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JohnDFX

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  1. Jackson Hole Symposium Has Too Much to Cover There are two particularly important, multi-day summits scheduled for this coming week. Given the individual market-moving capacity of US President Donald Trump, the G7 Summit from August 24th through the 26th will be particularly important to watch. He has announced remarkable change in policy at or around such large events before – particularly when provoked by flabbergasted global counterparts. There are five general topics on the agenda which are all important but the market-centric among us – and who wouldn’t considering them more dialed in given the state of the economic outlook – will be most interested in the third of the listings which is the conversation on globalization. It is worth noting that as of January 1st, 2020, the United States will take over the presidency of the group. Yet, as far as the impact this can reasonably have on the markets for the week in front of us, there is very limited potential given that the event begins on a Saturday. If anything, anticipation for surprise policy tweets will discourage positioning for fear of another painful weekend gap. There are two particularly important, multi-day summits scheduled for this coming week. The other major gathering on tap from Friday through Sunday is the Kansas City Federal Reserve-hosted Jackson Hole Symposium. This is a gathering of major policy authorities (government and central bank), business leaders and investors whereby they discuss the most important matters for the financial system and economy of the day. Given the current fragile nature of both dynamics at present, there is enormous pressure on this event and its participants to urge a sense of calm. They will find this exceedingly difficult to achieve. The official topic of the event is the ‘Challenges for Monetary Policy’ which is certainly a concern, but not one designed to immediately provide relief. The politicizing of monetary policy threatening short-term focus and policies that result in currency war- like conditions will likely come up explicitly if not in the undertone. If the Fed and others use this event to warn that the effectiveness of there tools are diminishing as they are already stretched to the max and face diminishing returns in economic and financial influence, that will only solidify reality for so many that have grown to believe that there are only three things certain in life: death, taxes and asset inflation. They will attempt to hedge their language, but market participants are extremely vigilant of cracks in our troubling backdrop. Furthermore, the world will be looking for as much reassurance of a safety net against an increasingly probable economic downturn as can be mustered. This will likely prove a very disappointing event for many. The Inverted Yield Curve vs Sovereign Debt Sliding Into Negative Yield The story of the inverted yield curve continues to gain traction across the market – from bond to FX trader, new investor to old hand. In part, this is testament to the self-reinforcing influence of the financial media and financial social platforms. That is why there is a cottage industry in analyzing the collective views garnered from browsers and tweets, whether for genuine view or contrarian signal. Yet, how much should we really read into such a signal. There is very strong statistical evidence to suggest that certain yield comparisons in certain countries heralds economic and/or market troubles. The 10-year to 3-month Treasury yield curve is an economist favorite and has been inverted for a number of months now while the trader-favorite 10-year to 2-year spread only slipped below the zero mark this past week. Just to be clear, this is essentially a situation where the market demands more return from (virtually) triple-A rated government at the front of the world’s largest economy to lend to them over 3 months and 2 years versus 10 years. Something is systemically wrong if this is the case. Usually, this portends recession as we’ve seen for most similar instances in history. There is caveat in the reality that the sample size is small and conditions do change between the generations that pass between many of these instances. The Fed and other central banks being so active in purchasing their local government’s debt is a very big systemic change. However, there is also very serious data to suggest that we are looking at a stalled economy despite all the unique circumstances and distortions we are dealing with at present. There is very strong statistical evidence to suggest that certain yield comparisons heralds economic troubles. Another consideration with the signals these curves offer is the time gap between the market-based cue and the official flip on the economic switch. Yet, just because there is an average 12 month lag time between the two, does not mean we can comfortably assume that we can continue to press our luck until mid-2020. The official signal of a recession by the NBER and others is two consecutive quarters of economic contraction. What’s more, the speculative nature of the financial markets rarely has investors hold out on their judgement of risk until that lumbering signal has flashed red. I find that the curve is not so personally concerning as the overall level of global yields themselves. The US 30-year Treasury yield plunged to a record low this past week. Globally, an unprecedented amount of government and high-rated debt is facing negative yield. That may seem fine on the face of it from a consumer’s perspective – who wouldn’t want to be paid to borrow money – but it is a reflection of serious problems in the system. Negative yields are an indication that there is no appetite for lending despite the affordability, it creates sever problem for profitability of financial institutions and it means there is very little policy room for authorities to ease conditions to jump start growth whether stalled or collapsing. As you see the headlines continue to flash negative yield around the world, remember that this is a serious problem for the environment in which you are investing. Trump Eased Trade War Pressure but Neither Markets Nor China Placated There was a noticeable waver in the Trump administration’s trade war pressure this past week, which many political pundit zeroed in on from both ends of the spectrum. Perhaps spurred by the market’s sudden bout of indigestion following the reciprocal escalations between the US (announcing the remaining $300 billion in Chinese imports would face a 10 percent tariff) and China (allowing the 7.0000 level on the USDCNH exchange rate give way), the White House backtracked to offer some modest relief in the pressure. It was announced that some small portion of goods would be left off the list all together owing to their importance to health and security while a wider range of consumer goods (clothing and consumer electronics) would avoid the new tax until December 15 to avoid hitting the American holiday shopping season. The half-life of the market’s enthusiasm was even more brief than their shortened bout of fear following the initial one-two punch to global trade. China’s was similarly dubious in its response. The White House lamented that China did not move to ease its own policies aimed in retaliation, but that should not exactly surprise given that the US had enacted a disproportionate escalation and China’s own measures cannot be linearly throttled – to push the exchange rate back below 7.0000 would only reinforce the belief that the PBOC is fully manipulating its Yet, my top concern remains on the risk that the two largest regional economies in the world could see threats evolve into actions. Moving forward, we will have to rely on unscheduled headlines to update our standings in US-Chinese trade relations. Perhaps the Jackson Hole Symposium or G7 summit will offer up some key insights, but there is little reason to believe these administrations are plotting it out thoroughly to offer investors genuine relief. Furthermore, it is crucial that we don’t lose sight of the other trade conflicts building up around the world. Japan and South Korea as well as the Eurozone and UK skirmishes are serious problems to the fabric of global growth. Yet, my top concern remains on the risk that the two largest regional economies in the world could see threats evolve into actions. The US and EU have warned each other with complaints and suggestion of policy preparation, but there hasn’t been serious movement yet. That may have changed however when France decided to push forward with a 3 percent digital tax on the largest tech companies in the world – which happen to largely be US-based. Some of these biggest players (Google, Amazon, Facebook) are due to testify to Congress early next week and they will no doubt cry foul. Yet, if they push the volatile government too far; their efforts to reduce their tax bill could trigger a much larger drain on global growth and trade…which will cause a much larger hit to their income.
  2. Is Trump Intentionally Stirring Market Volatility? The dust is still settling from the most recent string of reciprocal retaliations between the US and China in their ongoing trade wars. As a brief synopsis, the White House frustrated by the lack of progress in negotiations as they were due to break for a month announced August 1st it would slap a 10 percent tariff on the remaining $300 billion in Chinese goods that it was not already taxing. China responded the following Monday by letting the USDCNH cross the 7.0000 Rubicon. The US in turn labeled its counterpart a currency manipulator so that it could pursue other legal means to which Beijing suspended all agriculture imports from the US. That is where we find situation heading into the new trading week. It is possible that we are in another period of stasis where uncertainty starts to give over to complacency once again. Yet, there is motivation for President Trump to keep up the pressure. With the exchange rate adjustment made on the Yuan, China has essentially made a means to automatically offset much of the impact from US tariffs. This is more of a move towards a market-based currency policy than what we have seen before (there aren’t naturally hard barriers in exchange rates), and a weaker currency would be expected should an detrimental economic wind blow in. Nevertheless, the US President will use this shift to bolster his claims of manipulation, and the markets will grow wary of the implications for foreign investor capital repatriation that raises added concern China will not be happy to deal with given its financial and economic pains of late; but this was ultimately the most practical move. Moving forward, raising the tariff rate on Chinese import will be largely offset by exchange response, which means the principal strategy for exerting pressure on the country has essentially been neutralized. The administration could try to muster alternative plans with greater effectiveness but there is little the US could resort to short of mustering international support – and their regular threats to trade partners doesn’t make that likely – or that would otherwise pull other countries into support of China. With an appetite to ‘go it alone’ and keep on the offensive, the US government looks like it wants to simply improve the channel of influence with its tariffs. For that to happen, the Dollar would need to depreciate. This is why Trump has been relentless of his critique of the Federal Reserve, voicing discontent with the group nearly every day last week. He sees a simple formula of rate cuts leading to a weaker currency – which is not assured – but he seems to carry little about the group’s credibility or the concern such a move would inspire among investors (a sudden aggressive easing despite stocks at records and the jobless rate at decades low would suggest a crisis is ahead). With the central bank unwilling to cave to the pressure and no other practical approach within his means to devalue the currency without triggering heavy consequence, he may be attempting to rock the market such that investors demand Fed’s action. The slump last week, in May and through the fourth quarter (signaled in early September) all came soon after the US escalated trade wars. Could this ploy work? Yes, but it would carry serious complications. ‘Tis The Season of Holiday Trade, But Is This Time Different? We are entering into the prime period of the ‘summer doldrums’. Summer is a fairly generic phase when it comes to the markets and depending on the unique circumstances each year; but statistically, the lowest average daily volume for the S&P 500 – my favorite, imperfect risk asset – occurs through the month of August. This timing aligns broadly to holiday periods in the US and Europe which in turn leverages the remaining global investors’ expectations as to activity through the period. As a notable asterisk, historically, the VIX begins a steep rise through the same months before peaking in September and October. While prominent technical levels, a dearth of traditional fundamental updates and statistical norms are all means to coax expectations; I find a profitable bias and ultimately complacency are most reliable sources of market intent – much like the assumption of historical status like its ultimate safe haven position which triggers a flight to Treasuries when fear is on the rise once again. That said, market participants shouldn’t form the basis of their position on complacency which is essentially a decision to ignore risk in order to earn tepid returns. There is a saying in markets, ‘will this time be different’ which is used far more often as a contrarian’s criticism of those with that are dubious of a market that has deviated too far from what they gauge as value. It is the same sentiment shared by those that mock the caution of those moving to the sidelines or taking on hedge when risks retreat – particularly should those same unrelenting bulls be saved by a stiff bounce. Yet, asking whether markets are going to eventually shed an unearned optimism which would expose assets that have been artificially driven to excessive highs is the reasonable approach, not blindly buying every dip or (worse) simply adding to an increasingly stretched position with no plan to unwind during favorable times. GBPUSD Is Within Reach of a Three-Decade Low Though many technical measures may suggest the British Pound is stretched in its tumble – particularly in its past three months – and various fundamental aspects to the currency would argue a foothold of relative value, the currency is dropping like a rock. This past week, the Sterling continued its crash against an otherwise unsteady Dollar to trade within 1 percent of the more than three-decade low the pair hit during its October 2016, post-Brexit flash crash low. EURGBP has been of similar constitution. Despite the growing tab of issues for Europe between an ECB dovish drive, Italian government stability risk and the United States constant pressure on its trade status; this pair has climbed for 14 consecutive weeks through this past Friday – though it is still 5 percent from its recent record high set back in late 2008. GBPJPY is perhaps the most forgiving as it is approximately 9 percent from its own decades’ low, which I guess we would have to give credit to the Bank of Japan’s early work to devalue its currency. This past week, the UK economy was weighed by troubling economic data which included he first quarterly contraction in GDP since 2012. The real source of fear however remains with the troubled course of the UK-EU divorce. We are still months out from the official deadline (October 31st) for both sides to work out their differences and come to an acceptable split. Yet, with former Prime Minister Theresa May’s departure, the reassurances that the government would do everything in its power to avoid a ‘no deal’ outcome have gone. In fact, new PM Johnson seems to have as the centerpiece of his negotiation strategy a clear warning that this option is wide open. In fact, his reassurances have been so effective, that now the market is treating that once-unthinkable scenario as the baseline outcome. There is little doubt that severing the economic links with the diplomatic ties would carry serious economic and financial ramifications – the IMF, BOE and even the UK government have provided stark assessments. Yet, at what point would the Sterling be fairly valued for a hard break should it come to pass? That is open to interpretation – and the market will be making its best effort to find that balance so long as Boris Johnson voices his appetite for ‘no-deal’.
