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  1. Make or Break for Brexit? There have already been so many twists and turns in the UK’s efforts to negotiate its separation from the European Union that that investors are getting dizzy. It is troublingly difficult to gain a reliable bead on a probable outcome for this stalemate, but the lack of time and dwindling hope of an outcome that will satisfy the majority of those involved raises the threat of a ‘bad’ outcome and even worse market response. This is not one of those events where ignoring the risks can prompt complacent gains. Once again, we are coming up to a key milestone in this saga where conditions can continue with a narrow course forward where the best case scenario still reflects considerable uncertainty and no small measure of market fallout. Or, it can be pitched into disarray. If you are monitoring the march forward of this fraught Brexit divorce – and you should whether you have direct Pound or UK investment exposure or not – highlight on your calendar Parliament’s vote on Prime Minister Theresa May’s proposal Tuesday. The draft was made in concert with EU negotiators which produced a result that theoretically both sides could sign off on. That would seem a viable course forward if not for the level of discord in UK politics. Rhetoric surrounding the Prime Minister deal is distinctly harsh from both the conservatives who found vindication in the referendum outcome as a sign of a clean break as well as Labour and other groups who are attempting to keep economically supportive elements of EU access or do not support the withdrawal altogether. It is likely that Parliament votes the plan down which will open up a range of scenarios – very few of which are will avoid deeper trouble. After a rejection, the government has three weeks to work another deal, but the EU will be far less interested in an agreement that asks for more and the rapidly diminishing time frame will leave little opportunity to warm counterparts to their side. Parliament voted this past week – after finding the Prime Minister in contempt for refusing to release official legal advice on Brexit – to give itself greater say over the proceedings should her plan be rejected. This is likely to empower the MPs to demand more favorable – but perhaps ultimately unworkable – terms. It may also raise the pressure for a second referendum. Previously May has rejected the option outright, but recently she has floated the idea. It comes off more as a threat for conservatives to get in line, but she has said there is a choice of “my deal, no deal or no Brexit at all”. Two of those three options are considered assured crisis to all the relevant parties involved; and unfortunately, that third lesser evil is different for all of them. Beware Pound volatility and the risk of fast moving local capital markets which can be exacerbated by the waning liquidity in these final weeks of the year. This December is Already Bucking Seasonality Expectations As we have discussed more and more as of late, there are seasonal norms in capital markets. These unlikely cycles arise through a few different practical market occurrences. Mid-day direction changes in individual trading sessions, summer doldrums, quarterly earnings runs and more draw on reliable conditional developments that can shape conditions – though specifics like direction are still up to the unique circumstances that play out in the given period. In the final weeks of the calendar year, we have one of the most reliable norms in trading. For those that want the scene described in a short phrase, ‘Santa Claus Rally’ usually suffices as they can fill in the circumstances with their imagination. A reduction in liquidity for western holidays and/or a general sentiment is seen as the foundation for a market’s performance. The liquidity aspect is at least correct and conditions earned through collective habit can often fill in the rest. However, when we follow this theme to the assumed bullish-backed trend, there are certain environmental criteria that need to support the outcome. Normally, the pending risks column needs to either be small or populated with issues that can readily be deferred until more convenient market conditions return. That is not the case now with growth forecasts slowing, warnings of financial risks growing more numerous (from the likes of central banks and IMF), trade war consequences kicking in and political risks splashing the headlines. These are not issues that can readily be shelved and they are receiving media attention on a regular basis. With this backdrop, there are frequent sparks that can provoke panic which makes the backdrop all the more threatening. If an otherwise contained crisis arises somewhere in the world, the thin market conditions can amplify the ill-effects of panic to spread well beyond its normal reach. And, while it may not be capable of a lengthy collapse of the financial system through such diluted conditions, it can lay the groundwork for a vicious cycle that begins the process only to catalyze fully when markets fill out – much like a nuclear reaction. In portfolio and statistical theory, it is not advisable to position for collapse against these seasonal norms as the probabilities are still skewed in favor of the norms. However, it doesn’t mean that we need to be utterly complacent with the risks that we hold. Reducing size, diversifying away from ‘risk’ markets or buying hedges reduces your beta exposure, but it isn’t like we are missing out on opportunities through a period that will be ‘dead’ in the base case scenario. The volatility we have experienced this past week, the past two months and in two distinct periods over the year (Feb-March and Oct-Nov) are a reminder that we should be more proactive with our reducing our exposure to the capricious unknown. Who Faces the Greater (Probable) Systemic Threat: Dollar or Euro? Everything in investing is a probability – that is a mantra I repeat to myself to avoid the delusion of certainty in a view or position. To put belief into action, I try to always lay out the probable scenarios for a particular market, asset, event, etc. Even if I consider a certain outcome more likely, considering the alternatives can help to identify earlier when the theory isn’t panning out and to even help stage an actionable strategy for a lower probability path. Most of the time in trading, the focus is to identify best case (the most productive bullish) scenarios, but there is just as much value in projecting worst case outcomes and their probabilities. This can help us avoid markets with a severe probability/potential imbalance or even identify better trading opportunities – I would rather pursue a short in a productive bear trend than suffer a long exposure in a choppy bull market. In evaluating the majors for their practical ‘worst case scenarios’ (those outcomes that are severe but not wholly unlikely – or qualifiers for a true ‘black swan’ designation) I think the Dollar and Euro deserve closer observation. For the Pound, the market is well aware of the possibility of a bad fallout from the Brexit which puts investors on guard and making moves that help to hedge risk. The Japanese Yen is so inextricably tied to risk trends and the Bank of Japan’s policy so open-ended that other issues struggle to compete for anxiety. For the Euro, a return to existential rumination on the currency union with the Italy-EU budget standoff is a still-underappreciated issue. The bulls in the market likely look back to the situation with Greece and assume a routine path for any future confrontations to be resolved in the same way. That is presumptuous to be negligent. The fact that this is occurring after Greece and during the UK’s bid for a withdrawal (admittedly from the EU and not Eurozone) should raise the level of concern significantly. It hasn’t. Perhaps the lingering premium afforded the currency for the eventual turn from extreme accommodation by the ECB will be the first dashed enthusiasm to awaken market participants of more unfavorable outcomes. If a country were to leave the currency union (EMU or Eurozone), it would fundamentally change the appeal of the currency as a global unit by significantly reducing the size of its collateral (GDP and capital) which would in turn significantly increase its perceived volatility. And, those are critical properties of a currency. The situation is unusually similar for the US Dollar. The pursuit of trade wars inherently encourages the world to redirect funds away from the US Dollar to avoid the policy conflicts that it brings (in trading terms, the volatility). Meanwhile, the rising deficit becomes increasingly problematic as the cost to service the massive debt rises and outside demand dries up. This can lead to a general shift away from the Greenback’s use permanently which the market won’t fully appreciate until much deeper into the situation. Similarly here, the market may more readily recognize something is wrong via monetary policy as the Fed adjusts to some form of the systemic risks by slowing its pace of policy normalization. So, which currency faces the longer-term – but still reasonable – risk? The Dollar. The ubiquity of the currency globally (nearly two-thirds of all FX transactions) means that it has far far more to lose should its use diminish. And that is very likely as the threat of further credit quality downgrades occur owing to its appetite for debt and its withdrawal from the global markets.
  2. Weeks Left of Liquidity, A Laundry List of Unresolved Fundamental Threats We have officially closed out November Friday and we are now heading into the final month of the trading year. Historically, December is one of the most reserved months of the calendar year with strong positive returns for benchmark risk assets like the S&P 500 along with a sharp drop in volume and significant drop in traditional volatility measures (like the VIX index). There is a natural, structural reason for this moderation. The abundance of market holidays, tax strategies and open windows for various funds all contribute to this norm. That said, there is another element that plays as significant a role in the seasonal pattern as any practical influence – if not more – and that is habit. Mere anticipation of quiet during this period does as much to ensure a self-fulfilling prophecy as the practical developments of the period. Yet, assumptions of quiet when the market as a whole – and most traders individually – have so much exposure to surprise financial squalls would be particularly poor risk management. Through the final full week of the year, the markets will be severely drained by market closures and limited time and market depth to meet the tax and portfolio redistribution windows. Looking ahead, it is first important to assess the practical time lines of full liquidity. The next two weeks (the first half of December) are only sheltered from unforeseen storms by expectations alone. It would be prudent to at least be engaged and dynamic in the markets through this period. The third week of the month will see position squaring take its toll on speculative positioning and liquidity. This is a useful time as we can establish where investors believe the most aggressive risk exposure is held (‘risk on’ or ‘risk off’) as they unwind anything with a shorter-duration holding period. Through the final full week of the year, the markets will be severely drained by market closures and limited time and market depth to meet the tax and portfolio redistribution windows. To general a strong market move – trend or even a severe drive – would take an exceptionally disruptive event for the financial system. I am concerned over the complacency in the market, but not so apprehensive as to believe we will tip the beginning of a lasting financial crisis through the final week of the year – and yes, it would be a bearish run if anything as there is virtually no chance of a sudden wave of greed that will bring investors back to such a fragmented and thin market. That said, there is still plenty of potential/risk that conditions could deteriorate exponentially through the first half of the month owing to the convergence of structural and seasonal circumstances. In general, a near-decade of uninterrupted speculative advance has started to lose traction as market participants have recognized their dependence on extreme but limited monetary policy, the growth of securitized leverage and sheer self-enforcing momentum. In 2018, we have seen conviction built on that unreliable mix start to falter with severe bouts of momentum in February and October with sizable aftershocks in March and November. This speaks to the underlying conditions in the market that could fuel a sweeping fire if properly ignited by any of a number of systemic threats that we are tracking across the global markets. Trade wars, Fed policy, convergence of global monetary policy, lowered growth forecasts, breaks in trade relationship (Brexit, Italy, US,etc) and other issues are systemic threats that have gained some measure of purchase these past months. If there were a sudden panic spurred by recession fears for example, then the drain on liquidity naturally associated with this time of year could in turn amplify fear into a full-blown panic with systemic deleveraging into 2019. Now Everything Fed-Related Carries More Consequence There has been a notable shift in Fed policy intent, and the markets will be engrossed with interrupting exactly what this course correction will mean for the capital markets. Though there has been subtle evidence of a waning conviction in pace for some weeks, FOMC Chair Jerome Powell made it explicit (well, as explicit as their careful control of forward guidance would allow) in his prepared speech on the bond markets in which he remarked that the group was perhaps closer to its neutral rate than previously expected. Now, some would say that is merely practical observation that after three rate hikes in 2018, they have closed in on their projected ‘neutral rate’ range of 2.50 to 3.50 percent. We could still keep pace and extend the most hawkish forecasts and hit the top end of that scale. That is true, but we have to remember what the central bank’s primary monetary policy tool has been over the past half-decade. There has been a notable shift in Fed policy intent, and the markets will be engrossed with interrupting exactly what this course correction will mean for the capital markets. It hasn’t been changes to the benchmark rate or adjustments to the balance sheet but rather forward guidance. They have gone to exceptional lengths to signal their policy intent without making promises for the course so that they could back away from extreme easing without triggering a speculative panic based on exposure leveraged by years of excess backed by the vaunted ‘central bank put’. If so much effort is being put into this tool, then changes should be taken seriously rather than downplayed for convenience of a comfortable trading assumption. If there was intent behind the subtle change in rhetoric, it is an effort to acclimate the markets in advance of an event whereby the forecast will be delivered in black-and-white without the ability to establish nuance before the market’s respond with speculative shock (an event like the December 19 rate decision whereby the Summary of Economic Projections will make explicit the rate forecasts). If indeed this is the objective to temper the market before the frank forecast is offered, then each speaking engagement and key data update between now and then will carry greater consequence. In the week ahead, we have Powell testifying before the Joint Economic Committee, which is a perfect opportunity to slightly extend the effort to make its intentions known. Recognition of this undertaking is the first step. Establishing what it means for the Dollar with rate premium and risk trends that have found confidence in the central bank’s reassurances will be critical. G20 Aftermath Produces an Official Communique and US-China Trade War Pause Pop the corks. The G20 has agreed to an official communique while the US and Chinese Presidents made a breakthrough on the escalation of their escalating trade war. Yet, before we over-indulge in risk exposure build up, we should perhaps look further ahead to the hangover that confidence in which this development is likely to lead us. Typically, an official press briefing that all the leaders agree to (dubbed the ‘communique’) is routine. However, with the rise of populism in the global rank and subsequent deterioration of relationships, simply signing off a commitment to shared goals of growth and stability has become an exceptional milestone. The leading consensus heading into this gathering in Argentina was that no official briefing would be released as the United States would not approve anything that would set its America-first agenda into a negative light. Further, China would not sign off on a statement that cast its own policies as unfair trade. In years past, such a development may have spurred the next leg of a yield chase; but recognition of the risk/reward imbalance is far too prominent nowadays. Perhaps recognizing the deteriorating sentiment amongst businesses, investors and consumers globally; the other parties would not demand these inclusions as protest for making so little traction with their constant protests. The indirect references to US and Chinese policies were left out. That is not genuine progress but simply self-preservation. As for the more remarkable ‘breakthrough’ in US and Chinese relations, the countries’ leaders found enough common ground to compromise a pause in the rapid escalation of their trade war. For discussing key economic issues between the two countries, the US agreed to delay the increase in its tariff rate on $200 billion in Chinese imports from 10 to 25 percent due previously to take effect on January 1st. The threat made by President in the weeks preceding this gathering of adding another $267 billion in Chinese goods to the tax list didn’t seem to warrant specific reference – perhaps as a backdoor strategy or because it would assumed to be included. This is a pause in the escalation of activities rather than a genuine path back to a state of normalcy where collective growth is the foundation for the global economy. This is the bare minimum for registering an ‘improvement’ in relations, and it will be this thin veneer of progress that will truly test the market’s appetite to source anything of ancillary value to build up speculative exposure. I doubt this will inspire a true effort to significantly build up exposure in these unsteady times. In years past, such a development may have spurred the next leg of a yield chase; but recognition of the risk/reward imbalance is far too prominent nowadays. The question is how long this pause in an explicit outlet of fear lasts? Long enough to carry us through the end of the year? We’ll find out soon enough.
