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JohnDFX

DFX Market Analyst
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  1. JohnDFX
    Happy New Year everyone!
    Coming to Terms with a Bear Market
    We have experienced a remarkable level of volatility recently, which is particularly incredible from the past few weeks considering markets were distorted by holiday trading conditions. When volatility meets thin liquidity, the results can prove explosive. That said, the intensifying fluctuation in the global financial system is not just a phenomenon that could be attributed to shallow markets as we have seen both the price-based results and the explicit sensitivity to fundamental triggers increase through the months preceding the official holiday season. Through the past three months, we have seen a number of specific instruments that have stood as baseline for general asset classes tip into official ‘bear market’ territory – which is defined by a 20 percent correction from a recent peak. Appreciation for the changing tide really didn’t start to peak the sense of panic however until equities started to hit the critical, technical milestones. 
    When key US indices started to trip 20 percent – first the Russell 2000 in mid-December and then the S&P 500 Christmas Eve – the few that may have been oblivious were put on alert and diehard bulls started to feel a true sense of dread creep up their spines. Sentiment has notably shifted from unshakable confidence that the markets will bottom and return to their decade-long bull trend to a sense of desperation that buoyancy will hold out long enough to erase some of the losses late-comers had incurred since October or keep the window open long enough to simply exit. The bounce this past week with the S&P 500 moving back above 2,520 does play to the sense of hope. It is possible that we have found a low for the time being having only just technically hit the bear market milestone for a single day, but that seems improbable. Even with the retreat in this market – not to mention the rest of the world’s speculatively-inflated assets – we are still far from previous cycle peaks. Prominent fundamental themes from slowing growth to failing monetary policy effectiveness to deteriorating international relationships are not going to simply reverse course anytime soon. 
    Further, rising volatility is looking more and more a permanent feature of our landscape. Market’s struggle to calmly inflate already-expensive assets amid tense periods of possible instability. It is possible that we have seen the low, but it would not be wise to assume that is the case. Instead, the better approach for market participants would be acclimatize to a world where we are in a bear market or on the cusp of one. Just as bull markets have periods of correction before they reassert themselves, the bear markets can have interludes of recovery. That does not mean we should commit to the about face just because it is desired. Though some people prefer longer duration, systemic positioning; I still favor taking trades with shorter duration and closer targets until it is clear that momentum has returned to the bears. 
    Fed Fund Futures are Now Pricing in Rate Cuts 
    Through 2018, the Fed’s steady tightening (also fairly described as normalization) efforts accelerated. The fact that the US central bank was tightening at a regular clip while the rest of the developed world’s policy authorities were still contemplating when to make their first move, or at best attempting to take bites when conditions were ideal, became almost mundane. If we were to evaluate the benefit to the Dollar from the contrast in the textbook fashion, we would assume that the Greenback should continue to climb against its major counterparts for as long as it enjoys a yield premium – especially as the spread continues to grow. Yet, we know in speculative markets that investors will move to price in the advantage as soon as it seems feasible – and they did. While they couldn’t full price in the benefit to the USD of a Fed hike regime against such a cold backdrop, it could price in a considerable advantage. 
    After that high water market was set, it would be increasingly difficult to confer greater benefit – perhaps if other central banks were forced to revert to ever more extreme easing techniques while the Fed kept course – but it would be far easier to disappoint. This is what is referred to more generally as discounting the outlook. It also goes a long way to explain 2017 where the Dollar dropped steadily versus the Euro despite the fact that the Fed hiked three times and the ECB had yet to nail down a time for its first move higher. Fast forward to today. We have seen markets slump and economic forecasts drop significantly. As would be expected, the forward guidance from the central bank has cooled materially. The shift is clearly apparent to the broader market as Fed Fund futures and overnight swaps have completely reversed course on the hawkish outlook for 2019 – that at one point was fueling debate on whether they would hike three or four times through the year – with no further tightening expected. 
    In fact, the next move priced into the markets is a cut with the greatest weight afforded to 2020, though 2019 was clearly being assessed as a possibility given contracts through December. NFPs and the rebound in US indices through this Friday have cooled the dovish build up, but the shift has been dramatic. It will be difficult to lift speculative enthusiasm so high again especially after key Fed officials have suggested the need for forward guidance has waned significantly.