  3. Another Massive Escalation of the US-China Trade Wars The White House continues to double down on its aggressive posturing against China in a bid to force the county to yield to its demands at the negotiation table. This approach follows a few patterns in economics, sociology and debate whereby the commitment to escalation persists despite growing risks and diminishing return when or if a compromise is struck – such as the ‘escalation of commitment’ behavior. Late this past week, President Trump himself announced that an additional $300 billion in Chinese imports – essentially the balance of all trade with the country – would be saddled with a 10 percent import tax starting September 1st. He and his representatives – such as economic adviser Larry Kudlow – stated the burden could be avoided if China were to budge on the economic impasses, but the former would also remark that they could be increased further if the situation was seen as not progressing. China does not historically yield to such overt, public tactics; rather it more often responds by retaliating in kind. That is a problem as there is not a like-for-like option for China to respond at this point. It ran out of US imports to slap new or escalated tariffs on with the last volley. This disproportionate status was a glaring imbalance, but China likely resorted to mere threats as it feared pushing the US to more dramatic retaliations. In diplomatic terms, to not respond now would invite a more emboldened US as it sees no negative consequences for inflicting pain. The next steps from here is where greatest risks reside. If China finds a back channel agreement to halt the pressure, it could suggest an interim turning point. China however would not want the capitulation public for political reasons, but the US would for political reasons. If China retaliates, it will likely take the stalemate off the rails. Without US imports to tax, the country would have to resort to selling private US assets which would not sway the government, restricting rare earth materials which wouldn’t register to the White House until much economic damage is done or they result to a ‘nuclear’ (economic) option. Allowing the Yuan to depreciate sending the USDCNH above the 7.00 mark will offset strictly tariff-based costs, but it will give Trump a platform to claim manipulation – though a currency would naturally depreciate if it is on the short-side of economic pain. Selling US Treasuries would be the most severe option with plenty of pain for China to share as its holdings are enormous, but desperate times can push people to desperate measures. Side Effects of Trade Wars: More Demand for Stimulus, Other Countries Start Fights The immediate consequences of an escalating trade war between the world’s largest economies is easy to visualize: economic pain for both that spills over to the global economy as trade inevitably will be impacted for those ‘other’ countries. However, there are other outcomes that can result that have just as disruptive properties on growth or the financial system. One side effect of driving such a destructive fight is that it lowers the boundaries for taking further risks in other avenues, effectively normalizing detrimental decision making. One natural segue is for a country that feels aggrieved to utilize similar tactics with other counterparts for which it feels are taking its partnership for granted. That most threatening spillover for the global community would be for the US and European Union to take active measures against each other. That shouldn’t seem so far fetched now considering the number of reports that suggest the US President has moved forward with China against the suggestion of advisers. Both sides of the Atlantic have laid out lists of tariffs that they are readying against each other and there are obvious flashpoints like the Airbus-Boeing row. Spillover is not just a circumstance for those countries already engaged. Like nationalism, the tactics of protectionism can be adopted for other countries that feel they are experience circumstances similar to those that spurred the US to action. One example is Japan and South Korea who have gone through a few iterations of retaliation between them as they claim the other is taking advantage of the relationship. Another consequence of trade policy that directly throttles economic activity is outcry for relief through other circumstances. Monetary policy became the go-to aid for any threats to growth over the past decade, so it is natural demands for relief are directed towards groups like the Fed, ECB, BOJ and others. That exact pressure has been raised by the US President to the FOMC for months. The central bank has rejected the pressure for the purpose of its independence, but the group cannot very well ignore tangible risks to economic health that result from international policies. The response is not limited to the countries that are engaged either. While the Fed has cut rates and is expected to do so again next month, the ECB is investigating a return to QE and the PBOC vows to resort to easing in the second half; the markets expect groups like the RBA and RBNZ will have to offer relief of their own as soon as this week when they meet on policy. A Reminder: The True Tipping Point is Realizing Central Banks Are Powerless Speaking of the need for monetary policy, one of the greatest financial risks facing the global economy – aside from the excess of leverage at all levels of the financial system (government, businesses, consumer, investor) – is the realization that central banks do not have the tools to stabilize future crises. Rationally, most market participants would recognize this is the case if they were to project the course of future periods of market instability. Yet, after a record decade of bullish markets (in US indices), there is an understandable complacency and even a large pool of investors that have never even experienced a true bear market. When a troubled reality wins out, however, the tools that central banks can use are going to be severely limited. Even in the best of circumstances, rate cuts are not nearly as important for stabilizing the financial system as basic credibility – essentially the market responding to the belief that the deep-pocketed central banks’ efforts will alter the course. The Fed, among the major central banks, has the most room to maneuver through traditional policy – and that is not much scope with the high end of the range at 2.25 percent (225 basis points). The other major central banks are working with substantially lower yields. Stimulus programs are more directly associated to firefighting in modern times, and key central banks (the ECB and BOJ most prominent) have extremely little margin to add more liquidity to the system with any hope of earning financial return. A thought experiment: if fear started to spread across the global markets and central banks were not a reliable source of emergency stability, where would you expect to find support? If your answer is a coordinated government response in this environment, our precarious state should be obvious. Let’s hope it doesn’t get to that point.
  4. ECB Didn’t Live Up to Lofty Speculation, Will the Fed? There is a span of high-level rate decisions this coming week, but only one of these updates carries serious potential to not only move its domestic assets but further potential to generate reaction from the entire financial system: the FOMC. This past week, the European Central Bank offered us a look into how far the dovish reach of the largest central banks is currently stretching. Against heavy speculation that the group was going to clearly lay out the runway to further rate cuts and escalation of unorthodox policy, they instead offered a more reserved view of their plans. Fending off an approximate 40 percent probability of another 10 basis point rate cut, the ECB held rates and offered up language that said they expect to keep rates at their current level “or lower” through the first half of 2020. On a full swing back into stimulus – versus the half measure of the TLTRO – President Draghi said they were looking into options. There is complication in the ECB pushing ahead with further accommodation as new leadership is coming in a couple months. This seems to concern them more than the risks that their increasingly extreme measures risk degrading the efficacy of monetary policy all together, particularly risky in the event that we face another global slowdown or financial crisis. The swell in European investor fears about the prospects for the future may be soothed by an outside wind if it proves timely and fully supportive. According to the market, the Federal Reserve is certain to hike rates at its meeting on Wednesday. Fed Funds futures are forecasting a 100 percent change of a 25 basis point (bp) cut and is reaching further to an approximate 25 percent probability of a 50 bp move. That is unlikely. Under scrutiny from the President and the markets, the Fed is attempting to signal its consistency as it works to reinsure its credibility. In the June Summary of Economic Projections (SEP), the median forecast on yields was for no change to the benchmark this year. A 25 bp cut at this meeting would not deviate too far from their assessment as the dot plot showed at least 8 members expected at least one 25bp cut (1 anticipated two), so it was a close sway in majority. That said, 50 bp against a backdrop of data that has performed well and equity markets are records would send the wrong signal: either one of hostage to fear of volatility or a sense of panic that they are not sharing about the future. How much is the markets banking on the Fed to converge with its much lower yielding counterparts? That answer will likely spell how much volatility we should expect. Donald Trump Throws a Curve Ball on Trade Wars Fear over trade wars had receded recently as confusion seemed to replace the tangible pain of tactical threats. Between the US and China, headlines were more about the next round of talks that were being conducted at a high level in China while trouble over the status of Huawei and the retaliation that could bring was fading out of the news cycle. We almost cleared the week with a ‘no news is good news’ perspective when President Trump decided to weigh in on something the market had long suspected was a strategy but presumed would never be made certain by officials. In offhand remarks that suggest he does not appreciate the fear that can be easily sparked in speculative markets, Trump said China may not agree to any trade deal until after the Presidential elections in November 2020. That may very well be China’s strategy: wait it out until a more amenable administration potentially takes over. That said, the Chinese economy has already taken a significant blow from the standoff thus far. It is unlikely they would want to keep it up that long on the chance of turnover. This may also reflect a Trump administration tactic: refuse to compromise out to the election and use it as a campaign point that no other government would be able to close the deal. Either way, this is a concerning musing. And, in the meantime, don’t forget that there is pressure building up on other fronts. For the United States, the question of open trade war with Europe seems to be graining tangibility with the theorizing of explicit moves from both sides for a variety of perceived infringements including the Airbus-Boeing spat. The most costly threat though remains the potential that the US is considering a blanket 25 percent tariff on all autos and auto parts which could encompass many countries but carry the most pain for Germany, Japan and South Korea. Speaking of those latter two, there is an Asia-specific trade war burgeoning between Japan and South Korea with the former threatening the supply materials necessary for the latter to produce computer chips. And, though it isn’t often considered a ‘trade war’ front, the UK-EU divorce carries with it clear trade disruption implications that will compound a global figure in collective trade. Another Verse in Milestone Towards Currency Wars Most business leaders and financiers publicly project a confidence that the world faces little or no risk that a currency war could erupt between the largest economies in the world. Privately, they are very likely worrying over the pressure building up behind active measures to devalue currencies and setting off a chain reaction of financial instability. It isn’t a stretch to suggest certain major currencies are artificially deflated, but most instances are not this way intentionally (for the purpose of economic advantage over global counterparts) or have been implemented recently. The ECB deflated the Euro with direct threats of monetary policy back in 2014 when EURUSD was pressuring 1.4000. Japanese officials slipped up before that when they suggested they are pursuing their open-ended QE program in an effort to drive their currency lower to afford a trade advantage. They later back-tracked and now simply say their ceaseless JGB purchases are a bid to restart inflation, which has floundered for three decades. The Swiss Franc is faced with constant intervention threat by the SNB, but their efforts are tied to the Euro and ECB’s overwhelming stimulus drive. In most instances around the world, policy officials are attempting to account for missing their stated policy goals (such as inflation) or offset external pressures that are themselves the results of a collective unorthodox policy epoch. However, in this desperation, there is increasingly an assumption of malicious intent from trade partners. President Trump is certainly suspicious of global counterparts. He reiterated his concerns this past week in something of a different light. Seemingly facing pressure by advisers for his frequent lamenting of the strong Dollar being interpreted as a ‘weak Dollar’ policy, the President said the Greenback is still the currency of choice – which he supports – while the Euro wasn’t doing well and the Yuan was ‘very weak’. That still looks like intent. What is troubling were the reports that trade adviser – and noted extreme China hawk – Peter Navarro had presented a range of ideas to possibly devalue the Dollar to the administration. They rejected the ideas, but the fact that this is taking place at all certainly raises the threat level of a currency war extremely high.