  3. A G20 Meeting of Extreme Consequence As far as summits for leaders of the world’s largest economies go – in other words, an already very important affair – the gathering in Argentina this coming Friday and Saturday is crucial. There are a host of global conflicts that will inevitably be addressed at this gathering, but certain aspects will preoccupy the market’s immediate focus. It will be important to recognize what will carry the weight of speculative interest. On the one hand, there are discussion points of great consequence socially and culturally, but those issues will not show their economic consequences much latter and therefore will be largely ignored but for niche corners of the market. An example of this type of discussion point is climate change which has taken on greater importance with countries pleading with the US following its withdrawal from the Paris Accord and the strong of recent, dire scientific reports. In contrast, trade wars, is an ongoing threat to global economic and financial health inevitably drawing an inordinate amount of attention from market participants. There are a host of global conflicts that will inevitably be addressed at this gathering, but certain aspects will preoccupy the market’s immediate focus. Of course, the elephant in the room will be US President Donald Trump who has pushed ahead with the most consequential conflicts on international trade. There will inevitably be numerous pleas made to the leader of the free world to rethink his aggressive approach towards peers. That said, he likely has little interest to hear out there concerns. The mid-term election results will likely redouble his commitment to his current course. To be fair, nearly any outcome would have rendered such a result. Had the GOP swept the polls, it would have been taken as America showing its support. Yet with the outcome that was realized, there is a greater interest in pursuing those courses of action for which he can affect change without the of a divided Congress. And trade is just one such outlet. Alternatively, finding a course out of a discounted crisis could be registered as a political win – though what it would earn for the US markets is another matter. Avoiding a crisis (some would argue one self-manufactured) is not the same as inspiring genuine enthusiasm and speculative run. In particular, this summit should be watched for official and sideline commentary from the US-China discussions. Leaders of the two countries (Trump and Xi) are scheduled to discuss trade at the summit providing an ideal high-level opportunity to afford each an opportunity to claim a political victory. If they change decide to reverse course, it could offer considerable speculative relief and perhaps no small amount of recovery. This could very well be the strategy as Trump has voiced increasingly confident views of the relationship these past weeks that have been walked back by his administration – perhaps to build pressure. If we do see these two countries make nice and start the path towards recovery, yet markets do not translate the news into recovery, I would be concerned about what it reflects for sentiment. Alternatively, no encouraging course correction would be a ‘status quo’ outcome and keep our troubled outlook on its wary course. If the politicians involved want, they can render this event an obfuscated non-mover even without an official communique. Yet, subtly seems less and less standard a virtue of late. Liquidity Restored, Seasonality Conditions and Key Events The liquidity tide will roll back in over the coming week. As expected, the drain of US speculative interest this past week due to the Thanksgiving holiday played an effective role in sidelining a concerted effort to mount a system-wide advance or retreat in risk trends. However, the period didn’t end without its troubling signals for the future. The S&P 500 closed a thin Friday trade session with one of the least encouraging candles possible – a gap lower, larger ‘upper wick’, no ‘body’ between open and close and anchored to a noteworthy trendline support. The losses leading up to the US holiday reiterate a troubling frequency of painful losses for the benchmark US indices this year. What’s more, it serves to remind us of the fact that many other corners of the financial system – both in terms of region and asset type – have already trekked much lower. A retreat in US equities would be a general convergence towards significantly weaker global if that were the course that we took. ...if there were ever a time to worry about a passive climb in speculative positioning, it would be amid a wealth of overlapping and systemic financial risks. Yet, there is still the natural hold out for seasonal mood disorder – otherwise assumed to be a holiday rally. There is good statistical data to give weight to such expectations but of course there are exceptions to this norm. And, if there were ever a time to worry about a passive climb in speculative positioning, it would be amid a wealth of overlapping and systemic financial risks. From trade wars to the collapse of ineffective monetary policy regimes to growing evidence of excessive leverage (loans, debt, investor exposure), we are dealing with a potentially-toxic environment. As more factions in the global markets recognize the precarious environment for which we are exposed, there is greater threat to fragile stability in key event risk. There is a range of key global events and data due over the coming week. In the US, the Fed’s favorite inflation reading (the PCE deflator) will work with the FOMC minutes and Fed speak to set expectations for rate hikes in December and the pace in 2019 which have already suffered in recent weeks. In Europe, the Euro-area sentiment surveys and BoE’s financial stability report will anchor the focus on the region’s quickly fading sense of stability. Chinese and Japanese PMIs will give good proxy for recent GDP in Asia while actual quarterly updates are due from Brazil and India. Now is not a good time to embrace the comfortable warmth of complacency. As the Clock Winds Down for a Brexit Deal, Events Look More Ominous There have been a number of notable reversals in fortune for UK Prime Minister Theresa May and the course of the Brexit deal over the past month. And, with each successive ‘breakthrough’ the market has hardened its skepticism over the authenticity of a favorable path for the country’s divorce. We will see just how cynical the speculative rank and general public are at the start of this new active trading week. Over the weekend, May attended the EU27’s summit to discuss the Brexit proposal backed by the Prime Minister. European Council President Donald Tusk announced on twitter that the collective supported the bill, but enthusiasm was held in check with both lawmakers and observers alike. Top EU negotiators reportedly met May on common ground the week before, and the effort was ultimately doomed owing to PM’s own cabinet failing to offer up necessary support to move the effort forward. After the shakeup forced by the resignations of multiple cabinet members, there is little to suggest that she will have any easier a time of navigating the straights. There are also a variety of possible courses that end with May be ousted: from her offering up resignation, being pushed out by backbenchers, Labour mustering enough weight to force an election... In a few weeks, Parliament will put the deal to a vote; and confidence amongst its members has been shaky at best. Some – even key members to the Prime Minister’s support network – have suggested the current proposal would be not make it through. Should the deal be voted down, the clock will look beyond dangerous to the safe and stable withdrawal for the UK. At that point, May could stick it out and attempt to return with small tweaks latter which may not sway her government or will be too substantial and knock out the EU’s support. That would leave little-to-no time to earn agreement from all parties and scramble to get the passage approval with all governments along with the technical groundwork to set the dissolved relationship up for the March 29th cutoff. Either this course or an explicit refusal to back down on key items can push forward a ‘no deal’ outcome which Parliament has said it will rule against on – though it is not clear what the course will be from that point with so very little time left. There are also a variety of possible courses that end with May be ousted: from her offering up resignation, being pushed out by backbenchers, Labour mustering enough weight to force an election or the PM calling a general election herself in an attempt to gain support. All of these would burn precious time that they negotiations do not have. And, then there is the outlier chance that Theresa May finally entertains the idea of a second referendum which she has adamantly rejected so many times before. That would stop the clock if it were to end with a vote against Brexit or perhaps be used to strategically reset the clock. Whatever course we take, the clock has dwindled and all developments that are genuine progress register as a step to serious pain.
