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  1. A Return to Extreme Volatility and Realization It Won’t Stay This Quiet for Long Any way you cut it, the markets are experiencing extreme levels of inactivity. And, for those that are satisfied with the superficial and textbook interpretations of the mainstream measures, this seems like a cue to leverage exposure and commit to the decade-long bull trend which blossomed under the controlled conditions. Previously, traders would have been readily satisfied by the readings and thrown in with the assumptions. However, there is an unmistakable air of skepticism surrounding activity measures with indicators of exposure and uneven performance for ‘risk’ assets drawing focus back to the extreme bouts of volatility this past year. While market participants have shown a penchant for overlooking troubling fundamental backdrop and conveniently forgetting previous lurches in the financial system, the proximity and severity between the February-March and October-December storms were too prominent to simply slip quietly into afterthought. With that said, the question then must be raised as to what could trigger another wave of concern. While the best motivations for trend development in my opinion are systemic fundamental themes that can draw the largest swaths of market participants; during these periods of speculative interlude complacency can raise disputes over the urgency of otherwise serious themes. When we get into these self-sustaining periods of complacency, one of the best sparks to break clear of speculative opportunism borne of quiet is to see a uncomplicated slump across the capital markets. In other words, price-determined risk aversion. While the strongest indication that the markets are succumbing to their own fears is an intense deleveraging across all or most assets with a heavy dependency on speculative appetite, there can be fairly reliable precursors before we get to that undisputed scale. At present, one of my favorite leading indicators is the S&P 500. Representing the most ubiquitous asset class in the capital markets and in the largest economy, it is well placed at the center of focus. Further, its outperformance in this role has once again afforded it a position of carrying a heavy mantle of keeping the fires stoked in other assets and regions due to its approximate return to record highs over the past quarter. Most other preferred assets for the trading rank are significantly behind in their recovery efforts – rest of world equities measured by the VEU index is only now passing the midpoint of its 2018 losses. This attention isn’t just a benefit to the markets though. If the US indices were to falter in an overt and troubling way, it can spell disaster for other areas of the financial system that were considered far less resilient. A stall for the S&P 500 and Dow before overtaking a record high could certainly achieve this throttling for global sentiment, but a more complete obliteration of future efforts to recharge confidence would likely come from a scenario whereby the benchmarks overtake their respective highs, struggle briefly to mark new progress and then collapse. Currently, we find measures of volatility like the VIX back at lows last seen in October which is appropriate comparison. Yet, in other asset classes we find more incredible readings like FX implied volatility at levels that are only comparable to a few points in history (like the Summer of 2014). In historical terms, the Dollar’s range (an equally-weighted index) over the past 200-days is the smallest on records back to when the Euro started trading two decades ago. This misplaced association of confidence and lack of preparation sets up the market to be extremely exposed to a mere slump escalating into something more catastrophic. Trade with caution and diligence. China GDP Next Week’s Top Event – Could the World Survive Its Stall? In a holiday-shortened week with speculative focus blurred, the top event risk is unmistakable. The Chinese 1Q GDP reading will come along with a run of monthly readings for March that are influential in their own right. While the employment, retail sales, industrial production and other monthly data are worth taking stock of to establish direction for specific nodes of the broader economy – important for projecting where problems or resurgent growth could arise in the future – it is all superseded by the comprehensive growth report in the short term. The world’s second largest economy is expected to slow even further from a 6.4 percent annual pace to a fresh multi-decade low 6.3 percent. That will still sit comfortably within the growth target lowered from 6.5 percent to a range of 6.0 to 6.5 percent the last National Peoples’ Congress. Nevertheless, the international market’s more critical eye towards growth and unorthodox threats will disproportionately raise the risk for impact form a negative outcome. The implications for China and its markets are relative straightforward when it comes to the forecast for the soft landing that officials are trying to engineer against the backdrop of struggling global growth and amid a trade war. Though rhetoric around negotiations with the United States has improved, a year’s worth of economic pain has built up. The March trade balance offered a timely mixed picture this past week with a significant surplus for the month resulting from a distinct drop in imports (a poor reflection of domestic economic health). For the global economy, this particular economic update holds significant weight over assumptions for the future. As the world’s second largest economy and the stalwart through the Great Financial Crisis, a slide that seems to be picking up momentum outside the central authorities’ control will leverage serious concern about what the smaller economies with significant less control are facing. For countries that supply China with the many raw materials that it consumes for its unmatched manufacturing machine (Australia, New Zealand, etc), the restriction in export demand and likely drop in foreign investment flows will expose an unbalanced economy. For the rest of the world, the buffer China has maintained will mean the country’s demand for trade partners’ goods will not pose the greatest risk, but rather its carefully-controlled financial connections will represent the true destabilizing influence. Potential delay in impending efforts like the Belt and Road initiative and the tentative vow to ramp up purchase of US goods are tepid relative to the cascading exposure we would see if the country was forced to repatriate in order to shore up its own system which is heavily built upon leveraged and low-quality lending initiatives. The question I would pose is whether the world could survive a stall in Chinese growth – which would occur well above 0.0 percent GDP – given how troubled the globe’s future currently looks? I doubt it. Should China tip into a market-defined economic stagnation or contraction, it would infer one of the key players in the world’s stage has lost control over its reliable ability to plan and direct activity. The environment that would force that loss of control would be a serious threat to the rest of the world as the shock would eventually hit other shores like a financial tsunami. Brexit Delayed Six Months and Pound Range Trading Reinforced A sense of relief washed over the Pound this past week – though not that kind that can readily supply buoyancy to the battered currency. In an increasingly familiar story line in Europe, we have found the Brexit situation has resorted to the comfortable solution of punting an unsavory decision to a time significantly into the future. This is the same path we have seen taken when it comes to Europe’s monetary policy (ECB), political standoffs and external diplomatic issues. This is not to say everyone is simply defaulting to this delay. This results from serious impasse between parties that believe strongly in their solutions as well as the folly in crossing their red lines. At the direction of Parliament, UK Prime Minister Theresa May requested an extension from the European Union, with an initial suggestion of a hold out until June 30th. After a long summit, the EU-27 agreed to a six month delay that would move the cutoff date to October 31st. In the interim period, the UK is expected to participate in the EU Parliamentary elections which will take place starting May 23rd and for which some in May’s party and her own government are piqued. The question on most peoples’ minds are whether the additional time will offer the opportunity to overcome the impasse or whether it will just draw out the misery. According to the IMF, uncertainty will only accumulate greater economic deterioration over time – and given the state of data over the past year in particular, that is not difficult to understand. In terms of how that translates into the competitive position of the Sterling and UK-based assets, many would see this as a window for a speculative influx on discounted markets. In previous years when complacency was de rigueur, that is almost certainly what would have transpired. An appetite for even marginally underpriced assets would have triggered an avalanche of speculative influx which would have quickly sent GBPUSD above 1.3500 and the FTSE 100 rushing towards 7,900. However, as discussed above, there is a deeper sense of skepticism built into the system. As such, the sudden drop in implied volatility measured by currency options or the CME’s index is as likely to short circuit momentum as it is to prompt it. Whether you agree or not as to the potential in the Sterling moving forward, think it through to establish a bias and set criteria for when that view shifts. Having thought the situation through beforehand will better set your expectations for an event like the GBPUSD’s inevitable break from a wedge this past month with boundaries currently stationed at 1.3125 and 1.3050. If you think a more robust recovery is possible then you may see more intent on a bullish break – and be confounded by a move lower.
  2. The US Yield Curve Flipped Back to Normal, Is the Recession Off? A lot of attention was paid this past week by the financial media to the inversion of the yield curve. To understand the signal, it is important to define the circumstances. The yield curve is a comparison of the yield – in this case, on US Treasuries – of different durations. Normally, the longer the duration, the higher the yield should be owing to the longer tie-up of exposure. When a curve inverts, we have an atypical circumstance where there are lower yields (and thereby it is construed lower risk) to hold US government debt of a longer maturity than that of a shorter variety. That is unusual but not at all unheard of. When looking at two proximate maturities – such as 2-year and 3-year debt – brief, technical inversions can occur owing to issues like liquidity. Yet, what we saw last week tapped into the extremes: the 10-year / 3-month yield curve inversion. These are the most extreme of the top liquidity issues and thereby a favorite measure of economists to gauge economic potential. In fact, this specific spread is one of the economists’ favorite recession measures. So you can understand the wave of concern, and media interest, when the 3-month yield overtook its much longer termed counterpart. However, I was (am) skeptical that this signal is as useful as it has been in the past. Thanks to the Fed’s adoption of quantitative easing so many years ago, we have seen a serious distortion in monetary policy that comes to the forefront with their effort to normalize – starting with rate hike before addressing the unorthodox policy outlook. Given my skepticism of the signal’s efficacy with the inversion, I am equally as indifferent to the fact that the curve flipped back to positive this past Friday. There are some interesting considerations from this yield comparison, but they shouldn’t be taken at face value as they have in the past. So, where to from here with this traditional economic measure? I am of the opinion that the yield curve has been distorted and its ability to reflect economic pacing has been seriously undermined. However, the interest should not be in the tool that measures sentiment but rather sentiment itself. While I am dubious of what the 10-year / 3-month yield curve represents, its inversion just so happened to coincide with other more convincing indications that the economy is at risk of capsizing. Measures of economic activity virtually the world over have signaled a throttling while readings considered forecast (such as sentiment readings) continue their own slide. Add to that a speculative market that recognizes the unquestioned safety net of the past through central bank commitment will no longer support the kind of speculative excess we are dealing with, and we find traders are more cognizant of their personal exposure. Where few risk benchmarks are as excessive as the favored US indices, there is still a remarkable amount of speculative appetite / complacency built into most sentiment-dependent measures. As the realities of the economy and practical rate of return deepen, the systemic appetite for ‘risk’ exposure will continue to struggle. In short, recognize that the market is increasingly attentive to troubles on the horizon rather than the ‘troubled’ or ‘return to normal’ signals that we register from some of these traditional measures. The Start of a New Quarter and Greater Scrutiny Over Sentiment Depending on how you evaluate this past week, you could be left with a dramatically different opinion of market intent moving forward than some of your market peers. With this past Friday’s close, we have not only capped the trading week; but it was also the end of the month (March) and the first quarter. If we look at performance via the largest of those time frames, the recent past was extraordinary. Both the S&P 500 and crude oil posted their biggest quarterly rallies in a decade – 13 and 31 percent gains respectively – which is fantastic for diehard bulls that had grown nervous in 2018. That said, this performance was far from uniform across all assets with a sentiment bearing. Global indices regained much less of their lost ground compared to their US counterparts, while both more overt risk assets and growth-dependent benchmarks were seriously struggling. What’s more, the impressive rally follows a period of even more intense loss for these assets. The fourth quarter of 2018 suffered the kind of loss that we can only compare to the Great Financial Crisis. Mounting a recovery from such a severe retreat naturally insinuates a certain degree of pacing. Yet, it does not automatically imply intent. If we put these past two quarters into further context of the previous year, regular bouts of volatility and focus on fundamental maladies speaks to a lost momentum to self-sustaining speculative inflow. A rebound, in other words, is easier to accomplish. Fostering new sense of enthusiasm and a fresh wave of investment is a different beast entirely. That is not what we have registered recently. As we move into the second quarter of 2019, we continue to face a number of systemic fundamental threats: trade wars, fears of monetary policy limitations, fading growth forecasts, and more. If indeed the temporary discount from emergent, manufactured threats (like trade wars) has already been tapped; fostering further gains will prove very difficult as the global economy struggles