  5. China GDP Refocuses Speculative Attention from Monetary Policy to Growth Last week, it was fairly clear that a particular fundamental theme had stepped up to take command of our attention. Monetary policy has garnered greater traction recently owing largely to speculation that the Federal Reserve will have to reverse its course of normalizing extreme accommodation and subsequently cap the responsibility for global investors to bear the exceptional risks in our financial markets on their own shoulders. This speaks to a familiar equation that we’ve seen take center stage through the unique growth phase of the past decade: where genuine economic potential lags, central banks can compensate by offloading risk to make anemic returns more attractive. The US central bank was the chief threat to that calculation of complacency after 200 basis points of tightening and a slow runoff of its balance sheet. This is the official government-based growth reading that will set off the season of GDP readings, with the US figures due on Friday, July 26th Moving forward, the Fed’s support or opposition to supplemented risk taking will still carry enormous weight, but the perspective is now one of ‘wait and see’ until the next rate decision on July 31st – where the markets are certain of a 25 bp cut and price a 20 percent probability of a 50 bp move. In the meantime attention will likely shift to something with more immediate influence. For scheduled event risk through the week ahead, the top listing is arguably the Chinese 2Q GDP update. As an economic milestone for the world’s second largest individual economy, the gravity here is obvious. However, the implications run deeper than that. This is the official government-based growth reading that will set off the season of GDP readings, with the US figures due on Friday, July 26th. Furthermore, given China’s efforts to transition their economic dependency away from exports and onto domestic means as well as its central position in the ongoing trade wars, we are monitoring an integral player in the web of global health that is facing exceptional instability. There is perhaps some reassurance to be found in this figure given that the government has substantial control over the economy and the reporting of the statistics. It is very unlikely that we register a severe shortfall. That said, the markets compensate for these measured movements with greater deference towards even small changes. What’s more, Asia’s economic health was already cast in shadow at the end of this past week. Singapore – the world’s 34th largest economy – reported a dramatic 3.4 percent quarter-over-quarter slump in the previous quarter. This series does have some history of volatility, but the bare growth of 0.1 percent annual expansion is unmistakably poor with the worst pace since the second quarter of 2009. Pressure Increases Even Further for Trade War ‘Accidents’ and Especially for Contagion The good will between the United States and China in their trade relations following the G-20 sideline meeting seems to have all but evaporated. Without meaningful progress to seed reasonable hope of reversing the large tariffs the countries have placed on each other, we are left to evaluate the growing tension on the periphery of their fraying relationship. This past week, senior officials in the Trump administration reportedly agreed that China had violated its sanctions on Iran by importing a million barrels of its oil, but there was no immediate agreement on how to respond. On the other side of the table, China has said it will sanction those US companies that were involved in the arms sale to Taiwan. While a full reversal on the trade war doesn’t seem to be in the cards through the foreseeable future, there seems little will at present to escalate the situation along its natural course of the US going ‘all in’ on all Chinese imports while China responds with even more unorthodox measures such as restrictions on rare earth materials. Trump had tasked aides to look into means to devalue the Dollar is immediately believable and a serious threat of destabilizing an already-troubled situation Meanwhile, the pressure is ratcheting up outside the now-conventional channels of economic retaliation with the very real risk that all such efforts will be construed as some form of retaliation and escalation. Reports this past week that Trump had tasked aides to look into means to devalue the Dollar is immediately believable and a serious threat of destabilizing an already-troubled situation. The President has repeatedly accused China and the EU of using monetary policy and other means to artificially weaken their respective currencies to afford ill-gotten advantage to their economies. While there are arguments that can be made to both cases, pursuing retribution at this juncture would be a severe threat. A related issue that will no doubt draw the attention of Trump and his advisors was the appointment of IMF Director Christine Lagarde to be the new leader of the ECB when Draghi steps down at the end of October. The IMF recently issued its review of the EU with advice that the region should continue to sport its enormous stimulus given conditions. That can easily be interpreted by a person or people looking for antagonism as a move to further advantage. Another development that should be watched closely is France’s decision to move forward with a 3 percent digital tax on earnings made in France by large tech companies. Many of those companies that will face the levy are American, a fact that will not go unnoticed by the White House. With the UK considering a 2 percent tax of its own and the EU still moving forward with debates on a broad duty, there is a rising risk that the US pushes forward with the tens of billions in tariffs it has warned Europe over and perhaps even the adoption of a blanket tariff on auto imports. If this is the course we follow, take those atmospherical recession warnings more seriously. US Earnings Season Starts with Recession Fears, Trade Fallout and Business Cycle Under Scrutiny The second quarter US earnings season is due to start in earnest in the week ahead. We have already taken in a few noteworthy corporate updates these past weeks. Levi Strauss, who reported this past week, is the target for retaliatory tariffs from Europe while Micron and Fedex who offered updates two weeks ago find performance directly reflective of trade tension. While there are a few companies reporting that have overt exposure to strained Chinese relations, the high profile updates ahead will tap into other matters. Netflix’s report on Wednesday will look to leverage some of the influence that it enjoyed in previous years when tech shares paced US equities which in turn led the global view on risk appetite. However, lately, the FAANG members and collective seem to have lost the ear of the market. On the tech side, IBM’s update on the same day and Microsoft figures on Thursday will offer a more endemic growth picture. In revenue terms, a drop in benchmark rates is often a burden to banks Perhaps the most prominent theme to extract from this week of US earnings will be an important ‘cost’ of monetary policy accommodation from the Fed. The central bank is warning the engines for rate cuts, and most investors can only see benefit from the reversal with the moral hazard tide rolling back in. Yet, there are systemic risks associated to the fact that the group is so unnerved about the near future that it is contemplating easing despite still meaningful growth, not to mention the danger that could follow should the markets decide to lose confidence in central banks’ ability to fight off crises owing to their depleted resources. In revenue terms, a drop in benchmark rates is often a burden to banks. While each cut in the overnight rate does not confer proportional burden to financial institutions’ margins while each hike adds to it, that is more often the case over cycles and particularly when we are attempting to lift rates off of long-term deflated levels. We are unlikely to see the fall out in this past three-month period’s returns from JPMorgan, Citigroup, Goldman Sachs, Bank of America and Morgan Stanley; but their forward guidance for future profits can certainly offer up reference. Look beyond the single tickers’ response to their own financials and instead monitor the systemic repercussions.
  6. Enough Threats of a Currency War and You Find Yourself In One It has been a common theme in the negotiations between the United States and the countries they have targeted for trade inequities that aggressive language has preceded tangible action. While both sides (the US versus the ‘World’) have been clearly willing to dole out the warnings, it has been the White House that has advanced both action and intimidation far more willingly. At this stage, we have seen the trade war level out somewhat. US President Trump and Chinese President Xi agreed to some measure of armistice at the G-20 meeting, heading off a standing threat by the US to expand is onerous 25 percent tariff against Chinese imports to encompass the remaining $300 billion or so in goods that were not already being taxed. Yet, that is about as far as the agreement has stretched – with the caveat that US firms would be allowed to sell their manufactured goods to Chinese telecom. As far as the scorecard goes, this hardly qualifies as de-escalation; but negotiations are ‘ongoing’. ...if the US were to forge twin trade and currency wars, a financial crisis is likely and a systemic downgrade in the use of the US Dollar as top reserve currency would be inevitable. In the meantime, US policymakers seem to be anxious to avoid any impression that they are letting off the pressure on the rest of the world to ‘right their wrongs’ against the country. The US Trade Representative’s office this past week proposed tariffs on an additional $4 billion worth of EU goods to add to the $21 billion list offered up back in April. This is ostensibly a response to the ongoing spat between the US and Europe on what they each deem is unfair subsidizing of each other’s’ largest airplane manufacturer (Boeing and Airbus respectively). Thus far, the two principal Western economies have not engaged in an all-out trade war – like the US and China have – but all the ingredients of escalation are in place. I maintain that if these two economies engage in this growth-destructive behavior, it will inevitably stall the developed world (and like global) – GDP. As it happens, President Trump has taken the standoff to a different venue altogether: exchange rates. He revived his criticisms this past week that other key economies are targeting devalued currencies as a means to artificially amplify their own growth. Of course, a government that is conducting an aggressive trade war that looks to leverage taxes to change trade partners ways would hope for a steady – or cheaper – currency to ensure those levies have their maximum impact and the local reciprocal pain is minimized. While Trump’s threats have thus far have been kept to criticism over the Federal Reserve’s policies while his own administration say he is not seeking a ‘weak dollar policy’, if the central bank doesn’t acquiesce to his critiques, he may very well pursue other avenues to make a more comprehensive impact. That said, if the US were to forge twin trade and currency wars, a financial crisis is likely and a systemic downgrade in the use of the US Dollar as top reserve currency would be inevitable. Fed Monetary Policy Finds Itself In a Position to Steer the Broad Markets We have gotten to a point where there is so much reliance on monetary policy for the well being of the entire financial system that the markets are gauging their day-to-day sentiment against significant shifts in monetary policy expectations. While external support for the markets is a function of all the majors central banks’ collective efforts, the world’s largest authority holds greater pull owing to its symbolic status as captain to the world’s largest economy and as the paradigm of what a ‘hawkish’ policy is this unusual economic cycle. The interest is so sharp that the markets are reading into key pieces of event risk not for their economic consequences, but rather for the support or opposition it represents to a faster reversal in Fed Reserve policy. Point-in-case was this past week’s US employment report. Fed intent will remain a driving force for this equilibrium which places greater emphasis on top-line US data and central banker speak when gauging global market moving potential. The June nonfarm payrolls (NFPs) beat expectations soundly with a 224,000 net addition (versus 160,000 forecasted) with the jobless rate barely ticking up from its multi-decade low (3.7 percent) and wage growth holding steady at a 3.1 percent annual pace. All-in-all, this was a robust print to contribute to a remarkably strong series. And yet, the markets responded as if it was a bad omen of what was ahead as the major US indices (Dow, S&P 500, Nasdaq) all gapped lower on the open Friday. Why would run of important data that supported the outlook for growth provoke a slump in capital markets? Because, the market is not intending to profit through a long-term picture of strong economic expansion and steadily rising rates of return but rather through the tried and true strategy of front running deep pocketed and relentless central banks. This puts us in an economically-unusual but relatively familiar situation from this past decade whereby the speculative rank covets data that disappoints just enough to warrant monetary policy accommodation without tipping an overwhelming wave of deleveraging. That is a difficult balance to maintain. Nevertheless, Fed intent will remain a driving force for this equilibrium which places greater emphasis on top-line US data and central banker speak when gauging global market moving potential. That said, the week ahead holds a few particularly important milestones. On the economic calendar side, the market’s favorite inflation figure – the US CPI – is due for release on Thursday. For the more qualitative influences, there is a range of Fed speak scheduled with Chairman Jerome Powell’s Congressional testimony Wednesday and Thursday. The Curious Case of an Unrelenting Sterling Slide The British Pound cannot seem to catch a break. Where many of the key Sterling crosses have come to levels of meaningful support recently, we have seen the boundaries bow under the pressure while some pairs haven’t even broken stride. GBPUSD and GBPCHF are good examples of crosses that show little deference towards boundaries while both GBPCAD and EURGBP have extended incredible pace - 9 week slides for the GBP for both marking the worst performance in 12 years and on record respectively. Against the backdrop of Brexit, this may not seem that unusual a fate. However, it is not so straightforward a scenario when we consider we are not dealing with a relentlessly deteriorating situation – at least not yet. At present, we are in a holding pattern in the UK-EU divorce proceedings as the Britain works out who the next leader of the Conservative Party – and therefore the country – will be. ...be mindful when trading Sterling Normally, in this situation, we would find markets either trading without much progress either bullish or bearish while in some situations in the past there is a measurable unwinding of a stretched speculative exposure. The difference for the Pound is the practical recognition of probabilities for the difference scenarios. While possible that the leadership change will happen quickly and the two sides hash out a fruitful agreement that satisfies all, it is very unlikely. Instead, the front-runner for the next PM, Boris Johnson, continues to make clear his comfort with a no-deal outcome should European negotiators not relent. And, despite his suggestions that the country will be totally prepared for such an outcome, three years of uncertainty has led to a deeply-rooted skepticism. In the event that the controversial figure takes over the Tories and the country finds itself heading towards General Election, it will only extend the uncertainty and make a solution by the designated cutoff date (October 31st) virtually impossible. That deadline marches relentlessly closer. With a clear mandate for negotiation on the UK’s side still weeks away at least, the probability of a more disruptive outcome grows. And, against this backdrop, it is worth reiterating that uncertainty is risk. Be mindful when trading the Sterling.