  4. Another ‘Brexit Breakthrough’ Falls Apart Yet another potential breakthrough in the Brexit stalemate seemed to be hashed out at the beginning of this past week following hours of legal negotiation and closed doors discussions. Supposedly, a draft bill was worked out that both the Prime Minister and top European Union negotiators were comfortable moving forward with. If there were only two parties which needed to be satisfied in this divorce, that would be that. However, there are multiple parties whose needs in this debate are collectively at opposite ends of the spectrum. And, that inability to satisfy all these necessary groups once again torpedoed hope of progress. After hours of one-on-one meetings with her cabinet, the PM announced that she had received the support of her council only to see the foundation crumble again when a number of her senior cabinet members suddenly resign. And so, the confusion remains and time to work out a viable solution winds closer and closer to zero. It is important to remember the complexity involved in withdrawing from the EU – a move that has never happened in the collective’s history. Approval of the deal is only the first stage. Consent needs to be offered by all member governments and the technical steps need to be implemented in preparation for the first day of the actual split (March 29, 2019). So, even though politicians continue to voice optimism and time, the reality is that their initial assessment was the deal was necessary months ago in order to facilitate a reasonable transition. Moving forward, each week that passes without agreement is going to be met with exponentially greater concern by global investors and businesses. Inevitably, to make the critical breakthrough, one of the major vested parties will need to capitulate on a key point of their position. Remaining in the customs union for the indefinite future for work around on the Irish border is one primary sticking point. It remains an outcome of a hard break or soft withdrawal that keeps the United Kingdom one foot in the Union against the wishes of the Brexit supporters with a black-and-white interpretation of the referendum back in 2016. In my view, there are two general outcomes for this standoff: a compromise or no deal. There are many different possible variants for how the separation can look – with their pros and cons, virtues and vices. Yet, each would represent a plan. Alternatively, a failure to find common ground will disadvantage the United Kingdom and the European Union (more the former than the latter if you really want to keep score). An agreement – any agreement – is needed to prevent a European crisis from developing. And, a crash out would almost certainly start a crisis for the region. Global economic and financial conditions are already tenuous as it is with numerous other threats prodding our over-inflated, speculative balloon including trade wars, Italy threatening EU fiscal stability and recognition of the limits of effectiveness for global monetary policy. A recession-inducing and short-term credit crisis arising from a messy break in this event is certainly one of catalysts broad and acute enough to start the wheels turning on a global scale. Remembering the Volatility and Volume Relationship for Thanksgiving We are heading into a known draw in global liquidity this week. The Thanksgiving holiday is distinctly a US market closure, but the break in liquidity from a major financial hub is so well-known – and inconvenient – that the world tends to accommodate the drop in market depth. There is an important measure of habit that fulfills seasonal expectations in performance and activity level year in and year out. If you believe a speculative run that is starting to form will hit a road block because the subsequent session will drain half of the world’s liquidity, would you take the outsized risk exposure in hopes that the drive is so remarkable that it will overcome the disruption? There is one particular scenario for which I believe that an exception to establish an explicit trend despite a thinned market would actually occur: a panic-induced risk aversion. Greed is difficult to gain foothold as opportunities are not often seen as so fleeting as to require such a quick reaction as to override a contented sideline exposure. That said, a sudden crash in the market that puts in jeopardy a fund manager’s or individual’s capital can certainly override confidence in a quick burn. Ultimately, there is a distinct relationship between volatility and volume – or, in more universal abstracts activity level and participation. In a bit of a ‘chicken and the egg’ parable, it is somewhat self-evident that volatility and volume move hand in hand; but not which leads the other. So long as there isn’t an overwhelming threat to the global financial system for which European, Asia and North and South Americans (who are not the US) are driven to flee regardless of America’s participation; the low volume will inspire low volatility. And, for those that have not kept tabs on the VIX or other implied volatility measures, this aspect of the market is considered a ‘risk’ measure with an inverse correlation to benchmark capital market exposure like a long equities index position. If, on the other hand, there is a sharp increase in volatility, it will either draw more volume in to facilitate the development of a trend or cause an extreme response in the market similar to a tsunami gaining height as the water’s depth decreases heading into shore. Normally, I would be little concerned about conditions ahead, but given the list of systemic threats that circle just outside of the market’s comfort zone, it would be risky to assume quiet. A Trade Deal – No Trade Deal – No Credibility It is getting difficult to believe updates on the United States’ position in the global financial system and the prospects of the country’s growth moving forward. It has been a feature of the landscape for years (well into the past administration) to see the promise of an economic improvement crushed by political gridlock. However, the defusing of confidence is happening more rapidly, arising from within a single party and the stakes have grown so much larger through subsequent years of speculative build up. A good example is the infrastructure program that has been touted since the 2016 Presidential campaign for which both Republican and Democratic front-runners vowed to pursue to accelerate growth. Now passed the mid-terms, we have not seen progress made on the fiscal stimulus (though the tax reform and regulatory rollback did earn some points for the buoyancy). President Trump referenced his willingness to return to the effort this past month, but Senate leader Mitch McConnell threw cold water on market hopes when he said the program would not be considered unless it paid for itself – very difficult to do after a tax cut. An infrastructure bill would be an ‘addition to the economic outlook’, while an end to the trade war would reflect the ‘removal of a threat’. Said removal has been something the market has harbored some measure of hope would occur and likely one of the key reasons risk assets like US equities have not imploded. Trump seemed to give traction to that confidence earlier this month when he said that progress was being made in negotiations with China and a deal was on the way after a phone call with his Chinese counterpart, President Xi. The rally that followed those remarks however were quickly stifled when his chief economic advisor outright contradicted the President’s assessment and instead said he was even more concerned about the future than he was previously. One false dawn is enough to undermine the market’s confidence in taking such remarks in the future at face value, but a second time within a few weeks will almost ensure it. This past week, Trump again said a deal would be done with a short list of items left to work out and the need to apply the last tranche of tariffs against the country perhaps not necessary. Before those remarks could take any serious traction, White House officials followed up by saying the market should not read into his remarks. They seemed self-explanatory with no interpretation necessary, so the check reads as outright contraction – a move that will certainly curb the use of forward guidance into the future. If you want to see the fallout from losing the ability to direct market’s to views for the future, look to Japan or Switzerland.
  5. Will Holiday Conditions Save Us from Fundamentals and Speculation? Normally, there is not a strong appetite for holiday trading conditions because it can materially slow markets – and most traders seek out volatility, even if it is as much a risk as a basis for potential. However, this year, there will be a strong appetite for the typical conditions associated with the time of year. In 2018, we have seen an extraordinary bout of volatility with dramatic bear waves in benchmark risk assets like the US indices through February and October while the progress of the previous years of this decade long bull run has grown increasingly uncertain. We have yet to see a commitment to a bear trend by the S&P 500 and its ilk, but it is a far greater probability in these conditions – systemic shifts more readily occur after periods of consolidation rather than sudden ‘V’ tops or bottoms. It is against this backdrop that the promise of November and December seasonal performance expectations can raise hopes. The ‘holiday’ markets and ‘Santa Clause Rally’ are popular reference to the same general market conditions. Through the closing 8 weeks of the year, holidays break up the momentum that can build behind systemic trends, losses are booked for accounting purposes and open period for funds encourage portfolio changes. There is a reason that such seasonality expectations exist, there is statistical relevance behind the views. Yet, as the saying goes: ‘this time may be different’. Historically, the S&P 500 has accumulated an oversized portion of its annual gains through the final two months and the VIX volatility index has in turned dropped through the same period denoting a reduction in the variability of returns (in other words, risk). That said, conditions and context matter. If the markets are unstable and there is outsized exposure, sparks can turn into flames that raze a financial system. There are plenty of catalysts to track as potential catalysts of crisis, from trade wars to political instability to monetary policy normalization. Yet, it is the general state of the financial system that truly represents the threat. The excessive leverage taken on by investors (notional and thematic), businesses (buy back shares with proceeds of bond issuance), consumers (revolving credit and housing) and governments (growing debt burdens) makes the growth we have enjoyed these past years look borrowed and far more threatening than reassuring. That excess is already showing through in certain corners of the financial system. The steady dive in emerging markets, high yield fixed income and global shares relative to the unrealistic buoyancy of US stocks signal some sign of recognition. Nevertheless, it is clear that such appreciation hasn’t translated into capitulation. Deleveraging is essential and it will occur via intent or force with timing dependent on the method. Pushing Brexit to the Breaking Point An emergency November summit between European Union and United Kingdom leaders to secure a deal on Brexit will only occur should the latter party make significant progress on its position involving critical points of impasse at the previous meeting. And, recent reports don’t offer much to be enthusiastic about. Multiple times over the past month, we have seen enthusiasm trumpeted on breakthroughs among UK government and between the UK and EU; but each time, that confidence was quickly snuffed out. It seems virtually impossible to satisfy all relevant parties in this stalemate. The Prime Minister’s cabinet has a concentration of hardliners that demands no alternative to an absolute Brexit is acceptable. In contrast, Parliament is more flexible in its interest to maintain some connection to the shared markets and is willing to bend on some points of contention – though the number of its rank open to a second referendum creates some inherent difficulty. And, then there is the EU itself. The collective wants to maintain strong economic ties with the large economy, but it is not willing to make exceptions to its requirements for access for fear of other countries demanding the same benefits as they file their own Article 50 withdrawal intentions. This past week, the UK’s transportation minister resigned from the cabinet owing to his belief that the deal they can reach with the EU would not be the Brexit that the country had voted for, and a second referendum on the new terms would be necessary. Ultimately, this will not materially change the general complication of the process; but it does speak to the frayed nerves and quickly winding down clock. PM May has stated repeatedly that ‘Brexit means Brexit’ and that they fully intend to push forward when the two-year time frame for Brexit negotiations expires at the end of March. Adding the countdown to this situation only raises the risk that difficult negotiations will ultimately prove a push over a financial and economic cliff. If there is ultimately a breakthrough immediately at hand, there still are significant difficulties brought on by the short time left to work up technical requirements and to push through approval for all the member countries. That said, should the situation continue to shamble forward, the risks grow exponentially as businesses and investors move operations to avoid the unknowns that they march towards – already the 3Q GDP figures reported a further reduction in business spending. The flight in capital will in turn slow growth and undermine confidence figures which slowly graduate into more systemic economic factors. A financial crisis may not come to pass until later, however, as liquidity can hold up to hesitation – though not capital flight. It is growing clear that there is no ‘best case scenario’ with this situation whereby there will not be additional political, economic and/or financial stress for some participant in the divorce. Investors should be concerned with the subsequent issues, but they may not have the luxury given the threats so prominent in the immediate risks. Is an Italian-EU Debt Crisis Inevitable? Financial and political fractures in the European Union will continue to erode confidence for an entire trading session. In the week ahead, Italy’s standoff with the European Community over its plans to defy austerity measures the previous government had agreed to will hit another important deadline. After the EC rejected Italy’s budget proposal a few weeks ago for setting spending targets and GDP estimates too high, the country was told to go back to the drawing board to significantly reduce the projected 2.4 percent spending to GDP ratio it had planned. In the lead up that second effort due on Tuesday, Prime Minister Conte and Deputy PM Salvini made clear they had no intention of making significant changes to appease Brussels. If that is true, there is almost no chance that this situation will not devolve into some measure of an existential crisis for the Union. The middle ground is extraordinarily far for both parties with Italy operating on a voter mandate to rebuke austerity and Europe seeing little chance of avoiding an avalanche of anger amongst members should it make another exception to its budgetary rules to a country that has such an extraordinary debt in a general period of global economic strength and while so many of its peers are holding true to significant austerity. If the standoff between this country and collective does not turn off its current course, it could cause irreparable damage to the Euro’s standing in the currency market. The world’s second most liquid currency depends on the stability of its unions. If a member of this smaller subset were to leave – especially the third largest – it would carve out a significant portion of GDP and financial liquidity not to mention raise the risks of other countries following suit from ‘virtually zero’ to ‘probable’. Holding ‘European’ exposure against those risks would be a non-starter, especially if the situation were to unfold alongside global risk concerns (more likely). Specific interest in individual countries can continue to hold up, but identifying what portion of a country’s market will be unaffected by the financial ripples would be difficult and a bridge too far if risk aversion is undermines patience and nuance. Should this threat balloon, the lessons of the European sovereign debt crisis between 2009 and 2012 will be revisited. Yet, this time, populism is far more pervasive, the region is still recovering from the previous austerity and the central bank has no capacity to ramp up ramp up support beyond LTROs which will find its effectiveness as diminished as the QE program that replaced it.