     
    What Flash Crashes Say About Market Conditions Rather than the Afflicted Asset 
    One of the more remarkable episodes from this past week’s extremely unorthodox opening play at a new trading year was the flash crash that struck certain currencies (and even a few capital assets). Much of the focus was on the Japanese Yen, but it was not the only currency to exhibit extreme price fluctuation. The Australian Dollar exhibited even more extreme fluctuation in historical and percentage terms (its intraday reversal was the largest I found on record) while the ripples readily expanded out to the British Pound which didn’t even seem to connect to the purported spark to the move. 
    Afterhours to Wednesday’s New York session saw headlines light up on news that Apple (one of the principal firms in equity investors’ portfolios) was lowering its revenue guidance owing to the US-China trade war. Paired with the downgrade in Chinese activity readings earlier in the day and the ongoing US government shutdown, and it was no surprise that fear would hit. With the Tokyo markets offline for a holiday, the thin-liquidity-high-volatility conditions were once again triggered with a subsequent tsunami. This time however, the market response would not play out over days and weeks with a pervasive trend but instead struck all at once with extreme intraday volatility. The catalyst did matter as any lit match would, connections to risk trends are important and certainly automated trading influences (stops, limits, algorithms) no doubt contributed. However, boiling what happened down to these elements is a misleading – but common – psychology effort to regain a sense of comfort. 
    If this unforeseen disaster can be attributed to these elements, then we can feel more comfortable that it is unlikely to happen again and we can keep an eye out for the same environmental triggers. This is not an unusual development in the global markets, even for the most liquid. The Japanese Yen  saw rapid rallies followed by abrupt reversals (Yen cross tumbles followed by rebound) multiple times between 2009 and 2011 brought on by risk aversion, then monetary policy distortion and the intervention efforts of authorities (BOJ and the Ministry of Finance). The point is that conditions facilitated multiple such ‘fat tail’ events through that period, and they could continue to do so for us moving forward. It is the confluence of deteriorating investor sentiment, recognition of excessive exposure, fear that authorities cannot fend off any future financial crises and the abundance of threats to the collective complacency that currently colors our markets. While we may not see another 3.5 percent-plus swing from the Yen specifically in the near future, expect to see more developments that were considered unthinkable over the past 10 years. 
  2. JohnDFX
    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. 
     
  3. JohnDFX
    Is This a US-China Trade War Turn We Can Rely In? 
    The market was struck with a broad sense of enthusiasm through the second half of this past week. There were a number of developments – or expectations for forthcoming events – that contributed to this buoyancy. The theme stirring the most optimism was anticipation that the United States and China were finally making progress in their 15-month trade war. Just before the New York close on Friday, officials announced that indeed they had found some middle ground for compromise. The question global investors should be asking is whether this is tangible and significant enough progress between the world’s two largest economies to foster enough confidence in the economic and financial outlook to beat back unrelated systemic concerns that continue to march forward – such as the fears of an impending recession. It certainly draws some measure of concern that the build up to the announcement was answered by a pullback when the news actually hit the wires (‘buy the rumor, sell the news’), though that may be a function of the twilight hour for liquidity. 
    To properly evaluate the heft of the ‘compromise’, we need to first understand what was agreed upon. An agreement by China to purchase $40-50 billion in US farm products was the most tangible improvement – though it will partially be working to offset trade restrictions suffered the past year. The most important agreement is the deferment of the 5 percent point increase in the tariff rate on $250 billion in imported Chinese goods to 30 percent due to take effect October 15, though it was not clear if this was completely off the table. After that, the measures are more ambiguous. The US vowed it would review its entities black list (though Huawei was not part of that consideration) as well as reconsider the decision to label China a currency manipulator. There was also language to suggest discussions would continue over one of the Trump administration’s principal issues, cracking down on intellectual property theft and subsidies for state run enterprises, but there was nothing approaching detail on enforcement. 
    There is certainly material to point to in this agreement, but it falls far short of the milestone whereby the leaders couldn’t just reverse course with little warning as they have done a number of times before, including after the June G20 agreement. The potential of a mere delay in the tariff rate hike isn’t nearly as concerning as the fact that the planned increase in the United States’ tariff list on December 15 was left in place – likely as pressure to speed along a deal. Further, China’s interest to loosen control over its economic and financial influence for IP enforcement, subsidies and American access to the Chinese economy will be very thin as the government faces the slowest pace of growth in three decades. There is significant interest on both sides of this standoff to find a compromise – President Trump wants to avoid a recession before the campaign season heats up and China wants to avoid too severe economic pressure that can further contribute to social unrest – but the struggle to secure superpower status can be powerful and the pain absorbed thus far can prove difficult to reverse. Market performance Monday will be very telling as to where sentiment stands on whether there is enough confidence in these two parties and whether their cooperation is even enough. 