  7. Monday’s Open: Trade Wars Status Quo That Really Isn’t The G-20 Summit has passed and by the accounts of the key players, the results were encouraging. I guess no new fronts have been added to the global economic conflict after the two-day meeting, so that is a silver lining we can hold onto if we wanted to be optimistic to the point of true enthusiasm. According to President Trump’s account of his meeting with his Chinese counterpart Xi Jinping, their discussion was a success as it reportedly signaled the restart of negotiations between the two countries. To be sated by this news would mean ignoring the fact that they had supposedly never officially broke off talks and being on speaking terms is about as low as the bar can be set. The genuine improvement in circumstance after this summit was the fact that the White House’s threat to put another $300 billion in Chinese imports under the 25 percent tariff. The US President also announced that he was lifting the ban on US firms selling products to banned Chinese telecom Huawei – though the company remains blacklisted and cannot export its wares to the United States. The real question heading into the new trading week is how this news is leveraged: by bulls or bears, to charge conviction or short circuit intended trends. The real question heading into the new trading week is how this news is leveraged: by bulls or bears, to charge conviction or short circuit intended trends. If we do see the market buy into the optimistic perspective of the US-Chinese negotiations, it will prove very difficult to develop any meaningful trend. This outcome is tuned more towards a relief rally. That being the case, there was never a significant discount established in the broader markets. These past weeks have seen speculative assets rise with the S&P 500 and Dow in particular anchored to record highs. That would suggest that the markets may in fact have been pricing in a more significant improvement of circumstances which could completely drown out any low-grade rally that could arise. Further, in this conflicted backdrop, it would be very difficult to sustain a troubled risk-on rally with liquidity under pressure owing to the US Independence holiday on Thursday July 4th. A middling risk rally would very unlikely override shallow markets. Alternatively, a bearish take on the after-action would likely trigger deeper misgivings in the markets and potentially tip a selloff that can override thinned conditions. This scenario could start as a retrenchment as the excess premium afforded to an assumed reversal in one of the most abstract and wide-reaching fundamental threats registered in years (trade wars). It could further grow into an appreciation of the economic pain that is slowly compounding as the efforts put into place thus far build upon the burden in economic activity. That is recognition of true fundamental struggle that contradicts superficial speculative ambitions that have placed greater emphasis on the expectations around the likes of the Fed rather than the tangibility of GDP. While generating enough conviction to carry risk aversion through the liquidity drain this week, it is far more likely to happen in a fit of panic rather than greed; and this is the type of falling fundamental start that can get the ball rolling. Seasonal Forces Versus Fundamental Winds Generally speaking, there are strong fundamental winds blowing in these markets, but the urge to revert to restrained market conditions as is familiar during seasonal lulls like we are expecting during this ‘height of Summer’ week will prove a powerful deterrent. Seasonally, July is more buoyant for expected volatility (via the VIX volatility index) than June; but that is not saying much for state of turnover throughout the average year. Also, Thursday’s Fourth of July holiday is really only a US celebration; but the expectation for sidelined speculative activity fuels an assumption among the global rank that is often realized by sheer force of will – or want. Looking to the same historical norms, low volatility has also contributed to stronger performance for risk appetite, which fts the assumed inverse correlation between the likes of the VIX and the S&P 500. Given the record high of the latter and general premium-despite-fundamental-trouble for the many other speculatively-linked assets in the open market, it would be difficult to leverage genuine gains through the forthcoming period. ...the Federal Reserve’s policy decision and forecast on the 19th was seen as a boon to doves. Overriding liquidity conditions is difficult to do whether attempted through fundamental or technical means. It is, nonetheless, significantly more probable to mount an offensive when there is a common event or theme for which a wide swath of the market can line up behind. Trade wars referenced above is one such deep well upon which the speculative rank can draw. Another is monetary policy. This past month, the remarkable recovery mounted by the vast majority of risk assets seems to have a very clear connection to monetary policy. In particular, the Federal Reserve’s policy decision and forecast on the 19th was seen as a boon to doves. It should be said the group did not cut rates nor did it indicate any intention of easing through 2019, but the market took what it wanted from the event. That is another point of speculative reach. In the week ahead, there are a number of events and data points that could hit at this fundamental disparity, but Friday’s June employment report (NFPs) is the most distinct. If the general strength of the data holds firm, it could sharply drop expectations for a July cut – presently priced at 100 percent according to Fed Funds futures. Then again, if the data drops sharply, the implications for growth moving forward could lead the market to think more critically on the shortcomings of any future central bank efforts, as impotent as they already are. Setting the Course for the Official 2Q GDP Readings While monetary policy is a theme that will follow one of the top highlights for event risk in the coming week and trade wars will following the G-20 summit headlines, the most comprehensive matter to hit upon through the breadth of the period will be growth. Interest in the health of the global economy has simmered for months between the cumulative pain afforded to the trade issues, the uneven state of financial assets, questions over the policy authorities’ (central bank and government) willingness to offer backstop, the serious erosion of confidence surveys and specific high-profile market developments like the inversion of the 10-year / 3-month Treasury yield curve. That all builds into greater deference to be paid to the forthcoming official round of 2Q GDP readings that will start to cross the wires in a few weeks’ time. That run kicks officially on Monday July 15th with the release of China’s 2Q GDP figure. In the meantime, there are a host of economic readings on tap for this week alone. We are expecting ‘final’ readings for Japan, the Eurozone and US; but the figures for China, Italy and UK are just as important to the overview. As far as comprehensive views go, a Bank for International Settlements (BIS) annual economic update will most likely give a more dire assessment of what the world is looking at heading into the second half of 2019. This group is known as being frank about risks and somewhat pessimistic, with no compunction when it comes to warning over the instabilities developing in the financial markets. They will almost certainly decry the state of global trade and the precarious nature of risk taking. In data terms, the Friday NFPs are a good barometer for the health of the world’s largest economy, however, I put greater emphasis on the ISM’s service sector activity reading for June. That particular segment of the economy accounts for approximately three-quarters of output from the behemoth. That said, if the service and manufacturing reports from the group point to the same general direction, the implications are far greater. For a global perspective, there are Markit-observed PMIs are due for Asia, Europe and North America. We are expecting ‘final’ readings for Japan, the Eurozone and US; but the figures for China, Italy and UK are just as important to the overview. As with many fundamental dimensions nowadays, there is a significant bias in terms of impact for different bearings. A firmer showing would act as mild justification for the already optimistic slant from the markets. A worsening conditions will draw further and further on the discrepancy in speculative view and excess market pricing.
  8. There is Way Too Much for the G20 to Cover Typically, the G-20 summits that brings together leaders for some of the world’s largest developed economies cover matters that are important but not especially urgent. For the meeting in Osaka, Japan this coming Thursday and Friday (June 28-29), the members will officially and unofficially have to cover topics of exceeding importance. That would seem unusual considering we are still in the longest bull market on record and the closest state to general peace that we’ve seen in some time. On the official agenda are: global economy; trade and investment; innovation; environment and energy; employment; women’s empowerment; development; and health. As you can imagine, there will be certain themes that are more loaded than others and likely to generate more friction in group discussion as well as sideline talks than others. Since negotiations last broke down and the US raised its tariff rate on $200 billion in Chinese imports – to which China moved to match the tax on $60 billion in US goods. Trade wars will be the most frustrating topic to discuss for most of the members. In particular, the US and China have used this gathering as a timeline for the next stage of an ongoing trade war between the two economic giants. Since negotiations last broke down and the US raised its tariff rate on $200 billion in Chinese imports – to which China moved to match the tax on $60 billion in US goods – the rhetoric between the two has ranged between mild encouragement to outright threats. If President Trump’s timeline holds, the stakes are high for a breakthrough between the two. After the last move to raise the stakes, the White House said it would expand its onerous levy against its trade partner to encompass all of its goods coming into the US (another $300 billion or more) in ‘three or four weeks’. That time frame has come and gone which prompted negotiators to move out the deadline to a natural conversation between Trump and Xi at the summit. If these two fail to come to an understanding in order to de-escalate their economic conflict, it will represent the biggest notional curb on growth thus far. It would also almost certainly usher in the next stage of unorthodox measures as the options for retaliation have expended standard arsenal. China cannot meet the US like-for-like with straightforward taxes and will therefore need to consider actions on rare earth materials, blacklisting US entities, US asset exposure levels, exchange rate manipulation and other as-yet unmentioned options. The circumstances between these two giants is enormous but it is even more desperate for the other countries around the world who are caught in the middle as collateral damage. Further, depending on how President Trump views the benefits-risk balance of the affair with China – and conversely Mexico and Canada – there is the persistent risk that the Trump administration could expand its trade vigilantism against host Japan, the Eurozone and many of the other G-20 members. One thing is clear from previous gatherings of state leaders, President Trump does not respond well to multiple countries ganging up on him whether through aggression or frustrated pleas for reason. While trade will likely take up a disproportionate amount of the mental focus, there are further matters of flagging economic growth and geopolitical tensions to discuss. Trade is compounding a general cooling of economic activity and there is an unmistakable awareness as to the limitations of over-extended monetary policy. Further, protectionism is casting plans to offer more through burdened central banks and even plans for fiscal policy as provocative means to compete to the detriment of global peers. As for global relationships, there are many points of fray, but the only area where a military war seems a genuine risk at the moment is between the US and Iran. The downing of a US drone by Iran followed by reports that a retaliation was green lit then forestalled has raised the threat level enormously. Perhaps after these ‘manufactured’ issues are thoroughly covered, we will see a serious discussion on ingrained concerns like the environment and gender equality. The Market Prefers Its Own Interpretation of the Fed’s Options Sentiment in the global markets is a force of nature. It can readily overpower subtlety which is what happened this past week following the FOMC rate decision. At its ‘quarterly’ gathering, the world’s largest central bank held its policy mix unchanged with a benchmark rate at a range of 2.25 to 2.50 percent while its balance sheet efforts held trajectory. While the market had afforded an approximate 25 percent probability of a cut, there was little actual surprise and repositioning to be registered by the market. When it came to forecasts, however, there seemed to be outright disbelief; and the markets were willing to run with their own interpretations of what the future held. Looking to the group’s own Summary of Economic Projections (SEP), there was an official forecasts for no change to the current rate spread through the remainder of this year, one 25-basis point cut projected in 2020 and a subsequent rebound to our present altitude in 2021. That strayed dramatically from the market’s own debate over two or three cuts this year and further easing at a similar pace into 2020. Given the nature of speculation, we will be left with a state of hyper vigilance around data and rhetoric from Fed officials that reinforces the market’s skepticism or contradicts it. After the Fed’s attempt to throttle expectations, the markets only solidified its forecast with Fed Fund futures and overnight swaps showing the probability of three quarter-percent cuts this year rising to near certainty. Now, to be fair, the breakdown of the SEP’s rate forecasts shows an optimistic outlook for growth while the ‘blue dots’ indicated beyond the median vote that 8 members expected cuts and 7 of those assumed two 25bp moves. It would not be difficult to tip that balance should the economy start to flag more seriously. While capital markets are holding relatively steady through this disparity (and the Dollar has finally started to show the risk of lower returns and the economic state that would necessitate the response some deference), the divergent paths these forecasts represent are extreme and necessitate a convergence. That merging of views will come with significant market response whether it is speculative enthusiasm closing the gap to the central bank’s forecasts or vice versa. Given the nature of speculation, we will be left with a state of hypervigilance around data and rhetoric from Fed officials that reinforces the market’s skepticism or contradicts it. There are many prepared speeches among various members scheduled this week. That is likely on purpose as members make an effort to reinforce forward guidance. The members more on the extremes of the policy curve will be important to watch but the centrists and Chairman Powell’s scheduled speech are arguably the most important. On the data side, the Fed’s favorite inflation indicator, the PCE deflator, is due. Keep tabs on forecasts for Fed intent, because the record high from the S&P 500 that encouraged other risk assets higher, has drawn much of its lift from favorable US monetary policy. My Greatest Concerns: Recognizing Monetary Policy’s Bark is Bigger than Its Bite and Trade Wars Turn Into Currency Wars While my greatest fears for the future are ultimately a global recession, financial crisis or the beginning of a global war (much less all three); there are certain intermediary events that are more probable and could more readily usher in those systemically disruptive states. And, as it happens, they relate to both the aforementioned concerns. As chaotic as trade wars seem to be through their development and potential risk to the norm, they are at least conducted in measured and definable steps. The Trump administration has signaled its intent and indicated the criteria for which would trigger further escalation or a walk back of existing burdens. The other countries engaging the US or other global players have done the same. It is true that the decisions to intensify or cool the fight have been flippant at times, but it seems to always followed a clear lines of tactics and escalation. This is not the same pace that is employed when the fight shifts to exchange rates. The world’s largest central banks had to cut their rates to near zero and inject the system with extraordinary amounts of stimulus in order to make [an unprecedented climb in capital markets] happen Currency wars are inherently messy. They can confer significant economic benefit to those employing the tactics and detriment to all others. There is significant disagreement as to what constitutes a country pursuing this unfair line of policy which leads to fights out of sheer misunderstanding. And, ultimately, there is tendency for a retaliatory policy to escalate rapidly. We haven’t seen many genuine claims of currency manipulation over the past few decades, but the Japanese authorities were forced to quickly backtrack on a ‘misstatement’ and the Chinese Yuan has a permanent question mark next to it. That said, with trade wars underway and the US President not shy of labeling China’s and Europe’s currencies unfairly devalued, it seems risks now are far higher than they’ve been in generations. It is difficult to pull up from a currency war, and evidence shows these are not the leaders that are likely to let cool heads prevail. The other escalation that plagues my fears is: what happens should the markets develop an unshakable sense of skepticism around central banks’ ability to maintain control? The past 10 years has enjoyed an unprecedented climb in capital markets and underwhelming average pace of expansion. The world’s largest central banks had to cut their rates to near zero and inject the system with extraordinary amounts of stimulus in order to make that happen. While we have long ago restored record highs for the likes of the Dow and seen GDP stabilize in expansionary territory, most of the banks kept going. The reasoning was that either the extreme support was needed to keep the peace or it was worth it to leverage just a little more growth. Regardless of the justification, it meant that there was very little effort to re-stockpile policy ammunition for any future troubles. Now, as pressure seems to be building up once again, the markets are clearly looking to the Fed, ECB, BOJ and others to head off crises. If we were to reasonably evaluate what happens in the scenario where we face another slump, there should be little confidence that monetary policy could truly hold back the tide. That said, limitations for future troubles will start to trace back to an assessment of the current structure’s ability to keep the stability we currently enjoy. If central bank credibility were to truly falter, the fallout would be severe -all the more for the fact that it would commence from record high prices (with arguably a record gap to value).