and central banks are forced back into the role of protector. A contrast in market performance will be even more critical to keep tabs on. The performance of US equities relative to their global counterparts is one point of clear division that makes clear confidence is not global. Emerging market assets underperformance speaks not only to the lack of return the markets expect from this high-risk assets, but also the concern that global central banks are unable to close the gap. In particular this quarter, my interests will be the relative health of those assets that are more explicitly speculative in patronage compared to those with deeper ties to the genuine health of an economy. Commodities are just such an asset type that finds itself in the latter category. If GDP is throttled, demand for these goods flags which is an inherent weight on prices. Perhaps the most interesting market to keep tabs on for the overall health of the financial system is government bond yields. Historically, yields on these products are positively correlated to risk benchmarks like equities as capital moves away from their haven appeal thereby raising the return necessary to draw interest. Yet, we have to add to this the economic implications that are starting to garner greater interest as well as the central banks’ distorting influence through stimulus – a dubious structural support. If government yields continue to tumble as stocks rise, it is much more likely that equities are the market that capitulations to close the divergence. Brexit, Now What? Like a chess board cleared of all but a few pieces that are constantly moved to avoid a conclusion, the outcome for Brexit has been officially delayed (again) and the remaining possible outcomes is dwindling to fewer – and in most cases, more extreme – options. This past Friday, March 29th, was the original Article 50 conclusion date. Before this milestone was hit, Parliament attempted to wrest control over the directionless ship with a series of indicative votes that put to tally solutions that MPs believed could overcome the lack of support for Prime Minister May’s repeatedly rejected plan. All eight of the proposals failed to hit the critical market necessary to signal clear support. Empowered by this outcome and perhaps imagining strategic advantage in growing concern of a ‘no deal’ outcome, May put her scheme to vote once again on Friday. The third time was not the charm as 344 rejected her effort against 286 that supported it. After the outcome, the European Commission’s Donald Tusk called for a council meeting for April 10th while the EU stated, for both dramatic and practical effect, that a ‘no deal’ outcome is now a likely result. As a reassurance to local citizens and businesses, European officials said that they were prepared for such an outcome. Underlining this pledge is a not-so-subtle ding against the United Kingdom, insinuating that they, in turn, are not prepared for course they don’t seem to be able to navigate away from. The next critical date on paper for the divorce proceedings is Friday April 12th. That is the time frame that was given for the UK to find a deal or ask for an extension. It was previously offered by EU officials that if May’s withdrawal agreement – agreed between both sides late last year – then they could offer time out to May 22nd, just before the EU elections to work out the details. On the docket over the coming week, we have specifically penciled in another House of Commons run of indicative votes with MPs making the same assumption that May did that support will be mustered behind recognition that time is frighteningly short and the solutions extraordinarily few. These votes are non-binding and the mood of the crowd doesn’t seem to have shifted materially. Instead, what progress we do find on Brexit this week is likely to originate from unexpected headlines. A change in support from the DUP, surprise concessions from the EU, allowance for a ‘people’s vote’; while these may seem low probability, they are as fair to consider as an ‘accidental’ no deal would be. Don’t be surprised to see either some unexpected shift in the landscape or the plug to be pulled altogether. Anticipation and fear will keep liquidity in the Pound tempered and thereby volatility high. That makes for very difficult to trading, so don’t let the flash of sudden movement lure you in like a fish to hook. That said, it is worth noting that one of my top trades for 2019 was – and remains – a long Pound view when we clear on the outcome of the divorce. If it is a deal, the earnest recovery will begin soon after confirmation is delivered. If it is a no-deal, the rebound will take longer as the market acts to work out its exposure.
  3. In the Aftermath of the Fed The baton has been dropped. The Federal Reserve was by far the most aggressive major central bank through this past financial epoch (the last decade) to embrace ‘normalization’ of its monetary policy following its extraordinary infusion of support through rate cuts and quantitative easing (QE). Over the past three years, the central bank has raised its benchmark rate range 225 basis points and slowly began to reverse the tide of its enormous balance sheet. As of the conclusion of this past week’s two-day FOMC policy meeting, we have seen the dual efforts to level out extreme accommodation all but abandoned. A more dovish shifted was heavily expected given the statement in January’s meeting, the rhetoric of individual members as well as the state of the global markets and economic forecasts. Yet, what was realized proved more aggressive than the consensus had accounted for. No change to the benchmark rates was fully assumed, but the median forecast among the members accounted for a faster drop than the market likely thought practical. From the 50 bps of tightening projected in the last update in December, the median dropped to no further increases in 2019 and only one hike over the subsequent two years. Over the past three years, the central bank has raised its benchmark rate range 225 basis points and slowly began to reverse the tide of its enormous balance sheet. The Dollar responded abruptly Wednesday evening with a sharp tumble, but there was notably a lack of follow through where it counted – the DXY Dollar Index wouldn’t go the next step to slip below its 200-day moving average and break a ten-month rising trend channel (a hold that confounded those trading an presumed EURUSD breakout). Why did the Greenback hold – for now – when the move was clearly a dovish shift? Likely because the market is already affording for an even more dovish forecast as Fed Fund futures have set the probability of a 25bps cut from the Fed before the end of the year as high as 45 percent. What’s more, if you intend to trade the Dollar; it is important to recognize that even with a more dovish path ahead, the Dollar and US assets will maintain a hearty advantage over its major counterparts. That would particularly be the case should other groups extend their dovish views to more actively explore deeper trenches of monetary policy. Looking beyond the Dollar’s take, however, there are far more important considerations for the global financial system and sentiment. The Fed was the pioneer of sorts for massive stimulus programs designed to recharge growth and revive battered markets. It was also the first to start pulling back the extreme safety net when its effectiveness was facing deserved scrutiny by even the most ardent disciple of the complacency-backed risk-on run. In other words, its course change carries significantly more weight than any of its peers. The question ‘why is the Fed easing back and so quickly’ is being posed consistently whereas in the past market participants would have just indulged in the speculative benefits. The overwhelming amount of headline fodder – from trade wars to frequency of volatility in the capital markets – makes for a ready list of considerations. Yet, the group’s own economic forecasts brought the reality home far more forcefully. Though we have seen numerous economic participants downgrade the growth outlook (economists, investors through markets, the IMF, etc), to see the median GDP forecast in the SEP (Summary of Economic Projections) lowered from 2.3 percent to 2.1 percent for 2019 made the circumstances explicit. We’ve considered multiple times over previous months what happens if the market’s start to question the capability of the world’s largest central banks to keep the peace and fight off any re-emergences of financial instability. Now it seems this concern is being contemplated by the market-at-large. That doesn’t bode well for our future. A Sudden Fixed Income Interest When ‘Recession’ Warnings Take Hold Except for fixed income traders and economists, the yield curve is rarely mentioned in polite trader conversation or in the mainstream financial media. Its implications are too wonky for most as it can be difficult to draw impact to the average traders’ portfolio and given the considerable time lag between its movements and capital market response. Yet, when it comes to its most popular signal – that of a possible recession signal – the structure of duration risk suddenly becomes as commonplace a talking point as NFPs. On Friday, the headlines were plastered with the news that the US Treasury yield curve had inverted along with a quick take interpretation that such an occasion has accompanied recessions in the past. There have actually been a few parts of the US government debt curve that have inverted at various points over the past months, but this occasion was trumpeted much more loudly as it happened in the comparison to the 10-year and 3-month spread (what has been identified as a recession warning even by some of the Fed branches themselves). First, what is a ‘curve’? It is the comparison of how much investors demand in return (yield) to lend to the government (for Treasuries specifically) for a certain amount of time. Normally, the longer you tie up your money to any investment, the greater the risk that something unfavorable could happen and thereby you expect a greater rate of return. When the markets demand more for a short-term investment than a longer-term one in the same asset, there is something amiss. When the markets demand more return from a three-month loan to the US government than a 10-year loan, it seems something is very wrong. Historically, the inversion of these two maturities has predated a number of us the recessions in the United States – most recently the slumps in 2008, 2001 and 1990. When the markets demand more return from a three-month loan to the US government than a 10-year loan, it seems something is very wrong. First is the lead period the curve reversal has to economic contraction. The signal can precede a downturn in growth by months and even years. Preparation is good, but moving too early can ‘leave money on the table’ for the cautious or accumulate some serious losses for those trying to trade some imminent panic. Further, there are certain distortions that we have altered the course in normal capital market tributaries that could be doing the same for Treasuries and therefore this reading. More recently, the revived threat of the US government shutdown through December and the unresolved debt ceiling debate put pressure on the asset class. At the same time, though, few believe the US would do little more than allow for a short-term financial shock in order to make a political point. Far more complicating for the market and the signal is the activity of the US and global central banks. The Federal Reserve has purchased trillions in medium-dated government debt as part of its QE program. They only started to slowly to reduce holdings and push longer dated yields back up a few years after they began raising short term rates in earnest. Their recent policy reversal only adds to the complication. Now, all of this does not mean that I believe the US and global economies will avoid stalling out or even contracting in the near future. Between the dependence on capital markets and stimulus, the heavy toll of trade wars and nationalistic policies, and the pain for key players in the global web; there is a high probability that we will see an economic retrenchment in the next few years. That said, that wouldn’t make this particular signal a trigger (causation) or even correlated through the main forces that would bring on a recession. Nevertheless, yelling ‘fire’ in an a panicky crowd on foggy day can still yield volatile results. Brexit, Just Winging It Another week and another upheaval in Brexit expectations. Through much of the past year’s anxiety over the withdrawal of the United Kingdom form the European Union, there was at least some comfort to be found in the finality of the Brexit date (March 29th, 2019). While it could end in favorable circumstances for financial markets (a deal that allows considerable access for the UK) or acute uncertainty (a no-deal), at least it would be over. Well, that assurance is as clouded as the expected outcome from the negotiations themselves. Shortly after I wrote the Brexit update last week whereby there was a clear timeline for another meaningful vote on the Prime Minister’s proposals – after Parliament voted for an extension of negotiations – the Speaker to the House of Commons thwarted the effort when he said the scheme would not be reconsidered unless it was materially different. It is likely that see another significant change in this drama any times (and even multiple times) this week. At Prime Minister May’s request, the European Commission agreed to an extension of the discussions beyond the original Article 50 end date for this coming Friday. Yet, where the PM intreated a postponement out to the end of June, the EU agreed only to May 22nd – the day before European Parliamentary elections. Beyond that date, the UK would theoretically remain under the regulations and laws of the EU but would have no say in their direction which wouldn’t appeal to either side. So, now we are faced with another ‘fluid’ two months of critical deadlines. This week, it has been suggested the government will try to put up once again for a meaningful vote – though it is still not clear whether the proposal will be meaningfully different (the EU has offered no further concessions) or there has been a successful challenge against the Commons speaker. When this could be put up to vote is unclear, but it has been suggested between Monday and Wednesday. If the proposal is approved, the timeline to May 22nd will remain and we will start to see a genuine path form. If it is not, then the following week Parliament will have to indicate that “they have a way forward”. If they do not, an extension or no deal will likely be considered for April 12th – out to the previously mentioned May 22nd date. If we pass April 12th without a clear plan, the probabilities of a ‘no deal’ or ‘no Brexit’ will rise significantly. Those two scenarios are extreme and on the opposite end of the spectrum. From a Pound trader or global investor considering UK exposure, you can imagine what a situation where the probability of diametrically-opposed, market-moving outcomes are considered balanced would do to the markets. It will curb market liquidity and leverage uncertainty. That would translate into divestment, difficulty establishing trends and serious volatility. If that isn’t your cup of tea, it is best to seek opportunities elsewhere for the next few months until this is sorted.
