Will the White House Pick a Fight with Europe?
The long-awaited first step towards de-escalating the most taxing trade war in modern financial history – between the US and China – took place this past week. Representatives for both countries, US President Trump and Chinese Premier Liu He (notably not President Xi) participated in a very long signing ceremony. The contents of this first stage for finding a long-term and full compromise is important as is stands as the symbolic doorway with which these two superpowers can continue to work towards a true compromise that sees all the steep tariffs (largely put on by the US) rolled back and China take on the role of a norms abiding ‘developed economy’. That said, we are still critically lacking a path towards reversing the tariffs on $360 billion in goods already in place as well as acceptable monitoring for technology transfers and intellectual property protections. For now, we may find ourselves in a sort of purgatory for relationship between the two.
Looking out over the week ahead, however, trade will remain top of mind. For one thing, the World Economic Forum in Davos is likely to address the scourge of trade war just as it did last year. As confrontational as the members were the last go around, the tensions did not actually boil over into actions that the market would have to account for in price. That said, we do have a particular possible flashpoint staged by officials. The US and France set a deadline of January 21st (Tuesday) for negotiations over the controversial digital tax that the latter announced for large tech companies last year. The White House considers this a burden disproportionately applied to US companies and has threatened to retaliate against France if it is not lifted. A $2.4 billion tariff has been threatened if an agreement could not be struck. In turn, France and the EU’s trade chief have remarked that they are prepared to retaliate should the US act to retaliate.
Let’s also not forget that there is another front to this battle already underway. The US has pushed forward with import tax on $7.5 billion in European good in response to the WTO’s ruling that the EU had unfairly subsidized Airbus and that the US could pursue recompense. Turning the screws further, the US has threatened to pursue further tariffs after a follow up evaluation by the World Trade Organization’s report that Airbus aid was still not fully curbed. European officials will have their day though as a ruling by the same organization is due on Boeing and the United States’ support soon – likely this month. Will the US ease off?
Monetary Policy Will Gain Traction When Questions Over Reach are Asked
Monetary policy has been relegated to the backdrop as a systemic fundamental theme these past months, but its influence has not actually ebbed. The collective global yield (benchmarks set by the largest central banks) and additional stimulus infused into the system is still historically unprecedented. That reality seems to have simply become a natural part of our environment. Yet, a dependency on what was previously considered extraordinary monetary support – emergency stimulus – should not be viewed as a healthy foundation. For one thing, it leaves the world’s largest policymakers with very little in the way of ammunition to fight any future economic or financial fires that arise. Furthermore, the external support seems to have encouraged investors to bolster their exposure to ‘risk’ rather than seek value and help find balance in the system.
In the schedule of large central bank meetings ahead, we will see this stretched situation for authorities and markets raised between the Bank of Japan (BOJ) and European Central Bank (ECB). The former will announce its policy mix Tuesday morning after the liquidity lull caused by the United States market holiday the previous day. This group is unlikely to change focus on the 10-year JGB yield target and its essentially-zero benchmark rate, but their reiteration of having room to do more if necessary and seemingly indefatigable optimism for a recovery in the future is drawing more and more skepticism from the market given the constant shortfall on objectives. They are perhaps the most over-extended of the major banks as a percentage of GDP. The ECB isn’t as exposed as its Japanese counterpart, but the changes this past year stand out more prominently. The return to QE and drop further into negative rates has more members of their board questioning what are the costs of this extreme policy. The group is due to announce the results to its review of framework which could either bring serious change to modern monetary policy or act as a foothold to skepticism over the old guard.
Another central bank worth watching this week will be the Bank of Canada (BOC), which is not expected to alter its rate and struggles to stand as a model for global policy – whether the average or extremes. Instead, this group’s dovish or hawkish lean could offer influence to the Canadian currency. And, given their general perspective of balance, moderate shifts could give charge to pairs like USDCAD.
Range, Breakout or Trend Conditions?
This is a topic that I have raised before, but it deserves to be revisited at regular intervals as it can significantly influence your ability to navigate the markets. I think most would agree that conditions change, and it should thereby stand to reason that we should adapt to the evolution in order to reasonably pursue profitability. In general, I believe there are three types of market environment that we progress through depending on liquidity conditions, volatility and prevailing fundamental themes. Range or congestion, breakout and trend are three distinct environments that cycle progressively almost regardless of the time frame we consult. Naturally, if you have tuned your analysis to one of the three and/or established a trading strategy that is optimized for one, a systemic shift in the market will leave you adrift. It is absolutely possible to appreciate your conditions and adapt; but those that think they can create a one-size-fits-all approach are deluding themselves.
So what kind of market conditions are we dealing with? This is something I ask myself at least at the start of every week. There are some very interesting cases to be made by a few key assets out there. US indices for example have been climbing fairly steadily these past three months. On that alone, we can call a trend. However, the pace of the Dow’s advance is extraordinarily restrained; and there are not many markets that reflect the same intent. Recently, a bid for risk-based catch up from the likes of the FTSE 100, the EEM emerging market ETF and debatably some of the Yen crosses look like they are just recently clearing prominent resistance levels. That may be true, but breakout is defined not by a laser-accurate level but the measure of follow through when it is cleared. There seems limited backing for follow through. That leaves congestion. There are plenty of false starts and large ranges to point out. Furthermore, remarkably low volatility levels doesn’t support the immediacy of breakout. FX Volatility measured by JPMorgan’s global measure has dropped to a record low this month. As a mean-reverting condition, activity will normalize; but it doesn’t have to do so immediately.