  9. It’s Okay, This One is On the Fed There has been a notable shift in the market’s mood in just the past week. A sense of dull complacency that traders who were active during the first wave of the large scale, central bank stimulus infusions would recognize has bolstered key assets. After the benchmark S&P 500 and Dow topped at the beginning of May, a steady slide in the indices encouraged the same sinking feeling in conviction that was dependent on complacency. Evidence that we are the late stages of the economic cycle, the business cycle and the market cycle is piling up. Normally, as the pace of expansion flags, we find the market’s tolerance for lowered speculative potential is partially offset by higher rates of return as the demand for funds drives yields higher. However, the record-breaking bull trend that we have enjoyed over the past decade defied that particular convention as its initiation and extension was supported through extreme accommodation from central banks – first lowering interest rates to record levels and then adoption quantitative easing measures. While this would help stabilize financial markets and help stimulus growth, it would also necessarily lower rates of return to be expected from the investing. After a while, it grew more and more apparent that the latter waves of support produced less and less traction towards economic objectives (bolstering economic output and inflation) but they nevertheless ensured a lower baseline for expected returns. With a presumption of indefinite support by monetary authorities and a highly competitive financial market, it should come as little surprise that moral hazard would thrive. It is that base assumption that exceptional risks taken in recent years to drive assets of questionable value to record high prices (like the S&P 500) would be discharged by the Fed and its international peers. The anticipation is impossible to miss in the markets with Fed Funds futures pricing in an 85 percent probability of a 25 basis point cut by July and a healthy chance of multiple cuts before year’s end. Considering President Trump has called out the central bank multiple times over the past months and economic warning signs like the inversion of the 10-year/3-month yield curve have garnered greater attention, the assumption of more assistance comes as little surprise. Language from the Fed Chairman Jerome Powell, other board members and even official communiques have also made clear a willingness to step in should growth stall. My concern is not whether the Fed and others will step in should we lose traction, but rather what happens as we realize their limited capacity to extinguish further financial fires. The Fed arguably has the greatest capacity of the major central banks as it has tightened rates around 200 basis point since its first hike in December 2015. Yet, that isn’t a particularly sizable arsenal when we consider how little economic amplitude we leveraged from the massive stimulus programs and given how much more premium in capital markets they are expecting to keep propped up – the S&P 500 rose another 39 percent beyond 2015’s peak. If actions by the Fed fail to steady the market, it would do far more damage to sentiment Don’t Forget the Trade Wars Are a Thing With the recent rebound in speculative market benchmarks, there is an innate tendency to seek out favorable fundamental winds in order to justify the prevailing bias. Anticipation of further support from the Federal Reserve is one such rationalization for speculative lift, but another potential source of confidence heading into the new trading week is the Friday evening news of a trade war breakthrough. Following the week’s end market close, President Trump announced in a tweet that a deal had been reached with Mexico for the country to take action on stemming migration through the country destined for the United States in order to avoid a 5 percent blanket tariff on all Mexican exports destined for the US. This warning was made less than two weeks ago and it was roundly criticized by members of Congress, US business leaders and (reportedly) even White House senior staff. That means the market likely maintained a hefty skepticism that the threat would ever be put into action. As such, we now await the new week’s open to see if there is a flush of relief rally to play out or if the markets will struggle despite the faux breakthrough. Meanwhile, progress on one front of trade dispute for the US could be used as justification to escalate tensions on another in a bid to force capitulation. The last official action in the US-China standoff was a hike in the tariff rate by both countries on each other’s list of target goods ($200 billion and $60 billion worth respectively). Treasury Secretary Steven Mnuchin said over the weekend that the President would be “perfectly happy” to fulfill his vow to expand the list of taxed imports to all of China’s trade – over $500 billion in goods and services. If imposed at the prevailing 25% rate, that would translate into an incredible 250% jump in the notional bill of the trade war on just one side of the battle line. Perhaps even more troubling would be China’s inevitable retaliation. The country has already maxed out the like-for-like goods for which it can impose a tax. That would mean it would have to resort to further unorthodox means. With the US already moving to ban Huawei, it seems inevitable that the Asian giant would move to blacklist a number of important US technology companies. It is also very likely that it would throttle shipments of rare earth materials – for which it is the world’s largest producer – to hit the production of cellphones and other consumer technology. While that bill will add up over time, it is likely that China will pursue additional means of pressure in order to have a more pointed effect. A concerted selling of US corporate assets is the next logical line, but many are watching for Yuan depreciation or a strategic selling of Treasuries. Those are unlikely however as the financial repercussions would be too severe with necessary losses in their own capital exposure and a high probability that other countries rally to the United States’ cause. An Inconvenient Time to Worry About Eurozone Stability With the US Dollar losing viability owing to its pursuit of trade wars that undermine global stability, the Pound plagued by a directionless Brexit and the Japanese Yen lost in a deflationary quagmire, there is an acute need for a stable benchmark currency. Despite its many fundamental shortcomings, the Euro showed itself willing to offer an outlet for liquidity over the past few years as the recovery from the region’s sovereign debt crisis between 2009 and 2012 seemed to offer a sense of hard-fought stability that was prized above all else. When the European Central Bank (ECB) veered off its course to normalize policy following the December cap on its open-ended stimulus program – by implementing a new targeted-LTRO – the Euro’s appeal deflated significantly. With a renewed sense of dubiety, we have seen attention turn to other cracks in the Euro’s perceived durability. Perhaps the most tangible of the unique risks facing the shared currency is the pressure brought by its third largest member: Italy. The coalition government of staunch anti-EU parties has struggled to find a common cause outside of the general revolt against the European cause. After the Prime Minister threatened to resign over infighting by his government, the coalition parties seemed to settle their differences for now but that would not translate into any renewed support for the Union. In fact, the unifier between these extreme parties seems to be their agreed-upon discontent. Last week, one of the deputy Prime Ministers stated clearly that Italy would not change course from its plans to offer its citizens relief through tax cuts. In the meantime, the European Commission found the country warranted a preparatory document on disciplinary action over its financial position. According to deputy PM Salvini, this could amount to a 3 billion euro hit. The country and Union leadership can draw this fight out for some time before we reach the limits of financial stability as Greece showed us nearly a decade ago, but the market is unlikely to allow the pressure to build up for that long before it starts to price in a systemic threat. In the week ahead, the Eurozone and European Union finance minister meetings will no doubt discuss this situation, and any uniform positions will not pass unnoticed. Generally-speaking, the Euro would not retain the same global reserve that it represents today if one of its core members were to make a credible threat of withdrawal. That is still very unlikely, but there are first stage cracks that are being threatened that could build an unplanned head of momentum: It has been suggested that Italian authorities are considering the use of an ‘alternative currency’ to service its debt, a move that naturally ushers in reasonable speculation of a stability concerns underlying the Euro. As the second most liquid currency comes under pressure, it is natural to keep tabs on the only more ubiquitous benchmark – the Dollar – but I believe gold is the best measure to our particular set of financial uncertainties as the 2009-2011 period surge stands out for those seeking alternatives to the traditional currencies.