  4. Fed Sets the Tone for Global Monetary Policy Expectations Global monetary policy trends have shifted towards a more accommodative stance as forecasts for economic activity have stuttered and worries of ‘external risks’ have gained traction. This has sharpened the relative value of currencies as market dig into the grey areas trying to determine which groups are taking greater strides to loosen than their peers. However, it is crucial that all investors – no matter your preferred market nor time frame – keep sight of the collective impact the world’s central bank effort has on the health of the economy and stability of the financial system. While there has certainly been a boost to economic activity and all of its trappings through this past decade’s bull trend, there is undoubtedly a divergence between the extraordinary performance of capital benchmarks like the US equity indices and the more tepid clip of expansion we have registered lately. In fact, I would go so far as to say that the past four to five years of speculative abundance was chiefly the work of the largest monetary policy groups. The course change towards halting normalization efforts and entertaining further easing looks to tap some of the speculative magic of the past, but there is a definitive diminishing returns to successive waves of support. From central banks like the Bank of Japan (BOJ) and European Central Bank (ECB), the limitations are more overt as the scale of easing grows exorbitant. The BOJ for example owns an extraordinary percentage of the country’s ETF market and in turn holds an astounding amount of its capital market. That smacks more of desperation than safety net, and other regions are at risk of shifting to that unflattering distinction. Just how precarious that balance is finds more distinctive measure not at the most dovish end of the curve, but rather the most hawkish. The Federal Open Market Committee’s (FOMC) two-day policy meeting will conclude on Wednesday with no anticipation of a rate hike to follow on the ambitious pace of 2018. In fact, looking at Fed Fund futures, the market is pricing in a slight probability of a 25 basis point cut to the 2.25-2.50 percent range. The group’s view of the future is where the market will set its focus. This is one of the ‘quarterly’ meetings for which we are due the Chairman’s press conference and the Summary of Economic Projections (SEP). In the December update, the median forecast set expectations for 50 basis points of tightening this year (two standard rate hikes). Given the rhetoric used by most officials of late, that forecast is likely to drop at least one hike and could very well put even one move in 2019 under serious debate. If there is still a forecast for two, expect the Dollar to jump as the market has fully written off any moves (with nearly a 40 percent chance of a cut priced in by year’s end according to futures). The monetary policy statement and Chairman Powell’s remarks will offer important insight into the plans for the balance sheet reduction effort. We have already seen indication that they are planning on throttling the effort soon which will cap longer dated rates in the market – which will also mean rates of return will flag. Is this backing away from a tighter policy setting more supportive of economic activity or more troubling as clear indication that the world is in need of external support – support that is exceptionally limited compared to the past? Meanwhile, we are also due the Bank of England (BOE) rate decision which will be a conduit for Brexit uncertainties for better or worse. The Swiss National Bank’s (SNB) policy is a more extreme example of desperate policy that has lost traction, so its only true insight into global perspective is to amplify fears that the guardians of stability have failed. It is further worth registering what the Brazilian and Russian central banks do with their own policies as the emerging market draws direct connection to US health and risk trends register far more readily here. Trade Wars are Increasingly an Underappreciated Threat There is a hierarchy of systemic themes that rotates in its influence over the global markets and its participants. ‘Basic’ appreciation of economic potential was the focus these past two or three weeks owing to targeted economic data and troubling forecasts (such as China’s lowered target for the coming year at its National People’s Congress). Attention on this particular intersection of market-wide health will not simply vanish – we have important measures to contribute to forecasts like the Fed’s GDP forecasts and March PMIs on Friday – but appreciation will likely soften as catalysts offer a more obvious update. Monetary policy will offer the most tangible impact on a fundamental basis, but there is another theme that has garnered less attention of late but which should not be forgotten: trade wars. The course for competitive economic policies via trade pacts has shown definitive improvement in the status quo from six or nine months ago. The outright US-China trade war has seen the course of steady escalation frozen by the Trump administration as they continue to negotiate towards structure improvement as well as balance of consumption equity. Of course, the President’s threats that they could walk away if the deal is not favorable and President Xi’s calls for a clear time frame remind us that this is not a done deal. Another assumed reversal of fortune that is once again raising concern comes from the revamped relationship between the United States, Mexico and Canada. The replacement of the NAFTA accord with the USMCA deal was considerable relief for Mexico and Canada while simultaneously promoted as a success for the Trump Administration’s appetite for aggressive negotiations to hash out trade deals. That bargain is starting to come under significant pressure however as Congress threatens to scuttle what was agreed to amongst the three countries’ negotiation teams. Where we are already in the weeds on these two fronts of US trade, the threat of new economic conflicts garner even less appreciation. That is extremely shortsighted given the financial repercussions of the past year to the other efforts and the volatile nature of dealing with the US. A month ago, the US Commerce Department delivered its findings on an auto tariff probe that it conducted at the behest of the White House. We don’t know the results of that report and the President still has two months to decide whether to pursue something. However, we have seen explicit threats by the White House against countries with perceived unfair trade advantages for their auto industries – as well as vows of large scale retaliation by those in the crosshairs. If the President considers dealings with the USCMA and China a success, it is more likely that they pursue the same line on autos, particularly should political popularity rankings flag and/or domestic economic activity measures continue to crawl. A Third Meaningful Vote and an Update on Brexit Scenarios I don’t think anyone will miss Brexit when it is done. Nonetheless, we need to keep close tabs on its progress as it continues its uncontrolled tumble down the hill. This past week was loaded with votes – and subsequently volatility. Prime Minister Theresa May put up a rejiggered proposal for vote in Parliament this past Tuesday and the MPs dismissed it outright once again – though this iteration wasn’t a record-breaking defeat for the PM. That in turn led to the debates this past Wednesday which resulted in a decision to direct May to avoid a ‘no deal’ scenario at all costs, which definitively beats back the range of uncertainty inherent in this saga. Sterling traders took notice as we saw GBPUSD produce its largest single-day rally since April 2017. With a seeming cap on the economic repercussions this event may pose, the next question was whether May should be directed to request an extension from the EU on the Article 50 end date (set for March 29th). Approval of that particular leg is perhaps the least surprising of the week’s discussion points. Yet, with direction to seek deferment on the divorce date, serious questions followed asking whether more time would actually translate into a feasible deal. Given the state of discussions after two years, there is reason for skepticism. In turn, some hold outs have begun to signal a willingness to take a more moderate stance in order to find some compromise. That has encouraged the Government to put up proposal from May – it doesn’t look like she expects to have further concession – for another meaningful vote (MV3). Set against this Wednesday vote, we have seen the slogan turn to a simple arithmetic of May’s deal or risk a protracted period of uncertainty or even no Brexit at all. There are suggestions that some in Conservative party are willing to throw in some support in exchange for the PM’s resignation, but that does not come close to guaranteeing a majority. If the proposal is rejected once again Wednesday, focus will turn to the mood of the UK-EU negotiations. If support does not significantly shift in favor of the Government and May sticks to her warning that rejection will necessitate a long extension, then we will start to run up against the EU’s restrictions. EU elections will create further tumult in negotiations with the UK at risk of holding under the Union’s influence without say over the course the collective is taking – a very unattractive proposal. When assessing the Sterling and foreign investor appetite in the UK, the ultimate question is not the detail nor political advantage of one outcome versus the other. The basic question of taking risk or not is uncertainty. The longer the uncertainty is for the course of the UK’s economic and financial relationships moving forward, the greater the perceived risk for investors. That does not mean the Pound will just continue to drop throughout the imposed purgatory, but it will add volatility and cap the ambitions for substantial rally. Critical Fundamental Themes to Keep Watch For Next Week: - Recession Signals in Data, Markets and Forecasts [Indices, Yields, Gold] - Monetary Policy Supporting Risk Trends or Falling Short [Fed, ECB, BOE, EURUSD, GBPUSD, Gold] - Gov’t Bond Yields and Commodities as a Growth-Leaning Risk Asset [Dollar, Euro, Yields, Oil] - Brexit Article 50 Extension [GBPUSD, EURGBP, FTSE100] - US-China Trade War Deal Detail Headlines, Trump-Xi Meeting Time Frame [AUDUSD, USDCNH] - Threat of US Implementing Auto Tariffs [EURUSD, USDJPY] - Excessive Leverage / Debt in Public and Private Channels [S&P 500, Yields, Gold]
  5. Growth Takes Center Stage with Peoples’ Congress and OECD Forecasts Most investors and traders attempt to project into the future in order to take advantage of large market moves before they are priced in and the trend potential is spent. That is perhaps the most basic precept of speculation, yet it also brings with it a range of collective cognitive biases. One such mass psychological distortion is a prioritization of the means over the ends. When looking back to the 2008 financial crisis, there is often specific reference to the US subprime housing market implosion while 2000 is referred to as the Dot-com bubble owing to the remarkable outperformance followed by decline of technology shares. Both situations were charged by excessive leverage and resulted in both financial and economic pain, but they are best remembered by their ‘touch off’ event. Why is that? As pattern recognition machines, humans want to avoid a repeat of a painful event from the past, but we don’t always bore down to the root of the problem – especially when the situation is complicated or inconvenient (such as chasing mature and fundamentally dubious trends). At present, we have a range of high-profile fundamental themes that could ease experience another flare up that coincides with the eventual turn of the markets (trade wars, monetary policy flub, fiscal policy flub, political crisis, diplomatic relationships breaking down, etc). Yet, in a neutral market environment, all of these issues could be absorbed readily with little more than a brief injection of volatility. To see the market reverse course systemically, the fuel is more important than the ignition. As with most other periods of extravagant speculative reach – which have subsequently turned to collapse – we are dealing with an overabundance of leverage across the global economy. It doesn’t matter if we reference location (US, Europe, Asia) or participant segment (consumer, investor, businesses, governments), there is an exposure issue. As extensive as the risk may be, it doesn’t necessarily reach an obvious or quantitative level of critical mass whereby it collapses upon itself. As the saying goes: ‘the markets can remain irrational longer than you can stay solvent’. That said, recognition across the market that the ‘fundamentals’ are extremely divergent from the prevailing levels in the market will eventually trigger a cascading of hold out sentiment capsizing under the recognition. Arguably the most incontrovertible evidence that value does not align to speculative ambition are broad measures of economic health like GDP. We have absorbed most of the 4Q GDP readings from the US, Europe and Asia over the past month, and the general consensus is one earning clear caution. Of course, the period may prove a lull or a true turning point, but only time will bear that out. Yet, the impatient, speculative nature of the market may dictate determination before the data has a chance to verify months after it occurs. More timely data and surveys are therefore consumed veraciously as market participants perform their qualitative or quantitative assessments. References to historical, market-based patterns (such as the yield curve) grow in popularity. All this said, there is still greater weight attributed to ‘official’ figures. In the week ahead, we have a few important updates that will represent ‘official’ benchmarks. For the trade war-racked Chinese economy, the effort to throttle a debt-fueled explosive expansion threatens to trigger an unwanted rapid economic slump. How genuine a risk is this from a country where data is just as regularly second guessed? Their own growth target provided in the official Peoples’ Congress is one of the most insightful measures we find from the world’s second largest economy. In the meantime, the developed world will see a more comprehensive update to its growth forecast from the OECD who will release its updated projections mid-week. The more sensitive the reaction to these data points, the more worried about basic growth the market is. Monetary Policy and a Possible Repeat of History for the ECB The world’s largest central banks have taken a noticeably dovish shift over the past year. Many were unnerved by the disruption in global markets through the first half of 2018, but the second extreme bout of volatility in the fourth quarter and subsequent downturn in the economy in that same period has pulled most holdouts into the same camp. In recovery that unfolded after the