  6. Remove the Political Bias, Focus on the Volatility There has been plenty of political risk keeping the markets at a steady simmer these past months. Some situations like Italy’s budget stand-off with the European Union and the Brexit negotiations are more overt concerns. However, the general rise of populism and the erosion of cross border diplomacy (trade wars, sanctions, failed trade deals, etc) represents a more systemic risk. Yet, despite the ubiquity of this fundamental influence, there is an explicit focus on this theme through the coming week in the form of the United States’ mid-term election. The discourse in the country has become toxic, which will leverage the domestic market’s attention and ensure a broad evaluation of influence to encompass the factors that can steer the economy. Further, given the pressure the United States has exerted on the rest of the world via tariffs and sanctions largely via the Trump Administration’s executive powers, the election takes on global significance. While there is little doubt that the world is watching, there is considerable ambiguity over exactly how it will impact the markets. With tariffs or another break down in Brexit negotiations, it is easy to draw the lines to market influence. In the US election, there is far more social stake and clash of personalities than direct financial implication. That is not to say the ultimate effect on the economy and market are not significant – they are. However, it can be difficult to separate these elements. Nevertheless, it is crucial that we do so. The foundation of successful investing is removing emotion from the equation as much as possible. Besides religion, there is probably nothing more likely to elicit emotion than politics. When we put aside the anger and mania that radiates out from this event, we are left with few possible scenarios that can translate into key domestic and global policies that can impact the markets (see Christopher Vecchio’s article on this for more detail). This election will only translate to the legislative branch when we account for federal reach on key positions. If the Republican party retains both the Senate and the House, that would be seen as the ‘status quo’ as it presents continuity to the situation we’ve had this past two years. It is far from a happy and functional government, but it would still be possible to generate short-term growth via a planned second tax cut plan and perhaps reviving the discussion of an infrastructure spending program. Yet, the growing debt load over the long-term paired against the risk of a slowing economy will loom. If the one or both of the houses of Congress flip to a Democrat majority, pressure will increase significantly. That will lead to difficult progress on programs and likely lead the President to fall back on executive powers to approximate his desires. Overall, that will punctuate the uncertainty and volatility in the markets moving forward – perhaps securing and hastening a more systemic risk aversion for which the market has been threatening since February. The Asymmetric Potential in the Fed, RBA and RBNZ Rate Decisions When there is an event like the US mid-term elections on the docket, it is easy to overlook event risk that is scheduled for release after – and even before – the systemic distraction. Exploiting a very different theme of speculative interest and source of growing concern over the coming week are three major central banks’ rate decisions. Each is expected to end in no actual change to their benchmark rate or other unorthodox policies, but the market is effectively tuned to the nuance for which they were reference in their accompanying reports. Before we consider the potential of each, it is important to consider the wholesale influence that they have on financial system. Whether individual market participants appreciate it or not, the stability and reach of their markets are heavily dependent on the extremely accommodative policies the major central banks have committed to over the years. The abundance of cheap funds has lowered the assumption of risk while also deflating the rate of return – necessitating riskier and leveraged exposure in order to make a competitive rate of return. That translates into considerable risk taking. Should the spectrum continue to slowly shift away from easing to early tightening – following the lead of the Fed – the more readily the masses will recognize the risk in their exposure. That will raise the sensitivity to risk trends and encourage de-risking that can accelerate into a crisis. As for the individual events themselves, the Federal Reserve’s decision will garner the greatest global attention. Despite – or perhaps exactly because of – the Fed’s tempo of tightening, the market’s do not expect a hike at this meeting. The fourth hike the majority of the FOMC forecasted in the September SEP was given a December timetable by the market’s. No change, but language that confirms a fourth hike would leave the Fed untouchable as the most hawkish central bank for carry purposes, but the market will treat it as status quo. The most feasible surprise would come in more restrained language that would curb established rate expectations which would in turn sink the Dollar (and likely risk trends). In contrast, the Australian (RBA) and New Zealand (RBNZ) policy events are expected to end with no change and language that reflects the same ‘neutral with a modest dovishness’ that they have maintained for the past few years. Both the Australian and New Zealand Dollars have deflated for months to the point where they have significantly reduced their responsiveness to their detrimental yield bearing. Even if the groups raised the stakes on their dovish views, it would likely translate into a small market response. Alternatively, should they offer any improvement in their view and possible intentions, there would be a disproportionate rally from their currencies. He Said, He Said: US-China Trade War, Brexit, Italy Though we do not have the benefit of specific events and time frames on updates for some of the other more systemic concerns lurking in the financial system, that doesn’t make them any less potent a threat. Though the coming week, there are three general themes of ongoing concern that will remain on my radar. The First is the US-China trade wars. This situation has managed to avoid a clear path much less a genuine resolution to the point that markets are starting to grow wary of any remarks that could be considered signs of an improved path. This past week, we were reminded of the importance of this cold economic war when conflicting views were espoused – this time on the same side of the negotiation table. The US President voiced his optimism that a corner was turned in the negotiations after a call with his Chinese counterpart with reports that he had called on his cabinet to draft a proposal to find a solution. That helped extend the capital markets’ rebound. Yet, that optimism was quickly muted when Trump’s chief economic adviser said he was not given direction to come up with a plan and that he was less confident about the future of the relationship than he was in previous months. And, just to ensure we were fully confused on the point, the President made further remarks soon after the adviser reiterating his initial statement. Look for any mentions of production discussions before the G20 summit over the coming week first as campaign rhetoric and after the election as planning. Across the pond, the Brexit situation seems to find itself steeped back into despair after brief interludes of optimism charged by supposed progress. At this point, the holdup is finding agreement on the UK’s side. Last week, the earlier reports that the Prime Minister was willing to make concessions on an important point of disagreement to make a breakthrough, progress yet again stalled as her cabinet revolted. There is a cabinet meeting on Tuesday. Theresa May will need to get an agreement from her own government under the new parameters whittled down with the last EU Summit rejection. In the background, there are rumors that a solution is being honed in on, but their rhetoric in public certainly isn’t doing them any favors in market and business sentiment terms. Then there is the clear contrast in perspective between the Italian government and other European Union leaders. There is no ambiguity in this contentious disagreement. Italian leaders have repeatedly committed to increase spending well beyond what the EU considers acceptable. European leaders and central bank members have shown little interest in making an exception to the austerity rules for the region (and a backstop should market’s punish Italy in the latter’s case) for fear of losing stability internal and confidence externally. If capitulation is not found from one side, there is really no alternative solution as they head towards an existential crisis for another member finding its way out of the Union. And, unlike the UK, Italy is more deeply integrated as a member of the monetary agreement that shares the same central bank and currency.
  7. Risk Trends – Monitor Liquidity Closely Sentiment is turning increasingly septic across the financial markets. This past week certainly wasn’t the first week that signs of trouble were starting to show. However, a clear capitulation by one of the favorite benchmarks of hold-out bulls – US indices – has undermined one of the few reliable backstops left. The S&P 500 and Dow have been in retreat through much of October after hitting their respective record highs. Up until this past week, the slip still fit the mold of a measured retreat for which the ‘buyers of the dip’ have flourished. Yet, the past five-day stretch added a troubling gut punch to the opportunists’ gut. The major American indices, paced by the S&P 500, crashed through their respective multi-year bull market trendlines. While Wednesday’s 3.0 percent tumble was particularly acute, it was Friday’s more restrained drop that was perhaps more remarkable technically and a record setter. The gap lower on the open was the biggest in almost exactly 10 years (2 days off during the height of the Great Financial Crisis) and the largest on record. Furthermore, it the move that would treat a former critical level of support as new resistance. With this symbolic risk leader removing its support, we may find one of the most critical contributors to keeping the peace allowing progress as we slide into deeper retreat. Attempting to unload exposure but finding no market forcing a rapid drop in price to satisfy the offload is something completely different. As we keep track of this small sliver of the financial system, comparison to deeper and more productive retreat for global equities (VEU), emerging markets (EEM), junk bonds (HYG) and so many other important assets will act as a sort of speculative gravity. One of my favorite measures of genuine sentiment is to gauge correlation for these various risk assets as they commit to a clear and consistent trend. Yet, where that may indicate that sentiment is in control with a viable direction, the measures of intensity are different. Two crucial elements of a market that is tipping from controlled descent into relentless deleveraging are market positioning and liquidity. For market positioning, exposure can be assessed through open interest via derivatives like futures and ETFs. The net speculative futures position monitored by the CFTC (COT) is a significant medium-term evaluation – in contrast to the short-term readings from the DailyFX-IG sentiment data. That said, there are longer duration measures that we can utilize for trends. Total open interest in futures (for speculation and hedging signals), capital moving into and out of ETFs and leverage readings for different economic participants (investor, consumer, corporate and government) can all register the state of the financial system. As these readings start to reverse course and funds begin to prioritize safety over return, we begin to solidify a self-sustaining course. However, tipping the market into a true panic with all its important implications, we must monitor the liquidity behind the market. An abundance of selling overwhelming bullish interests is one thing. Attempting to unload exposure but finding no market forcing a rapid drop in price to satisfy the offload is something completely different. There are many ways to measure the strain on the system, but not all are made the same. I find many of the government (Cleveland Fed) and bank (BofAML, Goldman) measures are lagging. Spreads between market and sovereign (TED spread) or risk premium (high yield fixed income over blue chip) is more timely. Given how exposed investors are up the risk curve, the natural rolling out of the tide from higher risk and thinner markets can trigger a cascading problem in the opposite direction towards the core of the market. It is worth noting that late this past week, Japan’s central bank, Finance Ministry and financial authority (FSA) held an unscheduled meeting to discuss the tumble in equity markets (15 percent down in October). We should keep a close eye on whether more such concerns are confirmed on other points across the globe. Themes Versus Event Risk for Euro and Pound There are already significant fundamental winds blowing for the European currencies, but the storm will start to foster confusing cross winds in in the coming week. In particular, traders will have to untangle the influence between scheduled event risk and more systemic themes. We have seen this many times before in different asset types and different regions. How many times have we seen a high profile event draw the market’s attention in its approach only to find its ultimately impact waylaid by an unresolved and overriding theme? For this week, least severely conflicted currencies (hardly an inspiring designation) is the Euro. On the docket, we have a range of economic releases including inflation to region-wide sentient surveys. As important as those figures are, there is far more fundamental charge from the likes of the Euro-area 3Q GDP figures and Italy’s specific data. Italy will report its own GDP update, its monthly budget and other various indicators. We care about this specific country for its systemic, thematic influence. The standoff between the European Union and one of its most indebted members has hit a critical stage. The ongoing drumbeat for the Sterling is the unresolved Brexit, and we are fast approaching a critical deadline which looms like a cliff. Italy has made clear it has no intention of backing off of commitments to increase public spending to help spur growth through pensions, support for the poor and more. Yet the Union and other member countries’ leaders have demanded change to meet the previous government’s commitments and not run afoul of the Union’s restrictions. We were here before with Greece approximately 9 years ago. If this moves forward, the situation could prove far more severe as Italy is a core member rather than a small, fringe component to the healthy system. From the Pound, the fundamental conflict will be far more substantial. The ongoing drumbeat for the Sterling is the unresolved Brexit. This has been the general state of the market backdrop for over a year and a half. However, we are fast approaching a critical deadline which looms like a cliff. They have to start decelerating now to ensure they do not pitch over the ledge. Where it seemed last weekend a breakthrough was reached when it was suggested Prime Minister May was ready to compromise on the boarder, we saw late in the subsequent week that talks within her government had stalled over strong infighting yet again. We have few definitive dates to monitor for progress through the immediate future, so we have to rely on erratic headlines instead. In the meantime, the Bank of England (BOE) rate decision on Thursday carries more weight than normal. While speculation of another hike by the MPC (Monetary Policy Committee) before the end of the year has dropped off sharply, focus on policy standings has ramped up considerably thanks to the Bank of Canada’s rate hike. What’s more, this is one of the nuanced meetings for the BOE as we are also expected the Quarterly Inflation Report and Governor Carney’s press conference – which is collectively referred to as Super Thursday. Expect volatility but question trend. The Unique Signal on Risk from the Dollar, USDJPY and Aussie Dollar As we attempt to untangle the commitment in risk trends – a worthwhile pursuit given how much potential lays underneath this evaluation – there are a few measures in the FX market that deserve closer attention for their unique readings. First in that is the US Dollar. The most liquid currency in the world, this asset is often considered a binary safe haven. It is true that the currency represents a good harbor to stormy financial markets, but there are shades of grey to sentiment and to this indicator’s signaling. In the event that we see a full-tilt deleveraging of risky exposure, there is no question that the Greenback will climb. This has less to do with the depth of the currency’s own market, and relies far more on the international appetite for US Treasuries and money markets when the walls are falling down around us. When capital is fleeing to such safety, it first must cross the exchange rate barrier. However, short of the extreme measures capital shift, the Dollar’s status comes with significant caveats. This is a currency that has also drawn significant interest as a carry currency over the past few years owing to the Fed’s unmatched path of policy normalization. That hasn’t always afforded the USD lift, but it has factored in nonetheless. I would look instead for short-term opportunities. One such opportunity may come with the Australian Dollar and/or New Zealand Dollar. If we are in risk aversion that sees the Dollar drop, it is less likely to be the type that is systemic and associated to ‘panic’; while a USD surge would indicate something very different. This ambiguous picture of the Dollar can be extended to a specific currency pair as well: USDJPY. Both the Dollar and Japanese Yen respond to market sentiment as safe havens. The Yen is more appropriately ‘safe haven adjacent’ however as it is a funding currency that facilitates carry trade appetite. As confidence gives way to fear, a deleveraging of carry nevertheless sees the Yen appreciate and signals a change in course. Yet, what if the intensity picks up? The Dollar’s carry status would facilitate a drop in the exchange rate, but an extreme tempo would likely designate a more appropriate harbor from extreme fear. If it is difficult to evaluate confidence from the USD alone or via the correlation between assets, use the USDJPY as a barometer. We have done a lot of ‘preparing for the worst’. What if sentiment stabilizes and there is a rebound in risk appetite? First, it is important for me to qualify that I would not consider a bounce in risk appetite to signal a lasting trend. There are still deep, unresolved inequities between risk assets prices and their values. I would look instead for short-term opportunities. One such opportunity may come with the Australian Dollar and/or New Zealand Dollar. Both are carry currencies that have lost all appeal for their carry. They further have exposure to China which is troubling and host their own domestic issues (such as housing tension). Yet, if risk trends stabilize, there is deeper discount here than more confused outlets such as the Dollar or the Yen crosses. Further, these currencies have not dropped in recent weeks’ sentiment slump, which denotes a bias that can reduce risk and leverage potential under favorable conditions. There is still key event risk to monitor ahead such as Australia’s 3Q GDP and CPI, but we shouldn’t underestimate the opportunity should the course be set.