  10. Trump Using Mexico as a Trade War Warning to China? In a surprise move, the United States is now fighting a full trade war on two fronts as of this past week. With the path to a US-China compromise still lacking any clear hand holds, US President Donald Trump announced a wholly unexpected economic move against neighbor Mexico this past Thursday evening. According to his tweet, the United States would charge a 5 percent import tax on ALL Mexican goods coming into the country as of June 10th. He further made clear that this was move not in retaliation for trade issues – in fact conditions had seemed to improve significantly on that front with the US dropping the steel and aluminum taxes on both of its direct neighbors in a bid to push through the USMCA agreement. Instead, Trump said that this move was in response to his administration’s frustrations with illegal immigration from Mexico into the US. This political move drew serious consternation from a number of officials and institutions. Aside from the obvious Mexican bewilderment and condemnation; it was reported that Trump’s senior advisers (Mnuchin and Lighthizer) had argued against the move, Congressional members on trade and finance questioned the motivations and the economic impact and business groups in the US moved to bring legal action in a bid to prevent the inevitable hike in their supply chain costs (GM for example produces an estimated 30 percent of the cars it sells in the US in Mexico and could absorb a $6.3 billion hit). Trump said that this move was in response to his frustrations with illegal immigration from Mexico into the US We are starting to see some of the disparate systemic themes that have individually pulled at the markets – trade wars, political risk, growth concerns – begin to converge. There is little doubt that the growing chants of impeachment from some portions of the Democrat party are pushing the President to a more aggressive stance with domestic and foreign policies. Looking to secure a ‘win’, he is attempting an alternative route to curb illegal immigration to circumvent the roadblock in Congress. This solution, however, carries serious threat to growth and diplomatic relations; and the possibility of an alternative source of support via an a delicate infrastructure spending program negotiation which would rely heavily on Democrats seems a non-starter. As this new fissure grows, it is important not to forget the extraordinary and expanding risk from the US-China row. It has been a few weeks since the US hiked the tariff rate on $200 billion in Chinese imports from 10 to 25 percent and China’s matching retaliation on $60 billion in US imports (which went into effect June 1). The mood has only further soured since this salvo. The banning of Huawei – China’s largest telecommunications company with a global presence – has lead to considerations of a response through Apple, using rare earth materials and reports of a recent draft on US companies that could be partially or completely blacklisted. Theoretically, the US is counting down to an expansion of the goods it is taxing to encompass all of China’s imports, but that timeline doesn’t look solid. The US and Chinese Presidents are due to meet at the end of the month, but a lot can happen between now and then. What’s truly worrying is that both sides are increasingly favoring escalation in a bid to break their counterpart’s will – a game of economic chicken. Ignoring the Fallibility of the Dollar’s Reserve Status There is general acceptance that the Dollar is the world’s most liquid currency backed by the largest economy and market. That is easily confirmed through data, but with these statistics comes a level of undeserved assumption. Because the country is a superpower and the use of its currency around the world accounts for nearly two-thirds of all global transactions, it is assumed by many on faith that these standings are permanent. I would venture a guess that the British felt the same way 100 years ago, the Spanish 300 years ago or the Romans two thousand years ago. Looking far enough into the future, the US Dollar will not be the principal means of transaction, whether that leads to a direct and singular counterpart (Yuan?), an aggregate (the long-fabled effective SDR) or the era of the blockchain. Regardless of the next epoch of money, there was an inevitable move towards evolution as the rise of global trade and spread of wealth around the world raised issues with transacting through third parties. A plan to pullback on economic ties to the United States translates into a diminished use of the US Dollar which in turn reduces the need to hold the country’s currency and risk-free debt as a financial balance. The bottleneck risks from a common currency were further exposed in the last two financial crises. The excess leverage produced by the Dot-com bust was particular acute in the United States which witnessed a convergence of economic strength, favorable policy and supportive regulation to land on an investment phenomena. When the excess peaked and started to cave in on itself, the fallout was transmitted to the rest of the world. The following financial crisis in 2008 was even more obvious in its amplification of a US-originated problem (subprime housing) tipping the global dominoes until an unprecedented response from the world’s policymakers was the only feasible means of restoring stability. Many governments and institutions in the aftermath of this worldwide crisis stated some level of need to mitigate future contagion risks by reducing their unchecked exposure where possible – including the dependency on the US Dollar. Yet, the haste to make this shift was throttled initially by extreme monetary policy creating fragility in domestic financial paths while the economic expansion also encouraged feet dragging. That landscape has shifted however in recent years with a slowdown in global growth that looks natural in the waning light of the cycle while barren monetary policy stores looks increasingly incapable of holding back any storm tides. It is in this troubling convergence that populism has taken hold. Policies that favor domestic growth at the expense of shared expansion lowers the aggregate potential for the global economy but it sells well to the electorate. The Trump White House has certainly seized on that fervor with the President pushing for trade policies that look to correct perceived imbalances. If the US kept its fight isolated to China, there would be little outcry from other developed and developing economies that have felt the Asian giant’s policies unfair. That said, the US has embarked on a global fight with the metals tariffs from last year, the emergence of the Mexican tax, lingering threats made against Europe and the lurking consideration of a global auto import tariff. When the world’s largest consumer raises barriers, it can be difficult to retaliate in a meaningful economic way. However, when there are many countries that share the burden and willing to cooperate in order to ease the pain – and deliver some punishment – there is greater capacity to retaliate as a group. A plan to pullback on economic ties to the United States translates into a diminished use of the US Dollar which in turn reduces the need to hold the country’s currency and risk-free debt as a financial balance. That accelerates the seismic tide changes in currency dominance and economic position. Add to that the pressure through forced sanctions (such as the demands to trade partners to stop doing business with Iran) and the need for an alternative route increases further. Even at this pace, it will be a very long time before the Dollar is fully supplanted, but the measurable influence will show through far more quickly. A Jostle of Growth Data, Monetary Policy and Brexit Ahead My number one rule for the successful employment of fundamental analysis is to determine which theme or themes will carry the greatest potential influence. It seems intuitive, but many traders will end up assuming far greater weight to every known event – especially those that are prescheduled – than is reasonable. And, when you assume greater influence for every eddy in the market’s stream, you inevitably drown out those factors that are truly market moving. In gauging the fundamental landscape ahead, there are both themes and specific events that hold the potential of significant volatility or trend development if they render the proper outcome. Aside from the dominant force of trade wars, monetary policy will be a substantial influence over the coming days. The most pointed events in this vein will be the RBA and ECB rate decisions. According to overnight swaps there is an approximate 95 percent probability of a rate cut. That degree of discount means an actual cut is likely already priced in, so the Aussie’s response will depend on either the language in the aftermath of the cut or a surprise hold. As for the ECB, they have already made their dovish move a few months back with a hold on any intent for rate hikes and the deployment of the LTROs to compensate for the end of QE. This is a mess of exit from extreme easing and it leaves serious questions about the health of the global economy and financial system. In addition to these two policy calls, we have a host of central bankers speaking including the chiefs of the Fed (Powell), BOJ (Kuroda) and BOE (Carney). With the growing interest in market measures like the US yield spread, this stands to be an important theme ahead. Another collective theme that will find significant prompting ahead will be the general concerns for the state of economic growth. We have received most of the 1Q GDP figures at this point, but Australia is due its own figure. Instead, we will look for more timely metrics that act as good proxy to the big picture. There are a range of monthly PMI stats for May due – though the US and European figures are ‘final’ measures. The US ISM metrics are given considerable credit as are Japan’s quarter capital spending report, the US quarter net household wealth and NFPs data. It is not the concentration for any single economy that matters here but rather the breadth of the statistics that can form a clearer picture of global growth. With the growing interest in market measures like the US yield spread, this stands to be an important theme ahead. In terms of region-specific event risks that are worthy of our close watch, I will dedicate significant mental energy to following the progression of the Brexit situation for the Pound and the EC-Italy fight for the Euro. on the former, the British and European conversations on terms for divorce are actually still on ice. That is due to the long reprieve afforded the Article 50 extension but also the state of politics in the UK. Prime Minister Theresa May is due to step down on Friday and the leadership battle is clearly underway. The PM’s shortcomings and the EU Parliamentary election results are likely to encourage support for a candidate that is more friendly to using the no-deal outcome to make progress on the separation. That of course means greater uncertainty and preemptive capital flight as the markets await the fog to lift. In Europe, the cohesion among EU members will come under scrutiny with a number of events scheduled around the state of play in Italy. PM Conte was shown strong supporting in the EU Parliamentary elections, and he is looking to pull together the various countries’ nationalist seats. Given their stated policies, a loosening of cohesion to the foundations of what holds the Euro together will be a consequence. Alternatively, the European Community is not simply waiting for the disruption. The group is due to take up its review of Italy’s breaking financial rules, which Deputy PM Salvini recently warned could land Italy a 3 billion euro penalty recently.
  11. Are We Turning the Corner on Global Trade Wars? There were a few very prominent, positive developments on the trade war front this past week, but is it enough to systemically change the course of the global economic standoff back towards the cooperative growth of the past? Throughout the past week, there was a building din of unconfirmed reports that US President Donald Trump would delay the decision on whether or not to apply tariffs on auto and auto part imports at the May 18th initial deadline to the Section 232 report the administration ordered to investigate the competitive field. As the headlines channeled unnamed officials trying to assuage investor fear, the market slowly stabilized and started a tepid climb. Full confidence was withheld however as participants were still shell-shocked from the sudden reversal on US-Chinese relations the week before. Rather than wait for a weekend reveal to potentially leverage news cycle response and a Monday market swell, the President confirmed Friday morning through his press secretary that he would delay the decision ‘up to 180 days’ as negotiations continued. Technically, this is only a delay, but previous stretches of peace have been occasion for speculative interests to rally in the past. Interestingly, the market responded to the official news with a weighty skepticism, squandering a recovery developing through the second half of the week. There was another chip to play to potentially rouse the bulls to life. The stalled progress on the North American economic pact – replacing the long-standing NAFTA accord with Trump’s centerpiece USMCA – could find a jump should the White House drop the steel and aluminum tariff quotas on Canadian and Mexican partners. That would lower Congress’s reservations towards the deal and perhaps secure a clear ‘win’ in the course of a global trade war. The administration issued another confirmation Friday that it had done just that - removed the metals tariffs on those key trade partners – and Trump issued remarks shortly thereafter calling on the Legislature to pass the stalled deal. Yet again, the news was met with an apathetic response. Averting a dramatic escalation of ongoing trade wars (autos) and making strategic moves to realize previously stated plans (USMCA metals) carries limited sway when compared with the full stride of the US-China trade war. A week after the US ramped up tariffs on $200 billion in China’s goods from 10 to 25 percent and China retaliated on $60 billion in imported US goods (also up to 25 percent), we have seen strong language from both sides and reports that efforts to restart talks have thus far failed. This standoff is not a practice in academic curiosity but an earnest throttling of economic activity. We have seen the consequences of the higher costs and restrictions bleed through in the wide run of Chinese indicators while the US sentiment surveys and inflation reports show a more subtle, but still nefarious, influence. There are still approximately three weeks for the two sides to make headway according to the President’s warnings before the US expands it imports tax list to include all of China’s goods (they estimate another $325 billion). Speculative appetites may be such that they simply won’t run simply because they have a little longer leash. However, my concern is that we are already seeing the fruits of full expectation that this trade war will be resolved. If all of these artificial encumbrances are removed and the market still fails to gain altitude, the recognition of a decade-long cycle end may be difficult to miss. Is the Second Quarter Going to Cap Recovery Hopes Since the United States issued its better-than-expected first quarter GDP update, there has been a notable shift in the outlook for global economic activity. Before that milestone, there were mounting concerns that the cumulative effects of trade wars, central banks easing off the accelerator on monetary policy and feet dragging on fiscal policy were converging with natural late-cycle economic struggles. What the official quarterly growth update from the world’s largest economy was less of a definitive turn in conditions and more of a boost to sheer sentiment. Mere collective bias can dramatically change the way market’s move in terms of direction and tempo by amplifying the ‘favorable’ developments and tempering the fallout from the ‘adverse’. This prejudice of systemic speculative appetite will be put to the test moving forward on a number of key issues. The resurgence of the US-China trade war turns the focus onto the snowballing pain absorbed as long as the fight continues and any sign of intent for central bank support moving forward can be offset by a practical appreciation as to what the stretched monetary policy authorities can even hope to deploy. There real traction on sentiment however will always take more readily from unambiguous data. While sentiment surveys are still vitally important to translating the abstract issues into intent for investors, consumers and businesses; there is more mileage in price action from clear growth data points. On this point, we will be processing a number of updates through the forthcoming week that will cut right to the heart of the growth question. The most comprehensive ‘backwards’ update will come in the form of the advanced PMIs (Purchasing Manager Indexes) for May. We are due updates on manufacturing, service sector and composite activity readings from Japan, the Eurozone and the United States among other countries. As we’ve discussed before, the correlation between these proprietary – and timely – economic measures and the official – and slow – quarterly GDP figures is remarkably high. A strong showing in this run of data could beat back growing concern, but it will struggle to topple an entrenched bias. On the other hand, a poor showing could shake loose the hold outs in the financial system like the S&P 500 and other US equity indices to compound fears. There is plenty of complementary growth data that can subtly change course but much of it is dated (like the Japanese 1Q GDP update) or too narrow in focus (such as the US durable goods). If you are looking for a better line to project growth, keep an eye on the OECD’s updated growth forecast. As far as supranational group economic projections go, this group tends to hit close to the mark. The EU Parliamentary Election’s Influence Over Euro’s and Pound’s Future Perhaps one of the most influential events on the docket for the coming week is the European Parliamentary elections starting Thursday the 23rd and running through Sunday. As far as systemic but abstract fundamental themes go, there is enormous economic and financial influence from the pursuit of nationalistic interests. Frustrated by slower measures of growth these past years, global citizens and politicians have taken to escalating the portion of blame to be assigned to strategic economic and diplomatic relationships with other countries and regions. Never mind that the leverage from global growth over the past decades would have been far less expansive if it had been just the collective efforts of domestic agendas. In Europe, the threat of populist interests could turn into a existential risk. The European Union and Euro-zone (the narrower monetary collective) are held together by the belief that economic might – and no small measure of militaristic security – is dependent on their cooperation. That said, there has been an unmistakable rise in nationalist fervor across Europe with previously unrepresented parties gaining significant presence in governments. Perhaps the most prominent example of this political shift comes from Italy which is ruled by a coalition government that ran on a platform that was not shy about its anti-EU views. Alone, Italy represents a threat to stability for the EU and the shared Euro. Deeper rifts may develop as representation in the EU Parliament is sorted if we see a universal foothold in anti-Union sentiment. The stronger the showing from anti-EU/Euro representation is, the more fragile the future for a collective Euro. If there were an overwhelming threat to the economic alliance to draw from the results, it would not be a stretch to expect EURUSD to fall to parity through 2019. Another perspective to watch in the vote is the UK’s position. They have opted to participate in the election even though they intend to withdrawal from the EU as a requirement to earn an extension on their Brexit proceedings. The rhetoric from the British government has born little-to-no fruit with the allowance of additional time, and now the citizenry is likely to punish the principal political players for their inability to move forward and compound economic loss along the way. According to recent opinion polls, the Labour party was still in the lead for intended votes but it gave up a significant portion of its base to the new Brexit party. In the meantime, the Conservatives that are currently leading government are expected to drop back to fifth in the standings losing the bulk of their support to the aforementioned new entrant. This vote will also be used as strategy to force a vote on the Withdrawal Agreement and the timeline for the Prime Minister, Theresa May, stepping down. The Sterling does not need more reason to succumb to pressure.