    Hope for a Brexit Breakthrough Mounts Amid General Good Mood Market
    Another ongoing political standoff that both carries broad economic / financial risk and found a seeming break in the cloud cover this past week was the Brexit negotiations. It was difficult to miss the market’s enthusiasm with a Sterling rally that translated into the biggest two-day GBPUSD rally in over a decade. The Pound has shown time and again that while it may feel some of the crosswinds buffeting the global markets, the status of the UK’s separation from the European Union is chief to its bearing and all other matters have their volume turned to zero when there are developments. So, how encouraging was the news this past week? Looking to the headlines, there were updates to reflect upon. UK Prime Minister Boris Johnson and his Irish counterpart Leo Varadkar stirred hope when they both offered enthusiasm after their meeting, saying there was a “pathway” forward as they discussed the contentious border. That was followed by a meeting between the EU’s main negotiator Michel Barnier and UK Brexit minister Stephen after which it was stated they 'look forward to these intensified discussions in the coming days'. Though nothing material has yet been agreed to, this seems like a meaningful break owing to the language alone. Neither side has voiced confidence in their discussions for some time, so this does represent a significant change. 
    With this modest progress, what are the scenarios moving forward? A full compromise on the Irish border would likely set up a true breakthrough for the extended Brexit with an actual deal in hand. If that progress if found, the British currency will continue to climb. While the health and bearing of the UK’s economy and markets will not be able to avoid other known and unforeseen crags, there is a substantial discount to afforded to the possibility of a no-deal outcome. On the other hand, if Johnson refuses to settle on his aggressive position with the country’s withdrawal, there remain certain insurance measures that can forestall imminent crisis. Parliament voted before its court-ordered, shortened suspension period that the PM would have to request an extension from the EU should no deal be struck by October 19. While he has been adamant on the timetable of the exit, it is unlikely he challenges a law, and the EU for its part likely has no interest in triggering a recession in any regional economy by refusing. Keep abreast of headlines that will inform us on the state of talks as well as the planned EU leaders summit on Thursday and Friday. 
    The IMF Updates Growth and Financial Stability Forecasts
    While some cracks in the iron walls of global trade disputes seem to be providing a foundation for speculative enthusiasm heading moving forward, there are still serious fundamental encumbrances to a genuine bullish view of the future. Perhaps the most critical of the risks on the horizon is the threat that the global economy cannot avert its impending stall out. While trade wars have exerted material pressure on growth (the IMF director estimated the US-China fracas was going to cost the world $700 billion in GDP) and even more detriment through investor, consumer, business confidence; there are other – more natural – matters throttling growth. With the US enjoying its longest expansion and bull market on record, a moderation is overdue. I do not fully buy into the belief that periods of growth do not die of old age as there is limited resources that can be utilized to support such a period. That is especially true of the period we have experienced this past decade which has experienced bouts of extreme pace helped along by external and temporary influences such as monetary policy. Fed and other central banks have set their expansionary policy as a key strut to the health of the global economy. What is worrying is that this measure finds as much influence through self-reinforcing speculative belief as it does through genuine distribution of productive capital. That is why it is so troubling that recent waves of stimulus have not been met with the same conviction from market participants and disagreements among the policy setters threatens to further invite scrutiny. 
    In this fragile backdrop, we are expecting an important update on the economic health of the globe this week. In truth, there are important milestones on a weekly basis at this point – from monthly PMIs to sentiment surveys to warnings from supranational groups like the OECD. Yet, what we have on tap is both comprehensive and targeted to perhaps the most contentious situation in the global market. In the latter case, we are due the 3Q GDP reading from China. Though hope for an improved trade relationship with the US is warming markets, the absorbed effect of months of tariffs will show through in this lagging indicator. A poor showing is very likely (whether a new 30-year low or near the previously set figure) or otherwise the markets will treat it with deep skepticism. The only favorable aspect of this update from a trading perspective is that it occurs on Friday, so more anticipation in price action than actual discounting. As for the comprehensive view, we are awaiting the IMF’s updated forecast on world’ growth through its semi-annual WEO (World Economic Outlook). The week long meetings are anchored around this particular update and the new Managing Director, Kristalina Georgieva, has already signaled that the update would downgrade the perspective to the worst course since the Great Financial Crisis. Have her warnings already led the market to fully price in the pain? I will also be watching the groups GFSR (Global Financial Stability Report) very closely. Stability of the markets is one of the more critical accelerants to crises when things start to fall apart and the discussions around the effectiveness of monetary policy are starting to push these questions to the forefront.

