Is Trump Intentionally Stirring Market Volatility?
The dust is still settling from the most recent string of reciprocal retaliations between the US and China in their ongoing trade wars. As a brief synopsis, the White House frustrated by the lack of progress in negotiations as they were due to break for a month announced August 1st it would slap a 10 percent tariff on the remaining $300 billion in Chinese goods that it was not already taxing. China responded the following Monday by letting the USDCNH cross the 7.0000 Rubicon. The US in turn labeled its counterpart a currency manipulator so that it could pursue other legal means to which Beijing suspended all agriculture imports from the US. That is where we find situation heading into the new trading week. It is possible that we are in another period of stasis where uncertainty starts to give over to complacency once again. Yet, there is motivation for President Trump to keep up the pressure. With the exchange rate adjustment made on the Yuan, China has essentially made a means to automatically offset much of the impact from US tariffs. This is more of a move towards a market-based currency policy than what we have seen before (there aren’t naturally hard barriers in exchange rates), and a weaker currency would be expected should an detrimental economic wind blow in.
Nevertheless, the US President will use this shift to bolster his claims of manipulation, and the markets will grow wary of the implications for foreign investor capital repatriation that raises added concern China will not be happy to deal with given its financial and economic pains of late; but this was ultimately the most practical move. Moving forward, raising the tariff rate on Chinese import will be largely offset by exchange response, which means the principal strategy for exerting pressure on the country has essentially been neutralized. The administration could try to muster alternative plans with greater effectiveness but there is little the US could resort to short of mustering international support – and their regular threats to trade partners doesn’t make that likely – or that would otherwise pull other countries into support of China. With an appetite to ‘go it alone’ and keep on the offensive, the US government looks like it wants to simply improve the channel of influence with its tariffs. For that to happen, the Dollar would need to depreciate.
This is why Trump has been relentless of his critique of the Federal Reserve, voicing discontent with the group nearly every day last week. He sees a simple formula of rate cuts leading to a weaker currency – which is not assured – but he seems to carry little about the group’s credibility or the concern such a move would inspire among investors (a sudden aggressive easing despite stocks at records and the jobless rate at decades low would suggest a crisis is ahead). With the central bank unwilling to cave to the pressure and no other practical approach within his means to devalue the currency without triggering heavy consequence, he may be attempting to rock the market such that investors demand Fed’s action. The slump last week, in May and through the fourth quarter (signaled in early September) all came soon after the US escalated trade wars. Could this ploy work? Yes, but it would carry serious complications.
‘Tis The Season of Holiday Trade, But Is This Time Different?
We are entering into the prime period of the ‘summer doldrums’. Summer is a fairly generic phase when it comes to the markets and depending on the unique circumstances each year; but statistically, the lowest average daily volume for the S&P 500 – my favorite, imperfect risk asset – occurs through the month of August. This timing aligns broadly to holiday periods in the US and Europe which in turn leverages the remaining global investors’ expectations as to activity through the period. As a notable asterisk, historically, the VIX begins a steep rise through the same months before peaking in September and October. While prominent technical levels, a dearth of traditional fundamental updates and statistical norms are all means to coax expectations; I find a profitable bias and ultimately complacency are most reliable sources of market intent – much like the assumption of historical status like its ultimate safe haven position which triggers a flight to Treasuries when fear is on the rise once again.
That said, market participants shouldn’t form the basis of their position on complacency which is essentially a decision to ignore risk in order to earn tepid returns. There is a saying in markets, ‘will this time be different’ which is used far more often as a contrarian’s criticism of those with that are dubious of a market that has deviated too far from what they gauge as value. It is the same sentiment shared by those that mock the caution of those moving to the sidelines or taking on hedge when risks retreat – particularly should those same unrelenting bulls be saved by a stiff bounce. Yet, asking whether markets are going to eventually shed an unearned optimism which would expose assets that have been artificially driven to excessive highs is the reasonable approach, not blindly buying every dip or (worse) simply adding to an increasingly stretched position with no plan to unwind during favorable times.
GBPUSD Is Within Reach of a Three-Decade Low
Though many technical measures may suggest the British Pound is stretched in its tumble – particularly in its past three months – and various fundamental aspects to the currency would argue a foothold of relative value, the currency is dropping like a rock. This past week, the Sterling continued its crash against an otherwise unsteady Dollar to trade within 1 percent of the more than three-decade low the pair hit during its October 2016, post-Brexit flash crash low. EURGBP has been of similar constitution. Despite the growing tab of issues for Europe between an ECB dovish drive, Italian government stability risk and the United States constant pressure on its trade status; this pair has climbed for 14 consecutive weeks through this past Friday – though it is still 5 percent from its recent record high set back in late 2008. GBPJPY is perhaps the most forgiving as it is approximately 9 percent from its own decades’ low, which I guess we would have to give credit to the Bank of Japan’s early work to devalue its currency.
This past week, the UK economy was weighed by troubling economic data which included he first quarterly contraction in GDP since 2012. The real source of fear however remains with the troubled course of the UK-EU divorce. We are still months out from the official deadline (October 31st) for both sides to work out their differences and come to an acceptable split. Yet, with former Prime Minister Theresa May’s departure, the reassurances that the government would do everything in its power to avoid a ‘no deal’ outcome have gone. In fact, new PM Johnson seems to have as the centerpiece of his negotiation strategy a clear warning that this option is wide open. In fact, his reassurances have been so effective, that now the market is treating that once-unthinkable scenario as the baseline outcome. There is little doubt that severing the economic links with the diplomatic ties would carry serious economic and financial ramifications – the IMF, BOE and even the UK government have provided stark assessments. Yet, at what point would the Sterling be fairly valued for a hard break should it come to pass? That is open to interpretation – and the market will be making its best effort to find that balance so long as Boris Johnson voices his appetite for ‘no-deal’.