  12. Trade Wars Between the US and China – Perhaps the US and the World The world seemed to be on a very different path a week ago. Through the close on Friday, May 3rd, the rhetoric serving as forward guidance for the US-China trade war was clearly being directed to suggest the end to the economic conflict was at hand. That took a dramatic turn two days later when US President Trump contradicted the leaks of an impending compromise and deal by stating clearly that the United States would raise the tariff rate on $200 billion in Chinese imports that were being levied 10 percent to an even more punitive 25 percent. True to his word, the President ratcheted up the trade war between the world’s two largest individual economies. While this may not have the same level of shock impact as the first venture into the current trade wars, it is notionally the largest escalation and a peak in this period of ‘growth at the expense of others’ policy. With the upgrade in the tariff rate, the White House issued a further direct warning making it clear that the US is willing to push forward and tolerate its own economic and financial blowback to redirect the course of a trade partner that has long defied the conventions of free markets by pursuing emerging market tactics. According to the Trump administration, China has ‘three to four weeks’ to compromise on the United States’ key demands or the trade burden will expand to another $325 billion in Chinese imports (though 2017’s total imports was only $505 billion). Given last week’s unexpected escalation, there is increasingly less skepticism that Trump will avoid further dramatic moves that hold economic consequence for the US as well. Given the US has pushed forward with an exceptional escalation in the trade wars as of early Friday morning, the market’s reaction through the session that followed comes as quite the surprise. After an initial tumble across the board through morning hours, the week’s final session closed to gains for the S&P 500, the VEU rest-of-world equity ETF, the EEM emerging market ETF, junk bonds and a broad swath of carry trade. We have seen the markets write off other ambiguous issues over the past weeks and months, but the implications behind this situation are unmistakable: there will be negative economic and capital flow repercussions from this situation. Suggestions that the impact will be minimal or that this about face was priced in are nonsensical. Optimism sourced in the fact that the two sides are still talking or that a tough stance by the US will rebalance a global bias that is detrimental to most does not fit with the market’s short-term focus. It would be disingenuous not to mark this market disconnect to some degree of complacency. At what point does the market start to register the pain in the way that we would reasonable expect? Chinese markets (Shanghai Composite, Yuan) will start to process the pressure when government intervention is overridden by the markets. The emerging market and non-US developed market economies are already trading at a substantial discount to the US assets which receive a disproportionate amount of attention. When – not if – the Dow and S&P 500 cave, we are at even greater risk of catalyzing an accelerated and universal ‘de-leveraging’. In the meantime, it will be important to watch the spread of financial troubles beyond the US-China quarrel. The USMCA is still facing an insurmountable wall so long as the metals tariffs persist, there are two direct threats from the US to levy taxes against the EU that have yet to be activated, and the Trump administration has to make a decision on broad auto tariffs as the initial 90-day review process of the Commerce Department’s Section 232 assessment ends on Saturday, May 18th. The Expanding and Abstract Threat to Markets from Political Risks When the markets are looking for threats, there is usually an emphasis placed on those risks that are well-defined and carry an explicit date/time. The ‘convenience’ of counting down to a trouble with certain boundaries can help with preparation for its occurence. And, in such situations, the known unknown can also significantly reduce the sense of fear and in turn dramatically temper their impact. In contrast, those storms beyond the horizon that could inflict unknown damage offer poor preparation and conversely amplify the fallout that accompanies surprises. When we consider the dominant fundamentals winds trading influence over the global markets, there ware fairly well-defined criteria to recession fears (global growth), clear timelines for trade wars and key policy decisions that carry greater weight over the influence of monetary policy as a temporary prop and artificial amplifier of speculative excess. The concern that has constantly lurked on the border of our apprehension is the simmering threats from various points of political risks. Political discourse in general has deteriorated over the past few years with economic and defense-based relationships like the TPP, NATO and Iran Nuclear accords all facing existential pressure. Yet, the pressure isn’t simply reserved for ‘external’ trade partners. Nationalism has taken root across the world with an inevitable result of dissonance and resistance to progress where the benefits cannot be guaranteed to be evenly distributed. This is not the first time in history that such a tide has risen, and it will not be the last. When will it have run its course and give way to alliance and progress – as messy as that inevitably will be? That remains to be seen. In the meantime, we will continue to see the strife that arises from all players pursuing self-interests. The most overt example of this ongoing conflict is between the UK and European Union. The past weeks’ headlines offered little to be enthusiastic over when it comes to compromise for a favorable resolution to both sides. There is nevertheless a time limit in place – whether that be the late October extension deadline or participation in the EU Parliamentary elections from May 23rd to the 26th. Speaking of the forthcoming elections in Europe, there is an unmistakable presence of typically anti-EU nationalist participation and a host of top roles that are up for grabs (head of the European Parliament, European Commission, European Council and European Central Bank). While there are some disruptive voices in the campaigning, no one is as antagonistic as the Italian leadership which is committed to pushing forward with pursuing fiscal support for the economy despite its deficit forecasts ballooning to levels north of the Union’s allowances. In the Middle East, the United States is pushing hard to isolate Iran which is driving energy prices higher and threatening stability in the region – prompting the US to send war ships to the area to prevent rumored threats – while the developed nations fight over the relationship. Asia has multiple points of tension but China’s efforts to promote a sense of cooperation through its Belt and Road initiative are increasingly falling on skeptical views for those monitoring the progress of the US-China trade war. The internal conflict is worst in the United Sates itself. Hopes of massive fiscal stimulus in the form of a $2 trillion infrastructure spending program (necessary to pick up the reins from flagging monetary policy) are potentially held hostage by the growing warnings of constitutional crisis and pressure to pursue impeachment for the President’s perceived transgressions. Any one of these issues could take a severe turn for the worst with enormous consequences for financial stability. For more tracked out Political risks, keep tabs on the known elections around the world – beyond the EU and after Africa’s results have come in, we also have India and Australian campaigning underway. Volatility Measures are an Imperfect Tool We Too Often Find False Confidence Considerable weight is afforded to volatility measures as a definitive measure of sentiment. However, there are many caveats to these typical benchmarks that undermine both their presumed timeliness as well as their ability to even verify sentiment. This past week, there was a notable swell in volatility readings across asset class and region – though unusually not in the aftermath of a confirmed escalation of the US-China trade war as mentioned above. FX derived volatility measures hit the highest in six weeks as did measures for yields and oil, while the S&P 500-based VIX volatility index hit an intraday high last seen back in the opening days of January and the emerging market measure exploded to its highest levels since February 2018 when the market first made its transition from an environment of total complacency. There is little doubt that the fundamental gears were turning through the past week, but the concerns starting the engine turning were clearly not deep enough to undermine the markets such that a true market retreat would set obvious, deep roots. It is worth a refresher on the source of these activity measures. The popular indexes are almost universally ‘implied’ figures which are backed out of related options – the VIX is for example measured from S&P 500 options. Given all of the aspects of the traditional pricing model are known with the contract, that means only the ‘implied volatility’ as a measure of uncertainty and thereby the cost of protection are unknown. Also the underlying index may be traded in both directions, but the vast majority of capital behind the benchmark asset are dedicated to a buy-and-hold mentality. That makes options predominantly hedges, and therein lies the negative correlation between the performance of the index and the direction of the volatility measure. Tracing these indicators back to its fundamental originations, we can better understand their short-comings and perhaps derive some underappreciated signals to use towards our evaluation of the markets and our trading decisions. One of the most overlooked issues is that indicators like the VIX are not indicative of activity itself but rather strong bearish movements in the underlying. That may not seem a problem, but experienced traders will recognize that there is often an erratic nature to markets with violent moves higher or chop back and forth before that intensity is channeled towards a frenetic deleveraging. Another critical shortcoming for such indicators is the fact that they are hedges for which traders frequently disregard at the most inopportune times. Back in the second half of 2017, the US equity markets were defying concern over the upheaval in politics, the growing concerns over global growth forecasts and a march towards a trade war with an incredibly stolid march higher. The run of days without a one percent or greater decline from the S&P 500 hit a stretch not seen in decades. A push to record highs through a period of improbable quiet was destined to ‘revert to norms’ with a slide that would almost certainly offer violence to balance to roaring quiet. It is at such times that there is the most to lose and therefore hedges would be most important to hold. Instead, the VIX printed a record number of days below 10. Of course, we saw how that period ended, with a February collapse across all risk-leaning assets. As misleading as these indicators can become, we can use the lack of counterbalance the indicator should offer as a sign of how disconnected and exposed the participants of the system have become. When ‘realized’ (or actual) activity starts to rise and anticipation remains stoic, there could be systemic risk building that results in not only violent correction but follow through to the unwind. There is also something to be said about the picture of volatility across the financial system. Most will base their assessment of the market-at-large on a single measure like the VIX, but that is as flawed as using the S&P 500 as litmus for the entire capital market. There can be bursts of activity for certain asset classes with some leading depending on catalysts that can turn systemic (like monetary policy failure driving the FX and Treasury yield volatility measures to life), but there are few better confirmations than ‘fear’ spreading throughout the most liquid asset classes. This is much the way I feel about the direction and tempo of the different key assets like US and global equities, emerging markets, junk bonds, government yields, carry trade and more.
