and this is the type of falling fundamental start that can get the ball rolling. 

Seasonal Forces Versus Fundamental Winds 

Generally speaking, there are strong fundamental winds blowing in these markets, but the urge to revert to restrained market conditions as is familiar during seasonal lulls like we are expecting during this ‘height of Summer’ week will prove a powerful deterrent. Seasonally, July is more buoyant for expected volatility (via the VIX volatility index) than June; but that is not saying much for state of turnover throughout the average year. Also, Thursday’s Fourth of July holiday is really only a US celebration; but the expectation for sidelined speculative activity fuels an assumption among the global rank that is often realized by sheer force of will – or want. Looking to the same historical norms, low volatility has also contributed to stronger performance for risk appetite, which fts the assumed inverse correlation between the likes of the VIX and the S&P 500. Given the record high of the latter and general premium-despite-fundamental-trouble for the many other speculatively-linked assets in the open market, it would be difficult to leverage genuine gains through the forthcoming period. 

Overriding liquidity conditions is difficult to do whether attempted through fundamental or technical means. It is, nonetheless, significantly more probable to mount an offensive when there is a common event or theme for which a wide swath of the market can line up behind. Trade wars referenced above is one such deep well upon which the speculative rank can draw. Another is monetary policy. This past month, the remarkable recovery mounted by the vast majority of risk assets seems to have a very clear connection to monetary policy. In particular, the Federal Reserve’s policy decision and forecast on the 19th was seen as a boon to doves. It should be said the group did not cut rates nor did it indicate any intention of easing through 2019, but the market took what it wanted from the event. That is another point of speculative reach.

In the week ahead, there are a number of events and data points that could hit at this fundamental disparity, but Friday’s June employment report (NFPs) is the most distinct. If the general strength of the data holds firm, it could sharply drop expectations for a July cut – presently priced at 100 percent according to Fed Funds futures. Then again, if the data drops sharply, the implications for growth moving forward could lead the market to think more critically on the shortcomings of any future central bank efforts, as impotent as they already are. 

Setting the Course for the Official 2Q GDP Readings

While monetary policy is a theme that will follow one of the top highlights for event risk in the coming week and trade wars will following the G-20 summit headlines, the most comprehensive matter to hit upon through the breadth of the period will be growth. Interest in the health of the global economy has simmered for months between the cumulative pain afforded to the trade issues, the uneven state of financial assets, questions over the policy authorities’ (central bank and government) willingness to offer backstop, the serious erosion of confidence surveys and specific high-profile market developments like the inversion of the 10-year / 3-month Treasury yield curve. That all builds into greater deference to be paid to the forthcoming official round of 2Q GDP readings that will start to cross the wires in a few weeks’ time. That run kicks officially on Monday July 15th with the release of China’s 2Q GDP figure. In the meantime, there are a host of economic readings on tap for this week alone. 

As far as comprehensive views go, a Bank for International Settlements (BIS) annual economic update will most likely give a more dire assessment of what the world is looking at heading into the second half of 2019. This group is known as being frank about risks and somewhat pessimistic, with no compunction when it comes to warning over the instabilities developing in the financial markets. They will almost certainly decry the state of global trade and the precarious nature of risk taking. In data terms, the Friday NFPs are a good barometer for the health of the world’s largest economy, however, I put greater emphasis on the ISM’s service sector activity reading for June. That particular segment of the economy accounts for approximately three-quarters of output from the behemoth.

That said, if the service and manufacturing reports from the group point to the same general direction, the implications are far greater. For a global perspective, there are Markit-observed PMIs are due for Asia, Europe and North America. We are expecting ‘final’ readings for Japan, the Eurozone and US; but the figures for China, Italy and UK are just as important to the overview. As with many fundamental dimensions nowadays, there is a significant bias in terms of impact for different bearings. A firmer showing would act as mild justification for the already optimistic slant from the markets. A worsening conditions will draw further and further on the discrepancy in speculative view and excess market pricing.