  8. The United States and China Jostling for Economic Supremacy The world’s largest economies are starting to update on the status of their health. And, though it may not seem to be the case in these speculatively charged markets, financial performance relies heavily on a healthy global expansion. This past Friday, China reported its third quarter GDP reading. The 6.5 percent clip would be an enviable pace for most of the developed world, but for this debt laden country, this is slowing to a pace that is more likely approaching ‘stall speed’. In historical context, the reading represented the slowest clip of expansion for the country in 9 years – a period that was plagued by a global recession that had in turn prompted the government to plow funding towards infrastructure spending to buy it more time. Time is crucial for the world’s second largest economy. It needs to be balance its relatively rapid pace of growth with financial stability long enough that it can solidify its position as one of the dominant economic superpowers. The United States’ effort to bring trade pressure against its largest economic peer will come with an economic cost to the instigator For decades, the country has relied on the rapid growth that is borne from trade, financing, speculative appetite and practices that emerging market countries often utilize that are considered unacceptable among their developed counterparts. That said, it is odd that the second largest economy is still classified as an ‘emerging’ market and one of the roots of contention from the United States and others. Over the past three to four years, China’s intent and timeline have become more clear. Having avoided a the Great Recession, they had seen their standing in the global economy move up to a more stable plateau. To ensure they secured their position, the government has attempted to turn towards a more accepted growth plan and to reduce capital borders in order to become a full-fledged member of the globalized community. Without interruption, that initiative would have succeeded. Unfortunately for the Politburo, the Trump Administration has exerted enormous pressure on the country and threatens to undermine growth and/or tip the financial stability balance to create a permanent hurdle. The question of how successful this effort to stymie the economic engineering effort will be is only one facet of the equation, there is also the question of how much fallout the US itself will suffer along the way. The United States’ effort to bring trade pressure against its largest economic peer will come with an economic cost to the instigator, which they are attempting to offset by fostering investment and business growth through tax cuts and fiscal spending – a combination that breaks norms of its own (deficit control). In the week ahead, we are due the United States’ 3Q GDP update. This is the period through which the trade war truly ramped up, and it will be used as an evaluation of whether the polices are boon or burden at home. Should this and other more timely economic readings head lower, buoyant sentiment readings over the past year will start to flag and make a self-fulfilling prophecy of financial concern. The Euro’s Fundamental Path is Growing More Complicated For the most part, the Euro has spent the past 18 months either in a fundamentally enviable position or simply a neutral bearing that could take advantage of weaker counterparts. Economic activity has been slow but steady with members bearing extraordinary austerity following the Eurozone sovereign debt crisis finally turning a corner. Further, the initial threat of the region having to pursue the same costly economic war against the United States was averted when EU President Juncker agreed with US President Trump to avoid further tariffs so long as both sides continued to negotiate. Meanwhile, the mere anticipation of a rate hike from the European Central Bank leveraged the kind of speculative front-running appeal for the Euro through much of the past year that so closely mirrored the Dollar’s own charge in 2014 and 2015. That passive state of speculative appeal is starting to falter however. While growth readings still seem to be following a stable path, the commitment to slower growth to achieve fiscal improvement through austerity is starting to break down. Populism is spreading across the continent. The FTSE MIB is suffering more acutely than its large counterparts and Italian sovereign bond yields are climbing rapidly. Chief concern in the evaluation of Euro-area conviction is Italy. The country’s government has applied pressure and backed off in regular tide of ebb and flow; but through these phases, ever increasing the tension. It seems we have reached the point of no return where rhetoric will no longer be enough to satisfy markets. Heading into this past week’s EU Summit, the leadership of the Italian government made clear that it intended to rebuff budget restrictions to support growth and fulfil campaign promises. There was no mistaking the Union’s perspective on Italy’s intended path: they said the spending and deficit projections in their plans were unacceptable. This standoff remains unresolved, but the financial markets are starting to pull back to curb their exposure to the risk. The FTSE MIB is suffering more acutely than its large counterparts and Italian sovereign bond yields are climbing rapidly. A 10-year yield spread of over 400 basis points over the Germany bund equivalent is considered a level akin to serious financial pressure. We were just above 300 basis points to close out this past week, but that was before the news after the close that Moody’s had downgraded the country’s credit rating a step to Baa3. That will have an inevitable impact on funds that have to abide credit quality when dictating their exposure. In the week ahead, we have another assessment of Italy’s financial condition coming from Standard & Poor’s. This fundamental impact on the Euro is not the only theme competing for influence. Monetary policy is another fundamental strut that could buckle or hold the currency strong through the growing pressure. There is no change expected from the gathering Thursday, but there is growing concern over the internal and external risks for the Eurozone. If they cool expectations for the first hike coming mid-2019, there is still premium for the Euro to give up. A further complication to consider: if the Euro drops materially, expect the Trump Administration to raise its pressure on the regional economy. Brexit Risk Jumps after EU Summit, Rumor of Border Breakthrough, Protests and New Credit Ratings The Brexit countdown is taking on a Edgar Allen Poe-level resonance. The European Union summit this past session was specifically targeting discussion between the UK and 27 leadership to see if they could make a high-level breakthrough on the divorce proceedings. The primary hold up at the end of the gathering remained the border issue and the complications that it invites. It may seem that there is plenty of time to negotiate with a little more than five months until the official split, but there is considerable work to do in passing the proposal through so many different governments and working out the technical aspects thereafter. So long as this situation is unable to pass the critical step of an acceptable draft agreement between both sides, the Sterling is likely to see steady retreat as capital funnels out of the country to avoid the uncertainty facing London’s financial center specifically. With the risks growing, the attention on progress will intensify. At the very end of the coming week – after the close Friday – we are due two credit rating updates on the United Kingdom from Standard & Poor’s and Fitch. With that said, there seemed a possible breakthrough in the closing hours Friday when it was reported that Prime Minister May was prepared to drop their Brexit demands on the Irish border issue in order to earn a breakthrough. Such a move would likely earn the ire of Brexiteers who would balk at likely permanent participation in the EU’s customs union. It remains to be seen if the UK’s government would back such a appeasement, but it doesn’t seem enough for many Brits. Over the weekend, a protest in London calling for a second EU referendum drew reportedly between 600,000 and 700,000 participants – one of the largest in the capital’s history. It is unlikely however that the government will return to the polls on the issue unless there are a number of political turns that force the issue. Ahead, we will have to keep a very close eye on the headlines to see what transpires in the political environment in England as well as between the UK and EU. That doesn’t mean though that there aren’t any meaningful milestones on the docket to mark on our calendars. At the very end of the coming week – after the close Friday – we are due two credit rating updates on the United Kingdom from Standard & Poor’s and Fitch. These groups have generally maintained a wait-and-see perspective until it became clear that there would be a compromise scenario or a crash out. However, time is a factor that they can no longer ignore in this equation. With each week that passes without a breakthrough, the economic and financial ramifications deepen. More stark warnings are likely if there is not a confirmation of the border issue and a downgrade is not impossible.
  9. Risk Trends Trembles, Is it the ‘Crazy’ Fed’s Fault Market’s suffered a painful correction this past week. From peak-to-trough, the benchmark I like to refer to as a measure of hold-out enthusiasm, the S&P 500, dropped nearly 8 percent. That is still a ways from the technical ‘bear market’ designation which is a 20 percent correction from peak highs, but that scale of loss from a seemingly indefatigable climber rattles confidence. To be clear, the slump in sentiment was not isolated to the US equity market. That was just among the more remarkable victims of the speculative swoon owing to its typical outperformance. Looking across the other capital markets with a risk bearing, there were meaningful losses registered from foreign shares, carry trade, emerging market assets and more. I don’t think [the Fed] are really to blame for this move, but they certainly contribute to the environment that has necessitated it. The intensity of these other assets however was notably less severe than what was registered from the lies of the S&P 500. Some would take this as an indication of source from and thereby restriction to US-based trouble. I, however, think this is just a retreat that is commensurate to how much premium there is to unwind. The US indices have continued there climb these past months while other related risk-profile assets have spun their tires either leveling out or falling into retreat. So, while the implosion by the Nasdaq 100 (dropping over 10 percent from peek) and its direct peers was violent, other sentiment forerunners like the EEM Emerging Market ETF registered smaller percentage declines to fresh multi-month or multi-year lows. The risk aversion was deeply rooted and carried wide influence. The question is whether the inexorable momentum behind a sentiment collapse is already underway. Much of that depends on motivation. We still have event risk that has set off few alarms recently as well as themes like trade wars which cued few explosions beyond their already-troubling contributions. US President Donald Trump took a jab at the Federal Reserve who labeled the group ‘crazy’ for tightening the reins on policy and seemingly laid the blame at their feet. I don’t think they are really to blame for this move, but they certainly contribute to the environment that has necessitated it. Years of expansive monetary policy that stretched far beyond the need insinuated by the economic and financial recovery encouraged/forced speculative build up to unsustainable levels. When the inevitable withdrawal has to begin, the monetary policy authorities of the world are held hostage by a predicament that sentiment has been founded on these groups’ shoulders. Through the end of this past week’s plunge, there was a remarkable bounce through Friday – with the largest opening gap for the Dow since 2000 – which will tempt the Pavlovian response from dip buyers. However, the reversion to complacency will not hold forever. The gap between major market corrections is diminishing as recognition of the major fundamental risks grows. Remain flexible and have plans for bound or utter unwind. Light at the End of a Trade War Tunnel? We have seen some of the more prominent fronts on the on-going trade war find some measure of resolution lately. The holdout in negotiations between Canada and US was resolved and the three members are heading to a resolution that will bring about the USMCA (US Mexico and Canada Agreement). Whether the new program is more fruitful than the old one for the US or any other member is up for debate, but the fact that the threat of serious financial fallout from uncertainty in no resolution is not. Could his give some clue as to how the US plans to conduct negotiations to their conclusion with other countries in its line of sight? It certainly could stand as a template for the likes of Japan and the European Union (EU). These two major economies have not fallen into outright economic conflict with the United States. The willingness to appease in order to avoid the repercussions of lost business, investor and consumer sentiment in the face of verbal threats may show through. The sanctions the US is returning to Iran are unlikely to be walked back, and that is creating greater tension with key trade partners (like the EU) which have economic and financial ramifications. However, that is not likely the case with China. The US has found comfort in going after a country many have decried for unfair trade practices in the past and they have already applied aggressive tariffs. That said, the US Treasury is due to release its assessment on China, including whether to label the country a currency manipulator or not. According to sources, they did not find the country met the designation, but that is up to Treasury Secretary Steve Mnuchin who will have the President’s words in his ear. The US is unlikely to back out of its engagement without some further concessions, while China has pushed back such that its cost to meet this high bar requirement may pose more significant damage to its effort of maintaining a balance of landing steady growth and holding financial stability. Even if the situation was to be fully resolved as of tomorrow, it may have already pushed sentiment beyond a crucial threshold where recognition of more serious, systemic problems put us on an inevitable course. To add to this complexity, not all of the diplomatic scuffles are purely kept to decorous tariffs. The sanctions the US is returning to Iran are unlikely to be walked back, and that is creating greater tension with key trade partners (like the EU) which have economic and financial ramifications. Such economic/financial wars can escalate and get out of control faster than those who pursue them intend. A European Threat Rising and Another Cooling Europe’s fundamental health will take on particular importance over the coming week. Having ground on for over a year-and-a-half – and earning near-constant coverage in the meantime – the Brexit negotiations will hit another crescendo. The EU summit on Wednesday and Thursday is another one of the key last-minute turnoff points for the two sides to find common ground on the divorce before hitting a point of no return. We still have over five months before the official separation is due to take place, but there are still many political steps that need to be taken in order for a solution to be agreed upon and put into action before the cut-off date. This past week, there was yet another clearing in the ominous cloud cover when the EU’s chief Brexit negotiator, Michel Barnier, offered uncharacteristically optimistic remarks regarding the status of discussions between the two sides. If there is a breakthrough by Thursday, expect the Sterling to have a considerable rally ahead of it. He noted the progress made recently and suggested a deal could be struck as soon as this coming Wednesday – when he has more consistently warned that they were heading down a path of the UK crashing out of the relationship. Yet, despite his enthusiasm, there are still key sticking points (like the Irish border); and reports over the weekend indicate progress stalled before important breakthroughs were made. It has been suggested they will not hold technical discussions again until Wednesday – which would insinuate this will have to be a top-level call. Tuesday, Prime Minister Theresa May is reportedly going to gather her Cabinet in order to cement a common front in the discussions over the days following. If there is a breakthrough by Thursday, expect the Sterling to have a considerable rally ahead of it. Should they again fail to find common ground, the mood will darken significantly as the clock winds dangerously short. Unfortunately for EU leaders, the two-day meeting will not be a one-topic event. Besides Brexit, global trade strains and diplomatic troubles (between the US and Iran); the heads of state will have to address Italy. The third largest economy in the Euro-area, Italy has made clear its intent to bolster spending beyond the EU’s acceptable targets. The only scenario for which they will fall in line is based on an improbable forecast (a 1.6 percent or better GDP clip next year). This tests the tolerance of the collective versus the conviction of a member who has seen anti-EU sentiment grow out of economic struggle. Remarks by Italian leadership that the ECB could be a backstop if things grow too problematic for Italy in the market, only draw clear attention to the situation by global investors. The ECB’s reported rejoinder that such help would only come after a bailout only raises the specter of a return of the Eurozone debt crisis of six years ago. While official EU remarks surrounding this situation will be key, there are numerous other events that should be watched carefully to stay abreast of this situation. The Italian Prime Minister is due to speak the day before the EU meeting’s first day, the Finance Minister is set to speak, the Deputy Premier is on the docket for multiple appearances, but it is perhaps his visit to Moscow Wednesday that will draw some of the greatest scrutiny. Keep tabs on Europe.