  13. The Fed Finds Themselves in a Market, Economic and Credibility Quandary There is a lot of high-profile event risk – both data and events – on the docket this week. The distinction of importance for these potential catalysts is defined by their capacity to tap into more systemic fundamental themes. By that evaluation, there is a lot that can further shape our collective interests/concerns through trade wars, concerns over stalled global growth and the inadequacies of monetary policy as a financial firefighting tool. However, the most influential among the deluge will be the event/s that can reach as many of the major themes as possible. Naturally, there is connection between the aforementioned matters: earnings is an economic benchmark, trade wars stunt growth and recession threatens to expose central banks lack of tools. I would argue that the most loaded item on the menu is Wednesday’s FOMC (Federal Open Market Committee) meeting. This is not one of the quarterly meetings for which we expect the Summary of Economic Projections (SEP) and upon which every rate hike that has been pushed through in this cycle occurred. That won’t preclude a significance to this update however. The interest in this event is more a product of the broader market circumstances rather than an anticipation for any change in rates or unorthodox policy. There is essentially no anticipation for change at this meeting but there is approximately a 65 percent chance of a cut by year’s end according to Fed Funds futures. That is a dramatic reversal of course from where we were at 8 months ago. Before the market’s epic tumble through the fourth quarter (yes, market performance and policy intent are connected), the Fed’s members expected three rate hikes this year while the markets believed it would be more on the order of fourth hikes. There is essentially no anticipation for change at this meeting but there is approximately a 65 percent chance of a cut by year’s end according to Fed Funds futures. What prompted this dramatic about face? Inflation forecasts were generally in line with the central bank’s targets and the unemployment rate is still hovering around its multi-decade low. That would put the onus on forecasts and external factors. The assumptions of follow on pain from the government shutdown and year-end financial market volatility clearly shaped expectations. Therein lies the problem. The US markets have recovered dramatically through the past four months. Trade wars are still a burden with the threat that they will spread to envelop the US and European lines, but the US-China relationship seems to be improving materially. And, just this past week, the 1Q GDP release signaled that we wouldn’t see the world’s largest economy stall out in the immediate future with a 3.2 percent annualized reading – though the inflation figure that is derived from that comprehensive data notably dropped further below objective. Market’s cheered the general dovish shift by the world’s largest central banks, and none offered more relief than the Fed’s turn off of a steady course of rate hikes. So, what is the US central bank to do? Most likely they will default to patience with status quo settings through the foreseeable future. Meanwhile, the White House will continue to berate the Fed for not doing more and the market’s will cry out with any stall in the climb from indices. If there is a sharp drop in output potential for the US economy through the second quarter, response rate will be delayed owing to the strong 1Q figure, and that in turn may raise the interest in financial market performance to avoid late response. In this environment where everyone has different views on what the next stage will be for economic and market health, even the status quo from the Fed will draw out concern from some and speculative leverage from others. Earnings Season Fades as Trade Wars, Recession Fears and Monetary Policy Return Should Trump follow through on any of his three general threats against the EU ... the market is unprepared and the ultimate economic impact would be far more severe. Raising our focus from the top event to the steady drumbeats of more systemic fundamental issues, there is reason to anticipate the range of frequent systemic winds these past months to once again sweep across our markets. Before the ‘oldies’ to return to form, we will first see the recent top headline relinquish its influence. Earnings season in the US technically extends for a few more weeks, but the number of economically-important companies issuing their numbers to tout a greater influence over global growth forecasts or shape the other systemic matters in the financial system is dwindling. Most of the top listings are concentrated to the first two days of the week. Google and Apple will tap into the speculative leverage of the tech sector, Eli Lilly and Pfizer hits the worst performing major sector of late, General Motors will weigh in on trade wars, and General Electric will be another representative blue chip. Shifting the focus back to monetary policy, the Fed decision is the obvious focal point while the Bank of England decision is essentially a reflection of Brexit concerns. Beyond the official meetings, we should keep tabs on regular data and any sign that participants of the financial system are starting to question the capacities of central banks to foster growth and avert market crises. Speaking of economic activity, the sentiment around this fundamental health gauge has certainly jogged higher these past weeks. Both the US and Chinese 1Q GDP readings beat expectations – though the latter’s beat simply avoided a further multi-decade low. We have another official growth reading from a key economic center: the Eurozone figures. Yet, as we have seen from speculation preceding these official figures, fear can arise from less-comprehensive monthly data or even external measures like the US yield curve inversion. Trade wars will once again prove the least predictable overarching concern. Through the end of this past week, President Trump once again suggested he expected his Chinese counterpart in the US soon (insinuating a deal they could sign) while President Xi echoed a similar belief that the end of the negotiations is within sight. As for the market’s interest and ability to leverage this belief; headlines such as the second largest Chinese e-commerce companies being put on the US blacklist raise concerns, we have already seen the markets recover significant lost ground (‘erase the discount’), and new fronts threaten to open on the global trade war. Should Trump follow through on any of his three general threats against the EU (the $11 billion in tariffs in retaliation for Airbus subsidies, the loose threat to seek retribution for trade restrictions on Harley-Davidson earnings and the general threat to put levies on imported autos and auto parts), the market is unprepared and the ultimate economic impact would be far more severe. A Spat of Breakouts a Plenty of Reason to Question Conviction I’ve weighed in on this question before, but the occasion calls for a revisit: what constitutes a true breakout? We just happen to be facing potential technical breaks for the benchmark for global equities, the FX market and commodities. And, a side note before we delve in on the topic: ‘breakout’ is a non-directional term. Owing to the default long-only perspective of so many market participants (particularly those in equities), the association is immediately made for ‘favorable’ developments. If we are experiencing a bullish clearance from congestion, the proper term is a ‘breakup’ or ‘bullish break’ while the opposite conclusion would be a ‘breakdown’ or ‘bearish break’. With quibble out of the way, we have certainly witnessed some charged technical intent this past week. The most remarkable breaks would come from US indices which found the Nasdaq drive to record highs while the S&P 500 hit a technical high on the close, the DXY Dollar index surged through a near two-year range high which translated to EURUSD sliding below 1.1200, and crude oil tumbled through $65 and then below its 20-day moving average for the first time in 50 days (the longest bull run in years). For many, a technical cue is all that is needed to register a break, and the switch flips in their minds to expect a committed move to follow in the marker’s wake. That is supremely presumptuous. What if very few traders considered the same level relevant and therefore there was little intent to drive the market following the ‘break’ that an individual may have put emphasis on? I live by the axiom: it isn’t about the break, it’s the follow through. Yet, follow through is the result of intent. While sheer speculative appetite or an extremely popular technical level can occasionally heft its own influence over the market, the case is a rare one. Far more common in successful technical breaks evolving into robust modes of follow through is a scenario that involves a fundamental motivation that can help secure the tentative break but more importantly draws more speculative interest in or fuels the absolute need to abandon the market. Robust growth or a chase for yield are the best motivators for equities, but that seems far-fetched in our present environment. With the aforementioned three market leaders, we should consider their motivation rather than just the fact that they surpassed their technical boundaries. Crude oil’s slump through the end of this past month is the least convincing of the three. It’s tumble seems to have a very particular catalyst in President Trump’s suggestion that he reached out to OPEC members to encourage them to lower the market price for the commodity. Given the spotty record of his demands and the subsequent market movement over the past year, a bearish drive will depend far more on either a clear downturn in global growth and/or a systemic drop in risk trends. From US equities, the Nasdaq Composite readily cleared its previous record highs from September/October and extended the move beyond that level. That said, the S&P 500’s break was purely ‘technical’ with a new high based on a close over close basis. There were no intraday highs. Meanwhile, the Dow hasn’t even reached its previous high. Robust growth or a chase for yield are the best motivators for equities, but that seems far-fetched in our present environment. The Dollar arguably holds the most probable bullish scenario. The currency can find charge from more favorable relative growth or through a rate advantage leveraged through more dovish counterparts. Alternatively, a full-tilt global risk aversion can revive the Greenback’s absolute haven status. At present, neither end of those extremes seem probable, but they can certainly arise.
  14. Amid Extreme (Low) Volatility, Determine Your Approach and the Eventual Change Volatility continues to sink into extreme levels of doldrums – and this is a theme that all traders should take time to appreciate at regular intervals. Low volatility is a defining feature of a financial landscape. Whether fundamentals catalyze a cascade of value repricing or a technical cue is capable of triggering an avalanche of entry/stop orders is predicated on the conditions first laid out by the depth and activity level of the speculative medium. First and foremost, the type of markets we are dealing with should determine the trading approach we take. If we were to expect a high probability of key breakouts or simply expect such explosive moves to be relatively frequent in the broader market, we would expect volatility to be high and liquidity low – the thinner market depth helps amplify the ‘run’ from sudden jolts of activity. For trending markets, low volatility is a prevailing theme; but liquidity or market breadth are usually generous as participation in the move remains strong. In markets were both volume and volatility are low, observance of ranges (or imperfect congestion patterns) is more common. Recognizing the state of our markets alone is of incredible value for all traders. If my specialty is momentum trading in trends, I would want to remain sidelined when range trading prevailed or endeavor to create a robust range strategy and a barometer to tell me when we are transitioning to different speculative states. Yet, just as the phases of matter (solid, liquid, gas) are all related, so too are the phases of a speculative market. Range can transition to breakout with the application of volatility which then transforms into trend when liquidity follows the spurt of activity as the uncertainty in the volatility itself settles. In the conversion of these different forms, it often proves difficult to determine what kind of market we are dealing with – not even the market is certain – and thereby what type of trading approach we should take. Arguably one of the least forgiving transitions occurs from the quiet and steady ranges into the more explosive breakouts. The shallow liquidity can precipitate enormous moves beyond just the first bloom of volatility. This is often the ignition to sudden speculative collapse as with February 2018 or the eruption of a full-blown financial crisis as with the Dot-com bust. We are once again facing this particular fluid state. Some are comfortable in the range that they are seeing from the likes of the EURUSD which has carved out one of its longest, controlled ranges (as a percentage of spot) since the Euro began trading. Or even more dangerous, there is a default assumption of trend like that from the S&P 500 or Dow which are in the midst of recovering from the last explosion and are not yet returned to the decade-long bull trend so many have profited from through a passive strategy approach. From the trend assumption, there is an assumption of slow capital gains and modest dividend income against a backdrop of risk that is unrealistically low. So, how do investors/traders approach such an ambiguous situation? Use the strategy most common with range trading. Shorter term trades, more reasonable targets, awareness of important levels and more engaged observation of market conditions will make for active trading but also faster reaction time should conditions truly start to change. Trade Wars and US GDP: Top Theme and Top Event As we move into a new trading week with the recognition that market conditions are extremely restrained, it is natural to assume continuation of the same. Yet, as we discussed above, that is an assumption that leverages far greater risk than potential. When we consider the exact conditions for transition, there are various circumstances that can bring about a transition of indecision to trend or low volatility to explosive. That said, the evolution of quiet to volatile is very rarely based in sheer technical originations. It is possible that the rank and file grow so complacent and liquidity so shallow that an unexpected technical development triggers an outsize market drop that then cascades into wholesale deleveraging as everyone returns from the sidelines with a single motivation: to exit quickly. Far more common in the annals of transitional market history is a fundamental spark that draws mass participation and trading intent all at once. And, for those already familiar with the inverse correlation between the S&P 500 and VIX, the more capable driver is the one that is bearish and/or stokes fear. With that flight path established, we should take into account what the most promising/threatening theme and event risk are through the period ahead. On the theme side (meaning a general fundamental influence that is steadily a concern with flare ups around scheduled or impromptu developments), trade wars are presently the most ominous circumstance. It is true that we have a key growth-based risk (US GDP) and dependency on depleted monetary policy has leveraged an impossible future, but recognition of global recession or a hopeless backstop aren’t inevitable do to their existence alone. In some contrast, trade wars are starting to draw greater and greater scrutiny as burden to the global economy and circulation of capital around the world. What’s more, there are a number of threats being juggled presently and any one could drop. The US just recently threatened to apply $11 billion in tariffs against the EU in retaliation for subsidies the latter has given to plane manufacturer Airbus – and of course, the EU has said it is ready to retaliate as soon as the threat is acted upon. With the United States’ direct neighbors, there are hurdles being erected to the USMCA negotiated as a revamp of the previous NAFTA; but the real risk resides with the President’s threat to shut the Mexico border and/or apply tariffs to imports of Mexican auto parts if the country doesn’t do more to stem the flow of illegal immigrants into the United States. Then there is the universal risk of President Trump weighing a universal import tax on all autos and auto parts, a measure that will predicate a global trade war (or at least US versus the Rest of World) that assures a stalled economy. If we are looking for a capable threat with a clear date and time, the US 1Q GDP release will act as top event risk. The world’s largest economy is a bellwether for the globe with so many troubling figures coming cross the wires these past months and open risks like the monetary policy losing its ability to stabilize and the impact of trade wars leeching through. Market it on your calendar. US Earnings Will Have More to Say Than Just the State of US Corporate Profitability For systemic themes, the most frequent three in the rotation these past months has been: monetary policy; concern of economic recession and trade wars. However, these are not the only complicated matters that can spur fear (or greed in positive turn). One typically-seasonal consideration that will return to the forefront in the week/s ahead is US corporate earnings. We have actually had updates from a few major corporations over the past two weeks, with a greater concentration on the top banks. Thus far, we are left with an impression that registers as continuation of the questionable enthusiasm the markets has sustained for quarter after quarter stretching out through some years. If we are to maintain that questionably content view of profitability and growth through the weeks and months ahead, this week’s run will play a particularly important part in setting the course. At the top of the list, we have the likes of: Amazon; Microsoft; Anthem; Caterpillar; Exxon Mobil and Procter & Gamble among many others. These are some of the largest companies in a variety of different industries and they will naturally account for a strong overview of the entire systems health. However, there is another aspect to this bout of earnings season that we should consider: the thematic influences that will be touched upon in the underlying economy and financial system. If you were looking at the ‘bleeding edge’ of speculative appetite, there is good evidence to suggest that the tech sector continues to hold the torch that investors in most other areas of the economy and markets continue to follow. If you want to look at a quantifiable measure of this preference, consider the general performance of the tech-heavy Nasdaq Composite to the blue-chip Dow – or even the ratio of the two. A leader can be a boon or a burden though depending on the direction it takes. If tech were to pitch lower into a speculative dive, it would likely undermine confidence across the system. With that in mind, consider the largest players in Amazon and Microsoft or a more forward guidance-leveraged FANG member like Facebook as greater risk than reward. Another theme that we will touch upon is general economic growth. The largest companies in the indices or a look into the core of economic activity through the likes of Procter & Gamble, Anthem or Exxon will give some direct lead in to the GDP figures due. Then there are trade wars. We have seen these concerns flag as the threats are days or weeks old – and in the case of the US-China, negotiations are progressing – but the financial impact cannot be overlooked. The likes of Caterpillar who has registered negative impact in the past, Boeing who is at the center of the EU threats via Airbus and even Harley Davidson who was a target for President Trump last year can tell us the state of play.
  15. 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.
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