Great Financial Crisis, monetary policy authorities played a critical role in fostering the revival of investor sentiment and economic stability. Yet, their efforts over the past five, where the more extreme expressions of monetary policy hit their stride, resulted in far less productive economic return (inflation and growth). Not official objective, but nevertheless a sought-after result, additional waves of stimulus have also seen progressively less appreciation for local capital markets (targeting a ‘trickle down wealth effect’) and even a disconnect from forcing a trade-supporting depreciation in currencies. While in previous years this was not a mainstream topic of conversation as the impact was nuanced and there were supporting factors concealing the erosion of efficacy, it is now a glaring disconnect that the market is instantly wary of should reliance of economic health shift back onto the banks’ shoulders. This may be a trial that we are not able to avoid as the global economy sputters and the world’s governments’ show little interest or capacity to collaborate on a scalable solution. Thus far, most of the movement towards a more accommodative monetary policy position – from the already ‘crisis’-level setting for most – has been verbal. However, action may soon be on the way. Swaps are pricing in modest probabilities of rate cuts from the Fed and RBNZ with the RBA sporting a high probability while the Bank of Japan continues to inject stimulus with reckless abandon. The most overt signal to the global financial system that central banks have lost control would come from the European Central Bank should it decide to act. The group has just capped its progressive easing effort as of December and it finds itself already at the extreme with negative rates along with a massive balance sheet. Unlike the Fed, the ECB hasn’t given itself enough time to reestablish a buffer to employ further support should push come to shove. That said, the group has started to signal growing caution and seems to be testing the market’s reaction with thinly veiled suggestions of another policy adjustment. Despite this, going back to the QE program is not an option while further rate cuts deeper into negative territory would only prove the current settings are ineffective. Another tool has come back into the conversation from the Eurozone debt crisis days: LTROs. While not the same stigma as quantitative easing, it is nevertheless a tool looking to do the same thing – coax along stubborn economic recovery. The last time this central bank connected policy to economic trouble (at the time, it said the interest was deflation sustained by a too-strong currency), the side effect was an incredible 3,500 pip slide in EURUSD. If even a portion of that depreciation were realized today, the competitive trade environment would almost certainly trigger a currency war. And, in this environment, that would almost assuredly result in a stalled global economy and financial crisis. There is More to Trading Than Spotting Explosive Breakouts and Trends This is something I have written on before, but it is so important that it bears repetition. There is more to trading than spotting fantastic breakouts or riding enormous trends. These are the kind of market developments that can result into large profits if properly navigated, and the former tends to render those large returns more quickly. Large returns in a short timeframe is what every market participant is looking for, but these events are statistically infrequent and require considerable discipline to exploit. So, those seeking these conditions are projecting improbable regularity and they more-often-than-not do not have the experience to properly pilot. That is not a successful strategy. In contrast, range or congestion-based markets are historically the most common environment. Further, the shortened time frame of market moves, the greater compliance to technicals and a more forgiving connection to fundamentals (events and themes) makes for a backdrop that is far more aligned to the average traders’ tendencies. So, why do so few traders look to take advantage of these conditions? There are a multitude of reasons but among the most common are an unrealistic appetite for extreme returns in a very short time frame as well as a misconception of what successful investors are (everyone wants to be the hedge fund manager that makes an incredible account doubling return on one trade). This digs not into the conditions of the market or even strategy in particular but rather it speaks to trader psychology. If we can change our objective to more timely trades with reasonable objectives that lead to respectable returns over time, we will naturally align ourselves to more readily take advantage of the market. Now, this is not to say that we are always navigating a range-based market – only that such settings are the most common. The most prepared market participant is the one that has a different strategy or adaptations of a single strategy that are more appropriately attuned to range, breakout and trend environments. Of course we also need the tools to assess which setting is currently on display.
  6. Pricing in Trade Wars Versus Pricing in Recession Risks Investors are starting to see a path form for the United States and China to find a way out of their economically and financially-damaging trade war. After months of little more than a few words of optimism from only one side of the table – which was frequently reversed only days later – we are starting to see conviction from high level officials on both the American and Chinese sides. This past week was the most encouraging period for this year-long economic conflict, even offering a few tangible policies to break through some of the skepticism that had calcified these past months. Following an announcement of five MOUs (memorandums of understanding) to form the backbone of a deal, negotiators made a concerted effort to dazzle the markets Friday suggesting that significant progress had been made and that a summit between Presidents Xi and Trump was being arranged, perhaps for the end of March. And, while some of the US team qualified that some structural policies and intellectual property protection were unresolved, reports that an agreement was already made to prevent current manipulation and that China was prepared to buy $1.2 trillion in US goods indicated serious collateral to push the deal through. So, now what? Will committed breakthroughs and tangible deadlines prompt successive legs of a sustained rally? We have already seen a significant recovery through the opening two months of the year offset much of the painful slump through the fourth quarter of 2018. This wasn’t a recovery forged ‘in spite of’ the unresolved situation between the two superpowers. There was invariably a healthy measure of speculation that a breakthrough would be found in the foreseeable future. It is unlikely that the full weight of this fundamental threat has been fully shed by opportunistic interests (just look at the Australian Dollar or emerging markets), but we would not likely see a full economic recovery even if the issue were fully reversed. For trade wars, there remains the uncertainty that the US could engage other major economies. In particular, there is reasonable concern that the Trump administration could apply hefty tariffs against imported autos and auto parts. That would put a severe strain on relationships with the EU and Japan (some of the largest developed world economies), and the former has taken pains to spell out its preparations for retaliation should the US move forward with the Commerce Department’s recommendations. How much concern for future possible engagements is already weighing the market, it is impossible to tell; but the sheer economic implications suggests it is not being taken seriously as yet. Pricing in the rise and fall of trade wars can be complicated and volatile given the variable scale of the impact and the flippancy of headlines involved, but some of the direct economic impact related to this threat are not so capable of being fully accounted for in prevailing market prices. In other words, we can fully discount a full blown trade war in the short-term with a sharp decline in assets, or completely alleviate the pressure with speculative appetites reverting to complacent norms. In contrast, the implications of these efforts tipping the economy over the edge into recession cannot be adjusted for in spot. There is no ‘sell the rumor’ on true economic contraction that can see a ‘buy the news’ as the pain unfolds. The markets simply continue their tumble as capital is divested from financial, fixed and human assets. This is where market participants should tread more carefully about their calculations for the near future. The trade wars may have seen their peak, but economic data suggests the momentum if dragging us closer to the cliff. Central Bankers to Testify to Their Governments and the Markets Monetary policy around the world is in a difficult transitional phase. After years of unprecedented easing and venture into unorthodox stimulus programs, it seemed that we had finally found the central banks’ nadir. Though the Federal Reserve was the only major bank to actually take meaningful steps towards ‘normalizing’ its balance sheet and rates, many other outfits had taken small moves or had signaled their paths had leveled. Considering this shift was taking place years after the global economy had righted itself from the Great Recession and markets charged back towards record highs, the sentiment the transition engendered was a mixed one. While in part a sign of confidence that conditions had improved, it had also left the markets with the clear impression that the effectiveness of their policy tools had all but collapsed. If these officials had years for the economy and markets to return to cyclical norms while their own policy settings slowly reset to afford a future crisis-fighting platform, this lack of capacity would fade into the backdrop and perhaps not even resurface in the next economic slump. Yet, conditions are already getting rough and there is virtually no buffer rebuilt. Now some authorities are starting to recognize the trouble in the environment and the impotent position for which they find themselves. There are a few strategies being pursued to inspire confidence. The least surprising tonal change is the commitment to turn back to a dovish setting and provide further easing should conditions warrant it. While not unexpected, it raises serious concern as it highlights the lack of capacity they were hoping to paper over. The other unofficial approach to dealing with 2018’s volatility and the unmistakable slide in growth forecasts is willful ignorance. As all paths of the future are a set of probabilities and they have little ability to affect systemic change by their hands, why not just profess optimism and try to inspire consumption, investment and expansion through their own enthusiasm. Neither of these are the kind of options that could genuinely fend off genuine trouble, but it is where the policy authorities currently find themselves. The Fed’s minutes this past week has built on the speculation that new hikes would come this year (priced into the markets) with clear suggestion that the balance sheet wind down would stop – still around $4 trillion. This will make Fed Chairman Jerome Powell’s testimony in Congress this week that much more important. The conversation goes where the Senators and Representatives steer it; but expect assessment of his economic forecasts and evaluation of external risks. We may also find our way to some incisive questions as to the lack of means left to the world’s largest central bank. There will similarly be a Parliamentary testimony delivered by key members of the Bank of England (BOE) – as well as an open presser on a separate day. Here, the attention will be more directly fixed on a specific fundamental risk to the local economy: Brexit. There are other speeches scheduled by members of other central banks along with important data that often goes into authorities’ separate mandates. Yet, almost regardless of how the data populates or how the central bank members come off (optimistic, fearful, dovish, etc), the markets will be more critical with the overt troubles on the horizon. Another ‘Meaningful Vote’ as Brexit Realities Come Into Play As of Wednesday, there will only be 30 days until the scheduled March 29th Brexit date whereby the United Kingdom and European Union are due to spilt ways. Given how much back and forth there has been on this process, it is easy to forget that lawmakers were looking for a deal sometime this past September or October from which they could begin preparations for the actual Brexit date. Now, they are simply scrambling to secure a legally-binding agreement rather than end with the ambiguity of a ‘no-deal’. There is little doubt that some parties are using the pressure of the clock to draw more submission from their counterparts for a better overall deal. Traditional game theory applies, however, with the parties needing to have a degree of cohesion within their own rank and a general acknowledgement of the risks that their side faces. There isn’t strong evidence that these factors are present in this particular match. With a few painful defeats for the Prime Minister this past month and the EU making little movement to meet the requirements laid out by Parliament’s amendments to their leader, we are coming upon another important day in the Commons. On February 27th (Wednesday), MPs are set to debate whether they should take over greater control over the divorce proceedings from May. Previous votes looking to do exactly this were rejected, but time is growing very short. Furthermore, there have been a number of Conservative and Labour members who have publicly left their party owing largely to the lack of meaningful progress in the negotiations. Another crimp to the process are reports late this past Friday that senior members of May’s government have called on the Prime Minister’s resignation by the month of May. That could be construed as troubling, but it could also signal acquiesce to a deal in exchange for a change in leadership. Over the weekend, May promised a vote on her latest Brexit deal by March 12th, looking to buy a little more time at home and likely to avert a more serious defeat that could make negotiating with European counterparts armed with grand threats all but impossible. How much good will does Theresa May have to buy more time to negotiate when so little time remains? We will find out on Wednesday. In the meantime, concern by investors, businesses and consumers – already showing hints of panic – will increasingly translate into action. Investors will move their capital out of the Pound and Euro, businesses will push forward with their ‘no-deal’ contingency plans and the more alarmed Brits will look to safe guard their accounts from financial jolts. Anticipation and fear can carry very real world and lasting impact.