  10. It Can Be Difficult to Measure Complex Issues Like Trade Wars When dealing with a complex fundamental theme – without a binary outcome, numerous inputs and important to different investors for different reasons – it can be difficult to both analyze and trade the subject. Those are certainly criteria that would fit the ongoing trade war. It is proving exceptionally difficult to keep a clear bead on the progress of the economic conflict and the market has started to veer back into its comfortable habit of allowing complacency to take over. Drifting without accounting for clear and present danger is a recipe for eventual financial market seizures, and we would do well not to simply through caution to the wind as so many others have. That said, it does not do to simply position against the current presuming recognition will eventually dawn. To reconcile important but complicated themes with an appropriate trading approach, it is first crucial to keep accurate and as-quantitative-as-possible analysis on the matter as possible. In measuring trading wars, that can be a task. The trade figures like we have seen from the United States last week and are due from China next week are accurate but constrained and lagging updates. For those keeping track, this is a false sense of stability derived from the People’s Bank of China (PBoC) actively working to stabilize the rate. Simply referring to exchange rates or even capital markets alone does not give an accurate account either. From USDCNH (Dollar to Chinese Renminbi), we find the exchange rate has held to range for weeks after an initial surge. For those keeping track, this is a false sense of stability derived from the People’s Bank of China (PBoC) actively working to stabilize the rate. They are similarly acting to keep the Shanghai Composite and other equities propped up. Just as we learn from the Chinese index the government’s intent, we learn from the likes of the S&P 500 the extent of speculator’s complacency. But where do we see better measure as to the impact that the specific US-China trade war is having? I like AUDUSD. First and foremost, the cross liquid and un-manipulated. Further, Australia is heavily dependent on China for its own economic health thanks to its trade relationship (further solidified during the Great Financial Crisis). Other fronts of the US-led trade war can be even more difficult as they are not fully engaged. While the NAFTA replacement (USMCA) seems to on the path to being codified, the breakthrough has thus far had limited impact the Dollar, Peso and Loonie. Of the three, the Loonie was best suited to channel a response as it was the most at-risk in the final phase of negotiation with fewer competing fundamental themes. Meanwhile, the standoff the US has taken against the EU and Japan are in limbo. However, the temperament of the Trump administration and efforts to subvert the US’s efforts to reshape the global landscape (like the EU’s efforts to circumvent the United States’ sanctions on Iran) can readily revive these issues. Since President Trump made repeated threats to import European and Japanese autos before agreeing to the armistice, the health of the global vehicle production industry can be a good measure. I like the CARZ fund. In economic terms, it is also important to follow closely with sentiment figures. There are economic, consumer, business and investor surveys for various countries. Consumers tend not feel the impact of such economic efforts until later on when the costs trickle down and businesses outside of exports often initially see the upside before the full effect is registered. Investors and economists however, tend to evaluate on a wide basis with a significantly further projection. This may be a difficult issue to assess, but it is certainly important enough to make the effort. Dollar: Always Evaluate Alternative Scenarios Personally, I consider the best trades are those that I cannot come up with a viable reason as to why a market move will not happen. Such an approach puts us in a different frame of mind where we are inherently more critical of market conditions that could readily trip up trades. More often, the preferred method of trade evaluation is to filter all possible options and come to a decent – often people stop far short of the ‘best’ – option that can be pursued with the proper risk and money management. Find, and execute. However, when dive into the markets with such an intent, it often encourages us to tolerate shortcomings that are likely to trouble our positions as we simple want exposure to the market and unknowingly fall back on hope that the practical issues may not come to pass. It is generally not good to approach most things in life from a perspective of skepticism, but it most certainly prudent to evaluate our markets in this critical way when our money is on the line. It is generally not good to approach most things in life from a perspective of skepticism, but it most certainly prudent to evaluate our markets in this critical way when our money is on the line. With that said, I want to come back to the US Dollar. Over the past few weeks, I have weighed in on the Greenback owing to the turnover from the third into the final quarter of the year. My baseline forecast is a bearish one owing to: the lack of enthusiasm despite the Fed’s extreme disparity in pace, the role the currency now plays as a carry, the fact that the United States is the instigator of many different fronts of the ongoing trade war and the slow but destructive interest by the world’s wealth centers to diversify its exposure to the USD. Evaluating all of those themes, there is little potential in mind that these themes will ultimately turn out in favor of the currency. At best, they will be temporarily overlooked. However, there are ideal situations that can be considered that may ultimately afford favor to the Dollar, so it is worth enumerating them here for your consideration. First and most effective for supporting the Dollar would be a full-blown financial crisis. The currency has taken on a considerable carry status over the years and that can see it drop in the initial phases of risk aversion as weakly-held longs looking for carry in these low returns environs are shaken out. Yet, if the situation turns gangrenous, liquidity will be all that matters; and no other global asset is as revered for its haven status as US Treasuries and its most liquid money markets. Yet, in such circumstances, the opportunities will be endless – though most will likely be bearish, but panic tends to generate the faster moving markets. There has been suggestion that the US economy will continue to run at full speed aided by fiscal policies like tax cuts and benefits of trade wars. However, the US has not somehow found itself outside of the laws of market physics that maintain cycles nor is it so self-sufficient that a global pain will not wash up at its own shore. Further, if economic conditions stagnate and deteriorate, the Fed will have to slow its hikes preventing the speculative value from a growing monetary policy gap in the USD’s favor. A more recent, technical consideration has been proposed via the reduction in liquidity for US Dollars via policy and trade. This has shown some modest pressure, but if the Dollar were to continue to rise, President Trump has made clear his criticism of a higher currency as their debt load rises and trade war bites. If it is in his power to somehow arrest the currency’s climb – and he has avenues for it – he will prevent it. Correlation in Risk Assets – But for Government Bond Yields Some people like to draw their assessment of investor sentiment from indicators like the VIX volatility index or more simply from the performance of a ubiquitous asset like the S&P 500. Others will evaluate volume and open interest for participation, data like GDP, or pure sentiment surveys. I like to refer to correlation. In extreme conditions, what happens to markets in different countries or in different asset classes? They tend to move in concert. In a deep bear market or full financial panic, the market adage that ‘correlations go to one’ reflects on the fire sale mentality that cuts through any concept of which ‘mildly’ risky investment is worth holding when everything seems to be crashing down around us. In a boundless bull run where qualifying the risk that is assumed with high returns goes out the window. At the poles, we find the commonalities between these otherwise very different markets and their investors: the fundamental evaluation of risk and reward. That said, when we are not in an environment where animal spirits are running rampant or everyone is rushing for the exits, it can be difficult to see these undercurrent at work as individual catalysts promote a bid or unwind from the various assets. ...even with equities retreat[ing] this past week, the government rates kept rising. That is unusual. Yet, just because we are not in a panic or mania doesn’t mean that sentiment is nonexistent. Risk appetite can rise or fall with conviction in the middle of trends and with limited intent. Then, there are the periods where we are just gaining traction on a systemic move before it is obvious to everyone. This is why I like to reference the correlation between assets that are otherwise very different to each other: equities, junk bonds, carry trade, emerging markets – and for opposing relationship the likes of gold and government bond yields. Recently, we have seen the relationships between many of these markets tighten up. The US indices were unique for a while in that they have spent months forging higher until they returned to record highs while their global peers floundered and emerging market assets outright tumbled. That may be starting to firm up again as of this past week however. Another, persistent detractor from the global sentiment relationship are government bond yields. US Treasury yields have climbed alongside US equities, perhaps owing to the Fed’s influence; but even with equities retreat this past week, the government rates kept rising. That is unusual. If Fed forecasts are at play, hikes are a dubious course to set our time by, but consistent balance sheet reductions are more reasonable. The fact that other countries’ sovereign yields (Germany, UK, Japan, etc) were rising in tandem suggests there is something more systemic afoot. Is this evidence that global investors are now confident the central banks of the world will back out of their extreme accommodation either because they are confident or (more troubling to consider) they have run out of resources? If that is the case, beware the future for risk trends. The past decade of general bullish drift has been facilitated by the distortion of central banks affording speculative rampancy. If faith in monetary policy collapses, there is penance to pay.