  4. JohnDFX
    Another ‘Brexit Breakthrough’ Falls Apart
    Yet another potential breakthrough in the Brexit stalemate seemed to be hashed out at the beginning of this past week following hours of legal negotiation and closed doors discussions. Supposedly, a draft bill was worked out that both the Prime Minister and top European Union negotiators were comfortable moving forward with. If there were only two parties which needed to be satisfied in this divorce, that would be that. However, there are multiple parties whose needs in this debate are collectively at opposite ends of the spectrum. And, that inability to satisfy all these necessary groups once again torpedoed hope of progress. After hours of one-on-one meetings with her cabinet, the PM announced that she had received the support of her council only to see the foundation crumble again when a number of her senior cabinet members suddenly resign. And so, the confusion remains and time to work out a viable solution winds closer and closer to zero. It is important to remember the complexity involved in withdrawing from the EU – a move that has never happened in the collective’s history. Approval of the deal is only the first stage. Consent needs to be offered by all member governments and the technical steps need to be implemented in preparation for the first day of the actual split (March 29, 2019). 
    So, even though politicians continue to voice optimism and time, the reality is that their initial assessment was the deal was necessary months ago in order to facilitate a reasonable transition. Moving forward, each week that passes without agreement is going to be met with exponentially greater concern by global investors and businesses. Inevitably, to make the critical breakthrough, one of the major vested parties will need to capitulate on a key point of their position. Remaining in the customs union for the indefinite future for work around on the Irish border is one primary sticking point. It remains an outcome of a hard break or soft withdrawal that keeps the United Kingdom one foot in the Union against the wishes of the Brexit supporters with a black-and-white interpretation of the referendum back in 2016. In my view, there are two general outcomes for this standoff: a compromise or no deal. There are many different possible variants for how the separation can look – with their pros and cons, virtues and vices. Yet, each would represent a plan. 
    Alternatively, a failure to find common ground will disadvantage the United Kingdom and the European Union (more the former than the latter if you really want to keep score). An agreement – any agreement – is needed to prevent a European crisis from developing. And, a crash out would almost certainly start a crisis for the region. Global economic and financial conditions are already tenuous as it is with numerous other threats prodding our over-inflated, speculative balloon including trade wars, Italy threatening EU fiscal stability and recognition of the limits of effectiveness for global monetary policy. A recession-inducing and short-term credit crisis arising from a messy break in this event is certainly one of catalysts broad and acute enough to start the wheels turning on a global scale. 
    Remembering the Volatility and Volume Relationship for Thanksgiving
    We are heading into a known draw in global liquidity this week. The Thanksgiving holiday is distinctly a US market closure, but the break in liquidity from a major financial hub is so well-known – and inconvenient – that the world tends to accommodate the drop in market depth. There is an important measure of habit that fulfills seasonal expectations in performance and activity level year in and year out. If you believe a speculative run that is starting to form will hit a road block because the subsequent session will drain half of the world’s liquidity, would you take the outsized risk exposure in hopes that the drive is so remarkable that it will overcome the disruption? There is one particular scenario for which I believe that an exception to establish an explicit trend despite a thinned market would actually occur: a panic-induced risk aversion. 
    Greed is difficult to gain foothold as opportunities are not often seen as so fleeting as to require such a quick reaction as to override a contented sideline exposure. That said, a sudden crash in the market that puts in jeopardy a fund manager’s or individual’s capital can certainly override confidence in a quick burn. Ultimately, there is a distinct relationship between volatility and volume – or, in more universal abstracts activity level and participation. In a bit of a ‘chicken and the egg’ parable, it is somewhat self-evident that volatility and volume move hand in hand; but not which leads the other. So long as there isn’t an overwhelming threat to the global financial system for which European, Asia and North and South Americans (who are not the US) are driven to flee regardless of America’s participation; the low volume will inspire low volatility. 