  7. Don’t Forget Trade Wars Aren’t Isolated to US-China Trade wars remain my greatest concern for the health of the global markets and economy. There have been threats in the past where a localized fundamental virus has turned contagious to the rest of the world by unforeseen circumstances – such as the Great Financial Crisis whereby a US subprime housing derivative implosion infected the wider financial markets by destabilized a foundation built on excess leverage throughout the system. When it comes to trade wars though, there is no need to connect the dots. The systemic implications are apparent. The world’s two largest economies (and markets) are engaged in an escalating ****-for-tat economic conflict. There is little chance that the fallout from such a profound distress would be contained to these two contestants. The United States is the world’s largest consumer of finished goods and China is the principal buyer of the commodities. Whether appetite is trimmed owing to trade policy or stunted economic growth, its smaller trade partners would feel the pain. Yet another organization that is warning over the risks these two are charging was the United Nations whose trade group said further planned escalations could severely impact GDP (it estimated ease Asian economies could drop by $160 billion), trigger currency wars and generally promote contagion. That said, the headlines this past week should raise serious concern among traders. Reports (and remarks) signal the White House does not expect a deal to be struck between the two countries by the end of the 90-day pause on the planned tariff hike. What’s more, sources say President Trump is not going to extend that date and intends to increase the tariff rate on the $200 billion in Chinese imports from 10 percent to 25 percent on March 2nd. That is a severe escalation and one that Chinese officials will not likely take in stride. As tensions rise, there is movement in Congress to curb the White House’s powers to pursue this economic war through its utilization of Section 232 of the Trade Expansion Act of 1962 – this at the same time Trump is attempting to leverage more control. As this effort progresses, it is important to remember that this is not playing out on a single front. Where it seemed that the United States’ pressure on Mexico and Canada via the NAFTA agreement was resolved by the creation of the USMCA, Congress is now signaling that it may reject the effort if material changes are not made. What’s more, we may see the pressure expand yet further. The loose threats by Trump to place tariffs on auto imports have been made multiple times over the past year. A deadline is finally in sight of this threat to potentially gain serious traction. Next Sunday, the Commerce Department is due to give its recommendations following its evaluation of auto imports. Given Secretary Ross’s disposition, it is likely to be a charged report. If the US were to implement tariffs on imported automobiles, the economic and diplomatic impact would be far more significant than what we have seen between the United States and China thus far. Global economic stagnation would follow soon in such a development’s wake. Paying More Attention to Rates as Outlook Weakens Monetary policy as a financial theme never truly lost any of its influence over the global markets these past years. However, investors’ attention has waned on this critical pillar of speculative reach as appetite for yield has solidified complacency. Yet, conditions are beginning to change with economic activity slowing and volatility in the capital markets picking up. That in turn draws attention back to the backstop that so many have based their convictions – whether they realized it or not. To some, fear that markets are at risk of retrenchment bolsters expectations that the largest central banks are going to step in to temper volatility and lift risk assets by flooding the system with cheap funding once again. For those whose confidence remains, they still consider the likes of the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ) forces of nature. Closer examination of these groups’ current policies and the available tools still at their disposal, however, should raise serious concern. While the Great Financial Crisis is a decade behind us with growth having stabilized and markets surged in the period since, collective monetary policy has changed little. While the Fed may have raised its benchmark rate range over 200 basis points, none of its largest counterparts have moved significantly off of their own zero bound. Furthermore, there remains an enormous amount of stimulus awash in the system with central banks’ balance sheets bloated with government bonds, asset backed securities and even more traditional investor assets. If push comes to shove and markets started to avalanche lower despite the present mix of support still in place, what would these authorities be able to do muster in order to counterbalance? There is no meaningful capacity to lower global rates and QE has gotten to the point where its effectiveness draws as much cynicism as assurance. Adding more support against a persistently incredulous market would only solidify the realization that central banks are no longer the effective backstop for speculators they once were. And then where do we expect to turn for help? A coordinated effort from global governments when they cannot even maintain existing trade deals? As our markets remain volatile and economic forecasts soften, expect scrutiny over monetary policy and its effectiveness to increase. We have seen that already take place with the market’s response to the Fed’s dovish shift and even the RBA’s and BOE’s growing concerns this past week. Rate decisions, speeches and even data close to policy mandates will leverage greater focus – and likely market reaction – moving forward. Dollar Can Compensate for Issues By Advancing on Euro, Pound Pain The Dollar is in a complicated fundamental position. There are numerous domestic issues that represent a serious fundamental weight on the benchmark currency but global troubles will consistently work to counteract the loss of altitude. Of course, the likelihood of a perfect equalization is highly improbable. One development or the other will prove more severe than was expected or the market will decide a particular issue is of far greater consequence to the financial system. It is not clear which node will trigger a tidal wave of capital market flows, so we need to keep tabs on those themes that will exert greater influence on the benchmark as the dominant force will likely arise from these known quantities. On the economic front, the US economy has shown signs of economic slowdown and a sharp drop in sentiment readings from consumers to businesses to investors. This was only accelerated by the US partial government shutdown and the risk that it closes once again is worryingly too high. The stopgap funding runs out on Friday. The delayed economic readings with the status check before the shutdown impact was full felt are starting to trickle out and the GDP reading seems to be due next week. An ineffectual government looks to like it will increasingly be a core issue for the world’s largest economy moving forward with promising programs like infrastructure spending increasingly relegated to the dustbin of unrealized campaign promises. And of course, with the promise of economic wealth fading and sentiment withering, the Federal Reserve’s intention to further raise rates to establish a higher rate of return on US investments will naturally recede. Yet, all of these shortcomings will have powerful relative corrections. While the Fed may very well halt its monetary policy ambitious of the past three years, to stabilize at a 2.25-2.50 percent benchmark range while major peers like the ECB, BOJ and BOE shift to a dovish course from zero rates and expansive stimulus will maintain relative advantage to the Greenback. Should risk aversion build globally, the Dollar has more investment interest premium built up over the past years that could leach away, but a tip into severe risk aversion (which would be difficult to avoid in a committed downturn) would leverage the currency’s absolute haven appeal. What’s more, where the political infighting in the US is more localized, it is not a unique trouble to the United States. Further, it is persistently applying greater pressure on trade counterpart around the world through the trade war. Perhaps one of the truly untested and underpriced risks to the Greenback however is the intentions of the US President. Over the past year, Trump has voiced his consternation over the level of the currency as an impediment to his strategy for course correct trade and perceived inequities to trade partners. In the event of universal risk aversion which puts serious pressure on the global economy, we are unlikely to see an effective collaboration across the world’s largest countries as the game theory in their competitive efforts will more likely intensity under the weight. With demand or Treasuries resulting in a rise for the Dollar, it would not be out of the question to imagine the White House responds with unorthodox policy aimed at driving the currency lower. The real trouble would only begin if the world’s largest player touched off a currency war.
  8. With the Fed’s Language, Global Central Banks Signal Softening Policy Global monetary policy has shifted more noticeably to the dovish extreme of the scale over the past months, but investors were overlooking this questionable support because the markets were under serious duress. Yet, after the three-month tumble leveled out into a meaningful recovery into January, market participants began to look for fundamental reasoning to justify their growing confidence for their exposure. With the Fed’s unmistakably dovish transition between the December and January policy meetings, conviction in central bank support started to return to levels that mirrored the zombie-like reach for yield that defined the low-volatility, steady climb assets between 2011 and 2015. The terms of ‘plunge protection team’ and ‘QE infinity’ as applied to the world’s largest central banks are frequently voiced as skepticism by those that think extreme accommodation is ineffective and far more costly than central banks and the average investor appreciates. However, those phrases are just as significant to the bulls who have grown to depend on group’s like the Fed to keep an artificial calm over the financial system. There is good reason to believe the US central bank has taken a meaningful turn in its policy regime. The December Summary of Economic Projections (SEP) lowered the 2019 forecast for rate hikes, but last week’s rhetoric made clear that the water mark for even a single hike this year is likely beyond the reasonable threshold. The US central bank is only signaling a curb to future plans of rate hikes following 225 basis points of tightening, but that is arguably one of the biggest alterations of course that we’ve actually seen. There is little mistaking that the course is such that the comfort in slowly normalizing extreme policy easing has all but vanished amid slower growth, breaks in global trade and threats to financial stability. That will incur more concern amongst those in the markets than speculative opportunism. Benchmark risk assets are not trading at a value-based discount and our proximity to the extremes of traditional as well as unorthodox policy will curb hopes for the recharge for milestones like the S&P 500 to make it back to record highs – much less surpass them. Of far greater concern in monetary policy in my book is the consensus recognition among investors that central banks have no recourse to fend off a genuine crisis should the need arise. And, if we follow this path, the need will come. Only the US central bank has any leeway to purposefully lower rates, and that is only 2 percentage points to return to zero where the economy would once again find itself stuck in a financial hole. Returning to active stimulus expansion will only lead down the same path that the Bank of Japan has already found itself lost upon. The BOJ is stuck tying bond purchases to its 10-year Japanese Government Bond yield with no sign of reliably faster growth or sustained pressure for inflation to return to its target. The lack of traction for Japan’s central bank already draws enough unwanted attention to the state of monetary policy. If similar acknowledgement of a permanently disabled tool spreads to global monetary policy, we will find no other probable means to stabilize a market crash or economic slump by officials’ means alone. With Sentiment on the Upswing, Expectation Rise for Trade Wars We have seen a few of the more pressing fundamental threats to the global order abate over the past few weeks. It comes as little surprise in turn that sentiment in the market has improved in tandem. A slow normalization of monetary policy was seen as a slow strangulation of stubbornly nascent growth. With the Fed, ECB and others signaling their submission to the rise of external risks and stalling economic measures; the leash on speculative excess has been let out a little. Another point of perceived improvement comes from the end of the US partial government shutdown the week before last. After a record-breaking, 35-day closure that cost the economy an estimated $11 billion – a hefty portion that will prove permanent – this large component of economic activity is once again contributing to expansion. Of course, there are a number of caveats associated to this situation that should leave traders uneasy such as: the threat that the shutdown could be reinstituted by the middle of this month; that the tangible impact on the economy may have pushed a tepid expansion into a stalled or contracting economy; as well as fostering a collapse in sentiment around a government incapable of finding critical progress when it may be most necessary (such as in the emergency of a crisis). More generally, these improvements are notable the lifting of a fundamental burden imprudently applied to the system rather than a genuine upgrade to the outlook. How much growth and opportunity can we expect from the correction of errors? Well, at the moment; the answer to that question is: at least a little bit more. With these and a few lesser issues throttling back the burden, the markets will be monitoring for what other temporary boosters can earn a little further stretch. One of the most extensive threats to arise this past year with an explicit price tag attached to it has been the trade war. While there are multiple fronts to this effort to grow at the expense of trade, there is no skirmish more costly than the standoff between the United States and China. With tariffs on over $350 billion in products, we have seen sentiment and growth measures on both sides deteriorate. However, rhetoric surrounding the discussions between these two powerhouses has recently elicited more enthusiasm from officials and the market. This past week’s discussions between the Chinese Vice Premier and a delegation of key people from the US (Trade Representative, Treasury Secretary, Commerce Secretary) was said to have gone well and that the conversations would continue in China shortly. Never mind that there were no tangible policies suggested nor that President Trump said he would likely keep to a tariffs hike at the end of the 90-day pause as of March 1st. With speculative assets on the rise and market participants believing that officials are doing what is necessary to foster buoyancy in benchmarks like the S&P 500 (speculation the Fed capitulated in the market slump while Congress and the President surrendered in order to avoid the negative weight), it stands to reason that the White House would divert its trade course to afford further gains. In the end, though, these will still be temporary gains. How Important is this Week’s Bank of England Rate Decision? When it comes to the British Pound the principal fundamental concern remains the uncertainty that Brexit poses to the UK economy and financial system. This is more troubling for investors – foreign and domestic – than something more targeted and acute like a stalled GDP reading. There is no doubt that a halt to growth is a problem, but the issue would be a known quantity. From the details provided with the general update, we would know where policy and support would need to be targeted to course correct into the future and investors could still identify opportunities from those areas of the economy which are still progressing or are likely to do so from a temporary discount. When we are dealing with a complex and unwieldy situation like the UK’s divorce from the EU with a distinct countdown (to March 29th) and the sides obstinately at odds with each other, it can be extremely difficult to confidently assess the risks of your exposure. This same contrast will exist with the upcoming Bank of England (BOE) rate decision on Thursday. The central bank is very unlikely to change its key lending rate at this gathering and rates markets reflect that belief. However, this is one of the more nuanced gatherings with the inclusion of the Quarterly Inflation Report. The update includes pertinent information to assess the outlook for the economy and financial system – which Brits and investors are desperate for at the moment. Their growth assessment will no doubt reflect some of the troubled figures that we’ve seen via various timely sector updates. Further, acknowledgement of external risks and ongoing Brexit fallout (such as surveys showing businesses are actively looking to relocate or considering it) will be a central element to the update. Yet, will it be market moving? Governor Carney and his crew have warned of the risks to a ‘no deal’ split for some time now, and we have seen the market’s reaction to their concerns drop steadily over time. It is the case that the Pound’s recent climb these past weeks poses as certain degree of premium that could be cut down by otherwise routine concerns. However, if I were to see a headline suggesting a breakthrough or overt block in the dialogue between Prime Minister May and her EU counterparts, I would expect it exert far greater influence over the Pound than what the BOE could reasonable do.