  11. Markets Heading into October and the Fourth Quarter With this past Friday, we closed out week, month and quarter. The shortest measure was a period of consolidation for most assets – from the top performing US equity indices to the EURUSD’s make over break technical move to trade back into range. More impressive for its deviation from character (statistical norm) was the performance for the month of September. Historically, this period is one of significant upheaval for the capital markets (see the attached images). Using the S&P 500 as the imperfect standard bearer, September is historically the only month that has averaged a loss in the calendar year as volume picks up and volatility measures rise. That clearly was the case for 2018 and it also wasn’t true of 2017. Using the same study to evaluate October, it would suggest that significant gains are ahead for October. However, if one month’s average can deviate from the norm, so can any other’s – there is a reason it is called the law of averages. September is historically the only month that has averaged a loss in the calendar year as volume picks up and volatility measures rise. Statistically, the range of the samples for the monthly performance for the benchmark is wide in signal. For measures of activity – via volume for the same index and volatility from the VIX – there is far less ‘spread’ in the readings. Volume rises through the month of October as the post-Summer lull and pre-holiday trade period draws in active market participants looking to weigh in on market direction. Volatility similarly peaks in October historically, which makes an interesting combination of circumstances. Traditionally, volatility rises as risk aversion kicks in while a rise in volume behind market moves frequently signals commitment to trend. Of course, how the market commits depends on what is motivating capital distribution (positioning). It is possible to see assets with a ‘risk’ bearing bid as there is a host of assets that currently stand at a significant discount to the S&P 500’s record high. An ‘idolizing’ speculative play would depend on complacency and the avoidance of possible disruptions from the fundamental current. To propose a windfall improvement in economic and investment circumstances in the multi-speed environment with protectionism continuously rising is an approach akin to passing through the eye of a needle. Spinning our wheels around current levels is certainly a high probability given the market’s penchant for the status quo, but it is difficult to miss the laundry list of troubles we have yet to reconcile. With trade wars escalating and political risks growing (US election cycle, UK government fracturing over Brexit approach, EU facing another budgetary rebel), we should keep track of scheduled and ‘mundane’ influences like GDP readings as if they are asteroids that we discover are on a collision course with the planet. A Two Speed Trade War the Break in the Clouds? The updates on trade wars for the new week offer a modicum of hope that we can stave off an utter collapse into a global economic conflict. Yet, with so much riding on a steady bearing of economic activity, avoidance of financial troubles amid monetary policy normalization and even the whims of a single powerful individual (the US President); it would be careless to put so much faith into apathy. Between the United States and China there is as yet no sign of improvement – nor even a let up from further escalation of force. Following the United States implementation of a further range of tariffs on an additional $200 billion in Chinese goods and China’s $60 billion rejoinder, the situation has been in negotiation limbo. We will soon run out of room to add more items to the tax list. An effort to revive talks seems to have hit the skids and the only sliver of solace is that President Trump didn’t move immediately to execute his threat for a further $267 billion duty on its largest economic counterpart should it retaliate against the latest effort – which of course, it did. Perhaps the smaller response has bought them relief, but the ideological belief for both of these countries as to their righteous efforts likely leads this particular course to a ‘total’ engagement. We will soon run out of room to add more items to the tax list. New policy outlets will need to be explored, and they will either be ignored by the markets and populations which will only encourage desperation for those looking to exact pain in order to force capitulation or it will exact the intended pain. Either way, it ends in the same economic trouble. Of course, as far as this pain is isolated to these two countries, the better off the world will be. This past week, Japanese Prime Minister Abe managed to elicit the same vow from President Trump that EU President Juncker earned: no new import taxes so long as discussions continue. Of course, the US already slapped tariffs on both region’s steel and aluminum imports, but they may let that go so as not to provoke further lash out. Yet, progress will likely lack until there is some tangible blood sacrifice to appease the Trump administration’s demands for more favorable trade conditions. Meanwhile, the effort to steer the NAFTA deal to a successful conclusion is the most encouraging corner of this global pressure. Yet again, language this weekend has tempted hope that a deal is close at hand, but investors are acutely aware that the suggestion of a proximate deal were raised and dashed multiple times over the past week. If an agreement does go through, other US counterparts will evaluate what was agreed to as a template for charting their own course to a resolution. What is Driving the Dollar = What Can Drive the World What is driving the US Dollar? I like to keep particularly close tabs on markets or benchmarks that are at the center of so many overlapping fundamental considerations. Over the past months and years, I have paid particularly close attention to the S&P 500, gold, USDJPY and others for their ability not to cue trade opportunities of their own but rather to act as signal for the system at large. At present, the Greenback reflects that ‘deep cut’ market perspective that can offer seismic shift for the financial system at large. Starting from the most recent of the rapidly growing fundamental concerns, political uncertainty is moving out of the tabloid-like headlines into the tangible expectations of an impending mid-term election. We are six weeks out from the polls opening, and the country and world are even more on edge than usual for the event. Partisan appetites and beliefs should be kept out of our evaluation or market effect, rather it is the sense of uncertainty that breeds concern for the financial system. A turn in either of the houses can make an already difficult-to-operate government virtually grind to a halt. ...political uncertainty is moving out of the tabloid-like headlines into the tangible expectations of an impending mid-term election. Meanwhile, the ongoing trade war may be multi-faceted and hosting many different participants, but there is an easily recognizable common denominator amid all of it: the US. Not content to lead the world to general growth, the country has pressured its trade partners to sacrifice some of their own advantages to accelerate its own pace. There is little doubt that its size could be used to leverage capitulation from a few counterparts, but engaging a host of the world’s largest players runs the risk of a collaborative retaliation or simple an effort to reduce exposure to avoid themselves being held hostage so readily again in the future. That would be a significant and permanent downgrade to the United States’ financial position and its currency. Of course, it is possible that all of these countries yield – but what is the probability of that? And, lest we forget, there are also traditional fundamental themes that are as-yet resolved of the US. The Fed continues to push forward with a policy effort clearly set to normalization with steady hikes and reduction in balance sheet. After the last Fed hike, the central bank made it known that it expects to hike again in December and three more times in 2019. That can be encouraging from a carry perspective, but it doesn’t bode well for markets that depend on low lending rates such as corporate debt and real estate. Higher yields to be found in the US relative to other countries is appealing only so long as the markets are set to unhindered risk appetite. Yet, with dollar-denominated loans for areas like the emerging markets seeing rates soar to tip nonperforming loans, this divergence from the world norm can be the spark for its own immolation.
  12. Trade Wars Update: It No Longer Matters? Seemingly a routine occurrence for the global financial markets, we saw the state of global trade deteriorate yet again through the past week. As expected, the United States went forward with tariffs on an additional $200 billion in Chinese goods. The terms are for a 10 percent rate on a range of imports that will increase to 25 percent by the end of the year. The standard, immediate response from China was quickly implemented, but only on $60 billion in US goods. It is not clear the strategy from China as they vowed a ****-for-tat response to what they have deemed unprovoked trade wars, but the country does not have much more room to tax imports from its major counterpart – and certainly not $200 billion worth of goods. This alone moves us into a new phase of a standoff of escalating cost for the US, China and the world. The S&P 500 is at a record high while the EEM Emerging Market ETF is only modestly off its multi-year low Will China ease off the pressure? Are they simply plotting an alternative course? Could this be an attempt to prevent President Trump from pursuing his threat to trigger the $267 billion in further duties in the event of a reprisal to the $200 billion? It isn’t clear. With the situation clearly under greater tension, the news over the weekend that plans for further talks had broken down ensures greater financial threat from this already-enormous burden. What is even more remarkable than the state of trade from these two economic leaders is the apparent state of obliviousness from the speculative markets. While certain assets show greater disregard to the threat than others (the S&P 500 is at a record high while the EEM Emerging Market ETF is only modestly off its multi-year low), they have all displayed a measure of neglect these past weeks as the tab has grown exponentially. To suggest that this situation simply doesn’t matter would be recklessly negligent. It isn’t impossible that speculators accustomed to complacency and FOMO, but it would nevertheless increase the scope of risk to stability through the future. Ignoring the dangerous wobble in a tire as you steadily accelerate down the freeway is not a reasonable state even if we can sustain it for the time being. If we continue to build up exposure until a severe economic or financial crisis arises, it will only amplify the eventual collapse. What is Eating the Dollar and How Long Does it Dine? The Dollar marked an important technical tumble this past week. Already under pressure over the past months, the DXY’s drop below 94.35 and EURUSD charge above 1.1700 represents the break of ‘necklines’ on head-and-shoulders patterns (the latter inverted). This is pressure not isolated to the trade-weighted aggregate or its heavily represented most liquid pairing. We can see the currency’s unique struggle intensifying distinctly across the spectrum over these past few weeks. But with this evidence of broad struggle, we should attempt to identify its source if we intend to establish the intent of follow through – whether persistent or near its conclusion. Reverting to an old textbook relationship, some are connecting the currency’s traditional safe haven role to the recent rebound in risk assets – including record highs for certain benchmark US indices. The Fed is expected to hike rates another 25 basis points to a range of 2.00-2.25 percent. That would be a tidy explanation, but is suspicious for its timing considering this haven function hasn’t played a significant role for months. Further reason to question this relationship is the explicit status for the Greenback as the highest yielding major currency. That advantage will likely increase this week as the Fed is expected to hike rates another 25 basis points to a range of 2.00-2.25 percent. It could be the case that the currency’s premium could be deflating under expectation that the central bank is planning to downgrade its pace of tightening at this meeting through the Summary of Economic Projections (SEP) and Chairman Powell’s press conference. Yet, we don’t see that anticipation in assets that more directly relate to such forecasts - overnight swaps and Fed Funds futures. Political risk will prove an increasingly prominent risk through media headlines in particular over the coming weeks, but there is little direct threat to economy or financial markets just yet. This slow reversal of a six-month old bull trend may also have developed in response to the longer-term concerns. Over enough time, the accumulated cost of engaging in a multi-front trade war while increasing the budget deficit during a healthy economic phase will erode the appeal of the United States’ currency’s principal status. It is possible that this long-term pressure is starting to set in; but if that is the motivation, it can readily be sidetracked by more intense short-term concerns (like next week’s FOMC decision). Political Risk Increasing as US Election Cycle Heats Ups Political risk is an abstract fundamental influence on the financial system. Certainly each trade has their political beliefs on policies ranging from economy to social causes; but more often than not, these views only cloud our assessment of the markets. It is generally-accepted market wisdom to remove emotions from our trading; and there are few things in life that more readily trigger emotion than politics. Practically-speaking, however, there is little in the way of policy that can readily translate into significant market movement in the short-term. That said, one of the few outlets with a direct link to financial health and stability is the state of international relations. And, on that front, the danger has grown visibly and exponentially. Perhaps one of the most obvious instances of this pressure on net global growth and capital rotations through trade comes from the United States. Poland and Hungary pose a threat to core EU beliefs – and have drawn criticism for such – owing to their nationalist governments’ policies. The Trump Administration has driven forward with hefty tariffs and economic sanctions on some of the largest economies in the world. Whether we personally view the policies as good or bad / right or wrong, the economic impact is straightforward. As time marches on, attention on politics will intensify with the mid-term elections approaching. While much of the high drama related to the balance of the Legislative branch, threats of Presidential impeachment and the Supreme Court pick has little to do with the kind of direct market implications that we should keep in the forefront; it can nevertheless bolster the appreciation of economic and financial connection by virtue of its mere presence in the headlines. What’s more, this is not a uniquely US concern. There is political pressure rising across the world. Reports of a possible election call in the United Kingdom have followed the failure of progress in the Brexit negotiations at the EU leaders summit in Salzburg. Mainland Europe is not immune to systemic risk via political pressures. Italy is still a massive concern to stability between its enormous debt and populist government. Poland and Hungary pose a threat to core EU beliefs – and have drawn criticism for such – owing to their nationalist governments’ policies. In Asia, financial pressure is starting to show subtle cracks in social contentedness while US sanctions have spilled over from Russia restrictions. Japanese Prime Minister Abe managed to keep his position this past week, but the economic and international diplomatic position or the country has not improved materially. The question investors should ask themselves is whether these relationships improve for compromise or rapidly intensify should economic or financial crisis start to emerge.
  13. Is There an Effort to Keep Markets Uneasy in Trade Wars? How many times does something unusual have to occur before it is considered a planned? I have noted a number of times over the past month that some unexpected policy development was announced hours before the markets closed for the weekend. There is an unspoken commitment by central bankers and global leaders to prevent volatility in their respective financial markets. Volatility is the general definition of risk, and there is a clear connection between financial market and economy. In other words, no one wants to trigger speculative rout that could turn into tangible economic pain. And yet, that typical preservation of self-interest doesn’t seem to worry some of those in power looking to stir norms. Leaks are another increasingly common feature of the US political landscape which unexpectedly adds more uncertainty to an otherwise surprise-oriented policy approach. One of the more common culprits of this push against norms is US President Donald Trump and those in his administration. Announcements of new tariffs on Fridays are now commonplace. And this past week would not deviate from that new norm. Two people in the administration with knowledge of the plans said the President intended to push forward with the proposed $200 billion increase in tariffs on Chinese goods despite the effort to revive talks this past week. This is not exactly surprising given the United States negotiation approach of late. They seem to prefer discussing terms after exerting pressure on their counterparts in an effort to leverage a more favorable outcome. It is also the case in this instance that the remarks are not official – as in they do not come from the President himself. Typically, Trump prefers to announce such things himself to signal he retains final say over such matters. Leaks are another increasingly common feature of the US political landscape which unexpectedly adds more uncertainty to an otherwise surprise-oriented policy approach – but at least one where we know to focus for answers. Whether intentional or not, the major announcements in policy from the US and other major economies into the twilight hours of the week creates a resting state of increased uncertainty for financial markets. We do not need any more reason to question our already excessive exposure to risky assets between the dependency on excessive monetary stimulus which is starting to correct, exploding levels of debt, increased speculative leverage and obvious efforts by superpowers to promote local growth through policies that curb others’. A frequency of last minute and troubling headlines just before the markets close is yet another reason traders could naturally want to curb their exposure. Evaluating Fundamental Themes for Both Their Probability and Pace of Progress Trading fundamentals can be overwhelming for many. While there are many different motivations for market participants the world over to place or remove exposure, there are typically key reasons that draw many – if not the majority – to alter their views in tandem. If there were a first rule for trading using fundamentals, I would say it is to first establish what is most important to the market-at-large. Another functional application of this broad analysis technique (perhaps rule number 2) is to establish the nature of the theme or event itself. Is it complex or straightforward? Is there a distinct time frame for it to render its verdict or is the outcome something that can be debated through time? A significant step up in terms of fundamental complication are the ongoing NAFTA negotiations between the US and Canada. Depending on the circumstances surrounding these fundamental matters, we can determine what kind of contribution they can make towards our trading – or how effectively they can otherwise complicate the opportunities that may otherwise seem complete. We can use examples to illustrate. The Federal Reserve’s next rate decision is scheduled for September 26th. There is clear anticipation for yet another 25 basis point rate hike by the policy authority with swaps pricing in nearly 100 percent probability. That is clear time and outcomes (hike or not). Such simplicity can make for straightforward Dollar or risk trends – though it will also drain the market-moving potential of an outcome that meets deeply discounted scenario. There is still complication in the forecast for another hike around December, pace in 2019, concern over external factors and more; but those clearly are not the primary interest. A significant step up in terms of fundamental complication are the ongoing NAFTA negotiations between the US and Canada. While there have been a few dates of confidence thrown out by officials, there is no definitive end date. There is also substantial discrepancy in the outcome for these talks such that a compromise or dissolution of trade relations can render significant market moves. This is an even that is far more difficult to predict for timing and outcome, but it renders far more market movement. And, then there are those events that can continue without resolution for considerable time and the full impact cannot be readily be predicted until long after it is implemented. That is the situation with an event like the US-China trade wars. There are no milestones for furthering the tensions or reducing them and it can prove a systemic threat that directly leads to a global recession and/or financial crisis. Yet, without clear guidelines, the practicality of trading around it is exceedingly difficult. And Now, the Central Banks with Failing Credibility This past week, the European Central Bank (ECB) and Bank of England (BoE) delivered their respective monetary policy decisions. These are important policy groups whose decisions carry far beyond their respective economies. The ECB marks one of the most aggressive dovish central banks amongst the majors and carries significant responsibility for sustaining the belief that market enthusiasm is borne out of the extraordinary support these groups are offering to the system. Perhaps recognizing the position they hold and uneven health of its member economies, it is struggling to decide its course. The BoE is one of the most hawkish major players with a course of inflation that is above target and could be used to evaluate the central banks’ commitment to the ‘rule of law’ for targeting price growth as a determinant for monetary policy. Of course, they are dealing with the uncertainty of Brexit which is a situation not uncommon across the world’s largest economies. So this group is acting as an unexpected template for how to deal with external pressures. These are important groups whose moves will be monitored and likely mirrored by other central banks. Interest rates in Japan have been kept near zero for decades, and the rise of QE programs was eagerly adopted by the group in an effort to stoke price growth. The upcoming two rate decisions this week will not be evaluated for the guidance they can offer others. Rather, they will instead be used as lesson on what to avoid. The Swiss National Bank (SNB) and Bank of Japan (BoJ) have failed to apply policy that renders the deserved effect for promoting growth and price stability – not to mention unstated goals of financial health. They are in fact both groups that have lost significant credibility in the markets, which makes their job all the more unmanageable. The SNB will no doubt keep its rates firmly in negative territory, yet the desired depreciation of the Swiss Franc is unlikely to follow years of unchanged policy. Given the dependency on exports of goods and services – and particularly to the EU – they are primarily concerned with the unfavorable level of the EURCHF exchange rate. This will not change materially until the ECB itself follows a course that allows for more appreciation of the Euro. While the BoJ has not done anything so dramatic as the SNB’s implementation and sudden removal of a floor on its key exchange rate, the central bank has clearly embarked on a policy course that has consistently fallen short of its mark. Interest rates in Japan have been kept near zero for decades, and the rise of QE programs was eagerly adopted by the group in an effort to stoke price growth. Despite a steady escalation of this downpour of funds, price pressures have not solidified and the markets have increasingly discounted their ability to even move the Japanese Yen for secondary favor. What we should worry about from these two is what the market response is when such groups are forced to capitulate or the recognition of how exposed the system is should another crisis arise where such groups have no hope of averting collapse.
  14. Important European Central Bank Rate Decisions As we find distraction in trade wars and political risk, it is important to remember that we are still dealing with more traditional fundamental issues in the background. One of the most systemically important and extremely underpriced risks is the global market’s long-standing dependency on massive stimulus from the world’s largest central banks. That wave of easy money through massive rate cuts and largest stimulus programs has noticeably receded while recognition of more recent iterations of the collective effort have failed to earn the impact that it was pursued for: a return to steady inflation, faster economic activity and wage growth that outpaced the cost of goods. Instead, we are just left with the very effective but increasingly unwanted side effect of artificially inflated speculative assets. Currently, swaps are pricing in less than a 50 percent chance that the central bank will hike rates again before mid-2019. Eventually, this big-picture fundamental gap will be reconsidered by the investing masses; and if that occurs amid a financial unwind, it could readily turn mere risk aversion into full-scale panic. As we await the inevitable reckoning, we will take in two important monetary policy updates from major central banks on opposite ends of the spectrum: the Bank of England (BoE) and European Central Bank (ECB). The BoE’s policy meeting is not expected to deliver another rate hike, and anticipation for forecasting is likely rather restrained. Currently, swaps are pricing in less than a 50 percent chance that the central bank will hike rates again before mid-2019. Given that this is a group that has already hiked a few times and has inflation figures to justify further moves if Governor Carney and Co want a reason, this decision can help establish the outlook for global monetary policy as a baseline for economic expectations. Alternatively, evaluation of the ECB’s decision comes from the opposite perspective. The central bank is still employing its stimulus program but is expected to cut if off later this year. Following that, the expectation is for a rate hike to be triggered sometime mid-2019, but swaps currently put that outcome at a sparse 20 percent whereas a few months ago, it was supported by a more than 80 percent probability. Beyond just the rate decision and press conference, we are also expecting macroeconomic projections from the group. If one of the world’s most prolific (profligate?) policy groups deems the outlook does not deserve a steer away from crisis-level settings, what would that say about the health of the economy and financial system? Another Week in the Trade Wars Another week and another escalation in the ever-expanding global trade wars. From the heaviest front of the economic confrontation, the period for public feedback on the Trump administration’s proposed $200 billion increase in tariffs on key trade counterpart China came to a close. It is not clear how quickly this will be turned from theory into action, but the markets certainly aren’t simply discounting this marked intensification of the trade war between the two super powers as mere bluster. As remarkable as this threat is on its own, President Trump wasn’t content to leave the heavy threat to linger in the air. On Air Force One, the ‘leader of the free world’ said he was in fact considering a further increase in the United States’ pressure against its rival to the tune of $267 billion. That is $267 billion in addition to the as-yet realized $200 billion. A few months ago, the President – following on the initial warning of the $200 billion jump – said he was prepared to tax all Chinese tariffs. ...the Canadian Dollar is still significantly discounted and could generate a hefty rally in response to the good news. With these successive programs, he would be taxing more than the United States total imports of Chinese goods through 2017 – over $517 billion with the $50 billion and metals taxes already in place versus $506 billion actually purchased. If we only realize the first massive slug of additional taxes, the retaliation from China will further complicate this situation. It will not be able to do a like-for-like retaliation as it will soon eclipse the total imports the country consumes from the US. Resorting to other measures to approximate can easily be construed by this administration as not just response but escalation. Meanwhile, not content to keeping the fight on one shore, the US failed to find a compromise with Canada in its ongoing negotiations to shore up – or more likely replace – NAFTA. If a breakthrough is found next week, the Canadian Dollar is still significantly discounted and could generate a hefty rally in response to the good news. And yet, settling the dispute for the North American trade partners will not raise much enthusiasm for the rest of the world. In addition to Trump’s threats to raise the bill on China, he also made a very thinly veiled threat aimed at Japan who the US is currently engaging in trade discussions. A ‘good deal’ for the US is likely one for which Japanese officials will balk at even with the obvious risk of having to engage in a trade war. On the bright side, the US and EU have not furthered their war of words (autos tariffs, accusations of currency manipulation, threats to circumvent the other’s currency for causing systemic trouble) to one of action. Yet, considering much of this seems to move in cycles for who is targeted each week, give it time. Global Political Risk Always Simmering and A President That Lashes Out Under Pressure Political risks seemed to deflate in the US, UK and Euro-area this past week, but they certainly haven’t been resolved. Far from it. The coalition government in Italy is starting to run out of room for making commitments to both live up to campaign promises of increased government spending and checks on EU influence will simultaneously meeting obligations to control budget that will not send European officials and financial markets into a panic. From the UK, the Prime Minister Theresa May continues to find pressure from her government, cabinet and EU counterparts in navigating a Brexit negotiation that would somehow please all parties involved. This is ultimately impossible as the groups are in essence demanding outcomes that the antithesis of each other. In general, it is important to leave our own political beliefs out of our investing – and especially out of our trading (short-term). What we are left with when trading the Pound is a sentiment that seems to oscillate regularly but keeps landing back into the realm of firm warnings to prepare for a ‘no deal’ outcome. In the United States, President Trump is continually bombarded by the news media with scandals that are coming dangerously close to the leader himself. His penchant for retaliating on social media and in rallies is doing the opposite of quelling the storm. In general, it is important to leave our own political beliefs out of our investing – and especially out of our trading (short-term). There have been both economic booms and recessions under both Democrat and Republican administrations – and through various combinations of Executive and Legislative concerns. However, political risks can spill into more immediate financial and economic issues which in turn can charge the market. Trump has said recently that he has considered shutting the government down again if Congress does not curb the rebellion against his agenda. There is also suggestion of a second tax cut being floated and we are still awaiting word that the fiscal stimulus promised on the campaign trail will be revived. What is particularly unique to the US President is his tendency to react to personal pressure from the Mueller investigation and news media’s general criticism with aggressive policy on other fronts. Would he have made the $267 billion threat of escalation against China this past week if the scrutiny over his actions were not so intense? It is difficult to argue that he is too level-headed for that retaliation against the world as there are too many examples to suggest the opposite. USD price action ahead of ECB and BoE
  15. 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.