  9. The US Government Shutdown is Over, Now What? Late last week, US President Donald Trump announced from the White House that he would back a stopgap funding bill that would reopen the federal government in full. This would mark the end of a record-breaking (35-day) partial shutdown of the US government. Normally, that would be reason for a swell in market enthusiasm. An onerous pressure on the US economy – a 0.13 percentage point reduction in GDP – suddenly lifted would typically manifest in a sense of significant relief in both fundamental concern and speculative recovery. However, the markets were not set deep in discount when this news crossed the wires. The Dow and S&P 500 were already four weeks deep into a recovery effort that has already crossed the mid-point of the painful October-December tumble. In other words, there was no deep discount for speculators to readily take advantage of for a quick speculative rebound. And so, we are left to evaluate the outlook from a more-or-less ‘neutral’ backdrop. Removing the burden of an open-ended and tangibly detrimental threat, is not in itself a positive development. It simply removes an active affliction. When such a shift charges markets, it is a sign more of the general conditions whereby speculators are looking for any reason to reach further. Given that US indices – a proxy for risk trends – are still on pace for the best month’s performance in years, we may still see a delayed response to the breakthrough next week. However, if we do not, the lack of enthusiasm will start to draw a certain level of concern. From the shutdown itself, we are only earning a temporary break. According to Trump’s statement, the agreement is to temporary funding for the next three weeks. He has said that if there is not funding for a border wall by that time, the shutdown will return and/or he will use emergency powers afforded to the executive branch to secure funding. That alone is a delay of concerns, not an resolution. Furthermore, there will be permanent hold over from five weeks of partial closure for the US federal government in the form of sentiment. In the period since the closure began, we have seen a marked drop in sentiment surveys from businesses to consumers to investors. That is not just a reflection of this particular situation, but an environment souring doesn’t exactly improve circumstances moving forward. According to the calculations from the White House’s own economic council, this period has resulted in nearly two-third a percentage point loss in GDP. That is significant. Even more significant is the carryover effect of a market that is concerned that similar self-destructive policy breakdowns will happen again in the future. What if external risks touch off an economic slump, how will this inability to act quickly with accommodation impact the system? As the US debt load continues to rise to record levels, how will the threat to growth and tax revenue impact the United States’ credit rating? Even if this US government rift has been permanently closed – it hasn’t – be careful of reverting to a state of comfort that markets really can’t continue to live up to? A Rising Pound and Another Critical Brexit Vote We are heading into another important event in the ever-winding road towards the United Kingdom’s withdrawal from the European Union. A little over a week ago, Prime Minister Theresa May put her Brexit proposal up for vote in Parliament only to meet the worst rejection for a PM in British history. It is unlikely that she pushed forward without knowing that should would at least be met with defeat – and it is likely that she knew it would be a remarkable one. That suggests there was a plan involved – perhaps using the outcome to pressure her EU counterparts to offer further accommodation to appease a divided Parliament and finally find a way to create an amicable break. However, after three Commons’ sessions, the Plan B May was forced to submit for review seemed to draw the same general skepticism. The debate period will end Tuesday with a vote and the sentiment surrounding the scheme seems as if it is heading for another explicit defeat. Such an outcome would leave the UK in the same economic and financial straits it has traversed over the past months – yet this time, the sense that time is quickly depleting will be unmistakable. If there is no agreement to be found on Tuesday, it will be 59 days until the Article 50 period closes and the country leaves the Union. It is possible that May request an extension on the deal period – and a number of European officials have voiced willingness to grant additional time out to July – but May has repeatedly rejected the notion. If Parliament continues to maneuver in line with its previous efforts, the red lines may start to shift next week. Parliament may attempt to take greater control over the course this ship is sailing, but their inability to come to consensus has thus far been the most difficult roadblock. In the meantime, May and her colleagues have no doubt scrambled to secure some rung that can finally lift the situation out of its mire. Knowing that there is an active strategy being executed, it would be risky to speculate on a hard, binary outcome from this situation. Nevertheless, the Pound has climbed remarkably over the past few weeks. For GBPUSD, the climb carried the benchmark pair above an eight-month trendline resistance and then the 200-day moving average. That is genuine progress, not the course of measured oscillations in normal markets. It is remarkable to see such explicit risk taking with a key event risk ahead (and leaning more readily towards disappointment). Is this perhaps a reflection of growing confidence in either a soft Brexit or second referendum or perhaps just a drop in probability for a ‘no deal’. The Sterling has certainly found itself at a discount over the past few years, and the chances that a bid for more time or a warnings towards more flexible conditions is a higher probability. Yet, that should not prompt traders to grow cavalier over their risk taking. The Three Top Standard Events This Week: FOMC Decision; Eurozone GDP; NFPs If you were tired of abstract systemic issues and looking for more targeted market volatility events, the coming week should pique your attention. There are high profile, discrete (date and time determined) events due throughout the week. Though, before we dig into them, it is important to realize that the capacity of these data or speeches to prompt greater volatility and/or extend a run is founded in their connection to deeper, unresolved issues. It is therefore our present circumstance – with a market that teeters between a seemingly unrelenting sense of complacency and unmistakable slump in speculative assets across the world – that will dictate the amplitude that these events meet. For sheer number of events on tap, the US docket carries the greatest weight. Top event in my book is the FOMC rate decision. This is not one of the ‘quarterly’ events for which the central bank has consistently held off for in order to hike rates. However, we no longer seem to be moving at that steady clip. With external and internal risks rising, market’s expectations for hikes through 2019 have tumbled since October. What makes this meeting more interesting is an expected press conference from Fed Chair Powell. Given the sharp increase in debate over the next move (one or two hikes or whether we have a hike at all), this event could charge a more aggressive speculative environment. If it were not for the US government shutdown, the 4Q US GDP update could serve as a crucial update to growing dispute over the course of the world’s largest economy. It is not completely clear, but it is very unlikely that the BEA will have enough time to release this week on schedule. To perhaps compensate for that more comprehensive report, the Conference Board’s consumer sentiment survey and Friday’s NFPs will touch upon some of the crucial aspect of the US economy – employment, wages, consumer spending intent, etc. Over the past few weeks, it has also grown more apparent that the Greenback has been less responsible for its own speculative bearing. That puts responsibility for key pairs like EURUSD in the hands of active and liquid counterparts. The Euro will hit upon a number of its own key updates. ECB President Draghi will testify before the EU Parliament which may give us more insight into the central bank’s intent than what they officially announced at the recent rate decision. Top data will be a smattering of GDP releases, the most important of which are the Eurozone (the aggregate) and the Italian (the current firebrand) 4Q figures. Beyond that, we have a range of important data that can course correct rate expectations and growth like inflation, employment and sentiment data. For the next two liquid currencies amongst the majors, the Pound’s data will be overridden by Brexit while the Japanese Yen’s attention will be redirected to risk trends. Australian 4Q CPI, Canadian monthly GDP and Mexico’s 4Q GDP are a few other volatility-potential notables.
  10. Trade War Rumors are Generating as Much Reaction as Official Announcements The trade war remains one of the most far-reaching and economically-threatening themes currently assailing the global markets. After more than a year of escalation whereby the market has acclimated to a steady flow of stories detailing the malaise this conflict has sown, it should come as little surprise that the market has grown somewhat deadened to hints that conditions may grow marginally worse. Yet, in contrast, any budding suggestions that a demonstrable improvement in the relationship may be around the corner are being met with far more speculative enthusiasm. This past week, two such reports dotted the headlines and played no small role in helping push US equities beyond levels that technical traders would consider weighty (2,645 for the S&P 500 and 24,325 for the Dow). To follow up Friday, Bloomberg issued a new report that China had offered the United States a plan whereby it would dramatically increase its purchases of US-made good (to the tune of $1 trillion) in a bid to close the countries’ trade gap in six years. First, on Thursday, it was reported by WSJ that President Trump was debating with officials whether to lift tariffs on China. That would be a complete 180 on their negotiation tactic thus far, but it wouldn’t be exactly far-fetched given the President’s penchant to change course when his priorities change and to offer help to a struggling market since the Fed has shown little willingness to comply with his demands. Equities responded to the headlines with a smart rally to the midpoint of the October to December tumble. However, before traction could be fully secured; the US Treasury’s spokesperson rejected the news, saying neither the Treasury Secretary nor US Trade Representative had advised such a tack. While the market slipped on the official correction, the hope of an eventual breakthrough was appealing enough that Friday’s trading session opened to an official ‘breakout’ beyond the aforementioned barrier. To follow up Friday, Bloomberg issued a new report that China had offered the United States a plan whereby it would dramatically increase its purchases of US-made good (to the tune of $1 trillion) in a bid to close the countries’ trade gap in six years. This plan was not clearly and quickly rejected – perhaps because China is not as concerned with the favorable impact it can have in cooling financial markets. And, with that additional fundamental push, the indices closed out its fourth consecutive week advance strong. It is inevitable that we face another round of trade war updates in the week and weeks ahead; and whether they signal deeper divide or possible mending, they will likely be market-moving. That is because we are in a limbo where the general health of the global economy is crumbling, and this remains one of the more consistent drains. Further, the market sense of urgency over this state will increase as more reliable sides of economic health continue to degrade. We’ve seen a host of signals these past weeks – US consumer sentiment, Chinese liquidity conditions, etc – but this week’s 4Q Chinese GDP update will serve as a direct status update. The World’s Top Concerns, Monetary Policy and Recession Fears The economic docket has a few high-profile listings (China 4Q GDP and ECB rate decision among them) over the coming week, but the traditional fare doesn’t give the proper scale of the broad fundamental themes that we are dealing with moving forward. There are far more systemic issues under consideration by the world’s market participants, and a few items give perspective of the themes better than others. It is important in fundamentals to first and foremost assess what carries the greatest weight with the largest faction in the markets. With our laundry list of unfolding issues, no one would begrudge you uncertainty over that question. This week, we will have the rare opportunity to gain some insight into what most concerns the leaders of the world’s largest economies at a summit in Switzerland. The Davos World Economic Forum will cover topics that are no doubt top of our mind, and perhaps some that are under the market’s radar, but from the discussion, time dedicated and sideline comments, we will be better able to ascertain what issues are considered the most troubling. Politics in the meantime will be another great timekeeper for traders looking for the next jolt of volatility. And, while social troubles are of great importance, leaders are disproportionately fearful of economic troubles. No confidence votes, failed re-elections and general discontent more often follow economic troubles. Politics in the meantime will be another great timekeeper for traders looking for the next jolt of volatility. There is upheaval across the world from the US government shutdown to Brexit running out of maneuvering room to the Yellow Vest protests in France extending to a tenth week. Monetary policy will likely earn little for directly-linked currencies, but the sense of the underlying current can materially affect confidence in active support for growth and financial stability. On tap are two of the developed world’s most dovish major central banks. The Bank of Japan (BOJ) sees little chance of altering its active effort to keep QE pumping into the system, but the recognition of its inability to influence change in inflation or economic condition grows clearer with each week. In contrast, the European Central Bank (ECB) took the significant move to end its stimulus program last month – in a first step to normalize from an extraordinary dovish policy-setting. Yet, those intentions may not be fulfilled in the foreseeable future if concerns of economic struggle deeper. Beyond the warning on growth for China with trade wars, US via the shutdown (now cutting off 0.5 ppt), Germany drawing out recession concerns in data like factory activity, Italy risking it far more readily with the local central bank’s own forecasts, we are seeing the world bow under the maturation of a decade-long cycle and the eruption of numerous cuts in fundamental efficiency. If a slowdown becomes an overt reality, will we find relief from the world’s central banks (already at the extreme of their policy setting) or governments (struggling to function and certainly not cooperating well with each other). Where to From Here on the Brexit? As of Monday, the countdown will drop to 67 days until the UK is due to leave the European Union according to the two-year timeline dictated by Article 50. As of Monday, the countdown will drop to 67 days until the UK is due to leave the European Union according to the two-year timeline dictated by Article 50. And, despite our dangerous proximity to the official divorce, we seem to be no closer to a plan on how this separation will play out than we did six months ago. That is troubling. This past week, Prime Minister May offered up a proposal in the Commons on how the country may severe ties with the Union. The defeat Parliament delivered May was the worst seen in British history. On the back of that popular discontent, opposition leader Jeremy Corbyn tabled a no-confidence debate that took place shortly after. This time, the majority sided with the PM – though the margin was far smaller than the one she lost by with her plan. Due to votes pushed through in previous weeks, May now needs to issue a Plan B on Monday the 21st. It had also been previously discussed that should the no way forward be found by the PM’s efforts by this date, that Parliament could take greater control over the process to avoid a ‘no deal’ outcome. This will help delay that pressure. Though it is always possible that the EU will take the mandate of the crushing defeat dealt the UK’s leader to offer more concessions, it is more likely that the program she ends up with will still not pass the approval of Parliament. Nonetheless, with debate still to be had, the vote on it will take us out to January 29 (Tuesday). It is worth noting that May’s threats to choose ‘her Brexit, no deal Brexit or no Brexit at all’ have been trumpeted far less frequently as of late. It is not clear whether that is because she is genuinely softening her position and ‘red lines’ or perhaps just because there is a little less urgency with a few more days. The days are steadily ticking down and polls of Brits’ stance on whether to leave or not or what kind of approach to pursue (no deal, May’s deal or more concession) remains markedly mixed. With so much confusion throughout the country on how to proceed, it comes as little surprise that the state of the negotiations are as opaque as they are. Continue to monitor for Pound volatility.
  11. Ending a Trade War is a Windfall for Growth? US and Chinese trade officials met this past week to lay the groundwork for another attempt to push for a breakthrough in the superpowers’ ongoing trade war. These are lower level meetings aimed at finding concessions and terms for which Trump and Xi would eventually sign off on. With over $350 billion in goods from both countries saddled with import taxes, the economic toll the engagement is exacting is starting to show through in data. In the US, trade figures have shown a rise in the deficit and sharp drop in exports to China, costs have risen for a range of goods normally curbed by cheaper foreign production, and confidence metrics have reversed course. The NFIB small business sentiment survey for example has fallen back to the level it stood at during the Presidential election. China’s economic updates have also marked multi-year lows in GDP, industrial production and more. While they are generally all firmly in positive territory, there is likely a ‘premium’ China attributes to its data. A growing number of institutions and economists are warning that the world’s second largest economy may be on the path for a stall and/or the collapse of its excessive low-quality debt market. A growing number of institutions and economists are warning that the world’s second largest economy may be on the path for a stall and/or the collapse of its excessive low-quality debt market. The Trump Administration seems to have gotten whiff of at least one of those analyses as they have made repeated remarks about the strained position of their counterpart’s health when justifying their steadfastness. Officials jawbone (or talk a market or asset to a higher or lower level) for a number of reasons. Some central banks have attempted to talk down their currencies (BOJ, RBA, RBNZ), the Fed turned it into a tool (forward guidance) and economic leaders are constant cheerleaders for their own economies and markets. Yet, it is highly unorthodox, to say the least, for leadership in one of the largest economies in the world to stoke fear in a global peer. And yet, that is what President Trump, Chief Economic Adviser Kudlow and Treasury Secretary Steve Mnuchin have done over these previous months. If neither of these countries were to blink, it would inevitably tip a financial or economic crisis for at least one of them. And, if one slips into the abyss, it will pull the other in with it. Perhaps this recognition is starting to sink in, or the ‘game of chicken’ is simply too dangerous now with the US equity markets sliding with the President starting to take some of the blame. It has been reported that Trump has told his team that he wants a deal to be struck to help stabilize the markets. It wouldn’t strain belief at all to imagine this was a serious demand from the President. There were some boilerplate remarks of optimism this past week which were largely overlooked, but the Chinese Vice Premier’s planned visit on January 30-31 may indicate they may be close to resolving their issues. It is worth evaluating a future where a resolution is struck. Yet, putting the scenario to the test, would pulling out of a destructive economic policy in turn translate into a windfall of growth and investment opportunities? No. It would remove a manufactured threat that has already inflicted permanent damage and would allow the focus to shift to a host of other unresolved issues. Preventing further damage is the best the two sides can hope for in this situation. The Lasting Effects of a Record Breaking US Government Shutdown We have broken a record over the weekend. As of Saturday, the partial shutdown of the United States government surpassed 21 days to count for the longest closure on record (surpassing the 1995-1996 stretch during the Clinton era). This is not a record to be proud of as it will translate into weaker economic growth, a drop in sentiment and the complicated progression of lower sovereign credit quality. The general economic implications are perhaps the easiest to envision. Government supported industries (such as airlines) will see their costs and revenues suffer while the 800,000 federal employees that are furloughed will not be paid. It is estimated that every week, the US economy will lose between 0.05 and 0.1 percentage points of growth owing to the situation. We have broken a record over the weekend. As of Saturday, the partial shutdown of the United States government surpassed 21 days to count for the longest closure on record. Even three weeks of that is significant given the state of economic conditions when this factor is excluded. Perhaps a (small) silver lining was the strong bi-partisan vote by Congress to provide backpay for those same federal employees – though that doesn’t offset the ultimate pain. Sentiment is another victim of this situation. We have seen consumer, business and investor sentiment sink the past months for a few reasons, but this shutdown is no doubt a contributing factor. If the country can’t come to an agreement on a basic stop-gap funding, what is the probability that they will be able to fulfill the infrastructure investment plan touted ever few months for years? My greatest concern for this situation is the damage it does to the United States credit quality. All of the three majors have issued some sort of warning on pursuing this path, but the most recent official statement came from Fitch this past week. There are those that don’t believe a downgrade is possible for the US sovereign rating, to whom I say it already happened when Standard & Poor’s cut the country one step to AA+ back in 2011. There are far more that believe it wouldn’t matter if another cut was made – and they would use the 2011 example as their evidence. When S&P cut the US rating, there was a distinct and severe move in credit and risk assets. Eventually, the market’s did stabilize and push the concern to the background because exceptions were made for the event. Even though many covenants only allow for top credit rated assets as ‘risk-free’, most agreed to make accommodations so as not to completely upset a financial system that relies heavily on the haven status of T-notes. Add a second, third or more cuts, and it looks less and less like a one-off. It registers as an absolute need to diversify. It may be hard to appreciate how systemically important this is, but the tipping point could fundamentally change the financial system and US standing in the world. Breakthrough or Not, A Brexit Vote that Can Charge the Pound We are just over 75 days away from the official date that the United Kingdom is due to separate from the European Union. If all that was necessary was to come to terms with an agreement between the two parties on their relationship post-split, this would perhaps not be so frightening. Instead, there is considerable preparation that needs to be done before that date even comes around. Most would agree, that the time table for an accord and steady transition was some months ago. Now, with each passing week that infighting persists, the consideration and appreciation of painful scenarios increases. We have the opportunity to finally find agreement from the UK’s side this week. On Tuesday, Parliament is set to vote on the Prime Minister’s Brexit proposal. You may recall that a vote was called on a previous plan, but May called it off at the last minute when it became clear that it would be handily defeated. We are just over 75 days away from the official date that the United Kingdom is due to separate from the European Union. It is nowhere near as clear time around that the MPs will deal the PM another rejection, but that is the leading consensus. If the proposal is accepted and the UK can return to the table with the EU, it would certainly be construed as lifting a significant weight off the Sterling’s shoulders. There are still a host of unknowns including cross boarder investment, financing and banking liquidity; but at least there will be a viable path the markets can follow. If however, she is rejected, the markets will grow increasingly agitated, fearful that an accident will happen. Following recent votes, Parliament passed law that if the proposal was rejected, the government would have to produce a ‘Plan B’ within three sessions (Monday as Friday is closed) rather than the standard 15. They had also previously ruled that if the country were heading for a ‘no-deal’ Brexit, that Parliament would have more say over the ultimate path. As it stands, there seems less risk of a crash out; but the hurdle for an agreement between the government and parliament remains very high. Uncertainty is a bearish pressure on the Sterling. An agreement would remove a considerable amount of that fear and perhaps help stoke a recovery. Looking at the CME’s Pound Volatility Index, fear remains troublingly high relative to other currencies and even other assets. Outcome or no, be prepared for Pound volatility.
  12. Happy New Year everyone! Coming to Terms with a Bear Market We have experienced a remarkable level of volatility recently, which is particularly incredible from the past few weeks considering markets were distorted by holiday trading conditions. When volatility meets thin liquidity, the results can prove explosive. That said, the intensifying fluctuation in the global financial system is not just a phenomenon that could be attributed to shallow markets as we have seen both the price-based results and the explicit sensitivity to fundamental triggers increase through the months preceding the official holiday season. Through the past three months, we have seen a number of specific instruments that have stood as baseline for general asset classes tip into official ‘bear market’ territory – which is defined by a 20 percent correction from a recent peak. Appreciation for the changing tide really didn’t start to peak the sense of panic however until equities started to hit the critical, technical milestones. When key US indices started to trip 20 percent – first the Russell 2000 in mid-December and then the S&P 500 Christmas Eve – the few that may have been oblivious were put on alert and diehard bulls started to feel a true sense of dread creep up their spines. Sentiment has notably shifted from unshakable confidence that the markets will bottom and return to their decade-long bull trend to a sense of desperation that buoyancy will hold out long enough to erase some of the losses late-comers had incurred since October or keep the window open long enough to simply exit. The bounce this past week with the S&P 500 moving back above 2,520 does play to the sense of hope. It is possible that we have found a low for the time being having only just technically hit the bear market milestone for a single day, but that seems improbable. Even with the retreat in this market – not to mention the rest of the world’s speculatively-inflated assets – we are still far from previous cycle peaks. Prominent fundamental themes from slowing growth to failing monetary policy effectiveness to deteriorating international relationships are not going to simply reverse course anytime soon. Further, rising volatility is looking more and more a permanent feature of our landscape. Market’s struggle to calmly inflate already-expensive assets amid tense periods of possible instability. It is possible that we have seen the low, but it would not be wise to assume that is the case. Instead, the better approach for market participants would be acclimatize to a world where we are in a bear market or on the cusp of one. Just as bull markets have periods of correction before they reassert themselves, the bear markets can have interludes of recovery. That does not mean we should commit to the about face just because it is desired. Though some people prefer longer duration, systemic positioning; I still favor taking trades with shorter duration and closer targets until it is clear that momentum has returned to the bears. Fed Fund Futures are Now Pricing in Rate Cuts Through 2018, the Fed’s steady tightening (also fairly described as normalization) efforts accelerated. The fact that the US central bank was tightening at a regular clip while the rest of the developed world’s policy authorities were still contemplating when to make their first move, or at best attempting to take bites when conditions were ideal, became almost mundane. If we were to evaluate the benefit to the Dollar from the contrast in the textbook fashion, we would assume that the Greenback should continue to climb against its major counterparts for as long as it enjoys a yield premium – especially as the spread continues to grow. Yet, we know in speculative markets that investors will move to price in the advantage as soon as it seems feasible – and they did. While they couldn’t full price in the benefit to the USD of a Fed hike regime against such a cold backdrop, it could price in a considerable advantage. After that high water market was set, it would be increasingly difficult to confer greater benefit – perhaps if other central banks were forced to revert to ever more extreme easing techniques while the Fed kept course – but it would be far easier to disappoint. This is what is referred to more generally as discounting the outlook. It also goes a long way to explain 2017 where the Dollar dropped steadily versus the Euro despite the fact that the Fed hiked three times and the ECB had yet to nail down a time for its first move higher. Fast forward to today. We have seen markets slump and economic forecasts drop significantly. As would be expected, the forward guidance from the central bank has cooled materially. The shift is clearly apparent to the broader market as Fed Fund futures and overnight swaps have completely reversed course on the hawkish outlook for 2019 – that at one point was fueling debate on whether they would hike three or four times through the year – with no further tightening expected. In fact, the next move priced into the markets is a cut with the greatest weight afforded to 2020, though 2019 was clearly being assessed as a possibility given contracts through December. NFPs and the rebound in US indices through this Friday have cooled the dovish build up, but the shift has been dramatic. It will be difficult to lift speculative enthusiasm so high again especially after key Fed officials have suggested the need for forward guidance has waned significantly. What Flash Crashes Say About Market Conditions Rather than the Afflicted Asset One of the more remarkable episodes from this past week’s extremely unorthodox opening play at a new trading year was the flash crash that struck certain currencies (and even a few capital assets). Much of the focus was on the Japanese Yen, but it was not the only currency to exhibit extreme price fluctuation. The Australian Dollar exhibited even more extreme fluctuation in historical and percentage terms (its intraday reversal was the largest I found on record) while the ripples readily expanded out to the British Pound which didn’t even seem to connect to the purported spark to the move. Afterhours to Wednesday’s New York session saw headlines light up on news that Apple (one of the principal firms in equity investors’ portfolios) was lowering its revenue guidance owing to the US-China trade war. Paired with the downgrade in Chinese activity readings earlier in the day and the ongoing US government shutdown, and it was no surprise that fear would hit. With the Tokyo markets offline for a holiday, the thin-liquidity-high-volatility conditions were once again triggered with a subsequent tsunami. This time however, the market response would not play out over days and weeks with a pervasive trend but instead struck all at once with extreme intraday volatility. The catalyst did matter as any lit match would, connections to risk trends are important and certainly automated trading influences (stops, limits, algorithms) no doubt contributed. However, boiling what happened down to these elements is a misleading – but common – psychology effort to regain a sense of comfort. If this unforeseen disaster can be attributed to these elements, then we can feel more comfortable that it is unlikely to happen again and we can keep an eye out for the same environmental triggers. This is not an unusual development in the global markets, even for the most liquid. The Japanese Yen saw rapid rallies followed by abrupt reversals (Yen cross tumbles followed by rebound) multiple times between 2009 and 2011 brought on by risk aversion, then monetary policy distortion and the intervention efforts of authorities (BOJ and the Ministry of Finance). The point is that conditions facilitated multiple such ‘fat tail’ events through that period, and they could continue to do so for us moving forward. It is the confluence of deteriorating investor sentiment, recognition of excessive exposure, fear that authorities cannot fend off any future financial crises and the abundance of threats to the collective complacency that currently colors our markets. While we may not see another 3.5 percent-plus swing from the Yen specifically in the near future, expect to see more developments that were considered unthinkable over the past 10 years.
  13. Another Week, Another Set of Brexit Scenarios It seems the weather patterns behind the Brexit seem to changing at a more rapid clip – always ending up back ‘in irons’ (pardon the nautical terminology) as the clock steadily winds down to the March 29 separation. This past week, was particularly momentous with the Prime Minister’s proposal supposedly going to vote in Parliament; but May decided to pull the vote before the allotted session as it was clear it would be voted down handily. And, considering the MPs had voted the week before to give themselves more power in the event the PM’s effort was rejected, she wanted to avoid losing any further control over the already stumbling process. The week wasn’t uneventful however as frustrated conservatives called a no confidence vote in May’s leadership. Ultimately, she survived the challenge and cannot be contested again for a year – though that doesn’t prevent further political pressure nor does it make navigating negotiations on the separation from the EU any easier. We have long ago passed the event horizon for a balanced deal to be struck such that the technical work would be ready by the actual separation date. It could have been the case that Juncker, Tusk and their European colleagues were waiting to see the outcome of the UK no-confidence vote to prepare further concessions that would warm May’s government; but that did not prove to be the case. After enduring the challenge, May attended to two-day European Community summit where Brexit and a no-deal outcome in particular were to be discussed. She received a clear rebuff on any further compromises from the EU and in fact had some features of the previous offer revoked. We have long ago passed the event horizon for a balanced deal to be struck such that the technical work would be ready by the actual separation date. It is unlikely that this is holdout from both or either side to earn further concession as the brinkmanship only adds to the economic and financial trouble down the line. That means this situation is more likely to continue unresolved until UK leadership makes the call. If May can wrangle the conservatives to accept a temporary backstop, it may be the closest middle ground to be found. Alternatively, we will end up in either one of two extremes: a no-deal break or the call for a second referendum. If we end up with the former, it is more likely to be pushed all the way to the predetermined end date. A second referendum however would likely be called weeks – perhaps even months – before the March 29 deadline. All the while as uncertainty prevails, external capital will continue to drain from the UK. Already with a default backdrop of uncertainty, global investors will want to avoid an overt threat like the Brexit. Further, domestic capital will increasingly be moved to safe guard rather than applied to more productive, growth-oriented means (such as business spending, property development, wage growth, etc). As has remained the case for some time now, trade Sterling cautiously and with a clear intent – if at all. A Critical Fed Decision to Set the Course of 2019 Top event risk over the coming week is the FOMC rate decision in my book. This final policy update of the year from the world’s largest central bank is one of the comprehensive events we expect on the quarters. Along with the routine update on rates and the monetary policy statement, this event will include the Summary of Economic Projections (SEP) and Chairman Jerome Powell’s press conference. First and foremost, the central bank is expected to hike rates 25 basis points for the fourth time this year to bring the range up to 2.25 to 2.50 percent. While Fed Fund futures project this outcome at a 77 percent probability – I would set the chances even higher. The Fed has established forward guidance as the primary tool for monetary policy even though it has raised rates at a steady pace and started to reduce its balance over the past year. ...if risk trends are already unsettled, a market that is seeking out threats could fixate on this disturbance readily enough. The utility of guidance is that it can acclimate the market to tangible policy changes before they are implemented to defuse the detrimental financial market volatility it could trigger otherwise. That is extremely important given the transitional phase global monetary policy is in following nearly a decade of emergency-level accommodation. Markets have grown more than accustomed to the support, the have grown somewhat dependent. Normalizing its essential to promote a healthy financial system, healthy risk taking and restore the buffer necessary to fight future downturns. Yet, if this fraught course is piloted poorly, a policy authority can inadvertently trigger the next crisis. Of course, if risk trends are already unsettled, a market that is seeking out threats could fixate on this disturbance readily enough. That said, the Fed may already be picking up on some strain in the economy and markets, looking to trim its pace so as not to run aground. Preparing the market for that deceleration is just as important as setting expectations for its unrivaled hawkish drive over the past few years. Powell seemed to do start the adjustment a few weeks ago when the language in his speech on bonds seemed to denote greater caution and recognition of tension in the market. We have seen markets respond by pulling rate forecasts via Fed Funds futures and overnight swaps down to only fully pricing in one 25 basis point hike – whereas previously the market had afforded three with debate of a fourth. We are due a definitive view for rate forecasts from the group in the SEP. The update for December showed a majority – by a single person – projecting three moves in 2019. Given how finally balanced that forecast was and the language from some key members, it is very likely to be downgraded. The question is whether a downgrade to just 2 hikes will then be construed as better-than-expected and if the tempo change will trigger concern amongst market participants about financial market health. Was Italy Capitulation, Trade Concessions, A Brexit Vote Save Enough to Revert to ‘December Conditions’ What we have seen instead is a continuation of the previous two months were high volatility has leveraged incredible swings in popular benchmarks like the S&P 500 and Dow while the VIX holds precariously high. Thus far, we have witnessed a remarkable December. Historically, this tends to be one of the most reserved months of the calendar year for volatility and volume which in turn translates to steady gains for traditionally risk-leaning assets. What we have seen instead is a continuation of the previous two months were high volatility has leveraged incredible swings in popular benchmarks like the S&P 500 and Dow while the VIX holds precariously high. It is inevitable that liquidity will hit holes over the coming weeks owing to market closures, but that doesn’t mean that the markets have to drift calmly into holiday conditions. Shallow market depth and high volatility can converge to produce extreme moves. It is always wise to head into market closures or known liquidity contractions defensively, but that would be especially true of our current conditions. The question now is whether some relief on a number of ominous fundamental themes is enough to soothe the beast until markets fill back out in earnest when 2019 rolls in. Some points of progress optimistic bulls can point to include the agreement by China and the United States to a 90-day freeze fire on further escalation of tariffs, Italy softening its aggressive budget position and UK Prime Minister May surviving a no-confidence challenge. None of these developments are a long-term solution to the threats they represent, but it is breathing room at a time when the markets seem to need it most. Market biases can shift the response to events and themes – from exacerbating seemingly harmless issues into the foundation for true panic or quieting fear over a looming catastrophe. Ultimately, in conditions like these, hedges are worth it.
  14. 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.
  15. 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.