    And, for those that have not kept tabs on the VIX or other implied volatility measures, this aspect of the market is considered a ‘risk’ measure with an inverse correlation to benchmark capital market exposure like a long equities index position. If, on the other hand, there is a sharp increase in volatility, it will either draw more volume in to facilitate the development of a trend or cause an extreme response in the market similar to a tsunami gaining height as the water’s depth decreases heading into shore. Normally, I would be little concerned about conditions ahead, but given the list of systemic threats that circle just outside of the market’s comfort zone, it would be risky to assume quiet. 
    A Trade Deal – No Trade Deal – No Credibility 
    It is getting difficult to believe updates on the United States’ position in the global financial system and the prospects of the country’s growth moving forward. It has been a feature of the landscape for years (well into the past administration) to see the promise of an economic improvement crushed by political gridlock. However, the defusing of confidence is happening more rapidly, arising from within a single party and the stakes have grown so much larger through subsequent years of speculative build up. A good example is the infrastructure program that has been touted since the 2016 Presidential campaign for which both Republican and Democratic front-runners vowed to pursue to accelerate growth. Now passed the mid-terms, we have not seen progress made on the fiscal stimulus (though the tax reform and regulatory rollback did earn some points for the buoyancy). 
    President Trump referenced his willingness to return to the effort this past month, but Senate leader Mitch McConnell threw cold water on market hopes when he said the program would not be considered unless it paid for itself – very difficult to do after a tax cut. An infrastructure bill would be an ‘addition to the economic outlook’, while an end to the trade war would reflect the ‘removal of a threat’. Said removal has been something the market has harbored some measure of hope would occur and likely one of the key reasons risk assets like US equities have not imploded. Trump seemed to give traction to that confidence earlier this month when he said that progress was being made in negotiations with China and a deal was on the way after a phone call with his Chinese counterpart, President Xi. The rally that followed those remarks however were quickly stifled when his chief economic advisor outright contradicted the President’s assessment and instead said he was even more concerned about the future than he was previously. 
    One false dawn is enough to undermine the market’s confidence in taking such remarks in the future at face value, but a second time within a few weeks will almost ensure it. This past week, Trump again said a deal would be done with a short list of items left to work out and the need to apply the last tranche of tariffs against the country perhaps not necessary. Before those remarks could take any serious traction, White House officials followed up by saying the market should not read into his remarks. They seemed self-explanatory with no interpretation necessary, so the check reads as outright contraction – a move that will certainly curb the use of forward guidance into the future. If you want to see the fallout from losing the ability to direct market’s to views for the future, look to Japan or Switzerland.
  5. JohnDFX
    Another Week, Another Set of Brexit Scenarios
    It seems the weather patterns behind the Brexit seem to changing at a more rapid clip – always ending up back ‘in irons’ (pardon the nautical terminology) as the clock steadily winds down to the March 29 separation. This past week, was particularly momentous with the Prime Minister’s proposal supposedly going to vote in Parliament; but May decided to pull the vote before the allotted session as it was clear it would be voted down handily. And, considering the MPs had voted the week before to give themselves more power in the event the PM’s effort was rejected, she wanted to avoid losing any further control over the already stumbling process. The week wasn’t uneventful however as frustrated conservatives called a no confidence vote in May’s leadership. Ultimately, she survived the challenge and cannot be contested again for a year – though that doesn’t prevent further political pressure nor does it make navigating negotiations on the separation from the EU any easier. 
    It could have been the case that Juncker, Tusk and their European colleagues were waiting to see the outcome of the UK no-confidence vote to prepare further concessions that would warm May’s government; but that did not prove to be the case. After enduring the challenge, May attended to two-day European Community summit where Brexit and a no-deal outcome in particular were to be discussed. She received a clear rebuff on any further compromises from the EU and in fact had some features of the previous offer revoked. We have long ago passed the event horizon for a balanced deal to be struck such that the technical work would be ready by the actual separation date. It is unlikely that this is holdout from both or either side to earn further concession as the brinkmanship only adds to the economic and financial trouble down the line. That means this situation is more likely to continue unresolved until UK leadership makes the call. 
    If May can wrangle the conservatives to accept a temporary backstop, it may be the closest middle ground to be found. Alternatively, we will end up in either one of two extremes: a no-deal break or the call for a second referendum. If we end up with the former, it is more  likely to be pushed all the way to the predetermined end date. A second referendum however would likely be called weeks – perhaps even months – before the March 29 deadline. All the while as uncertainty prevails, external capital will continue to drain from the UK. Already with a default backdrop of uncertainty, global investors will want to avoid an overt threat like the Brexit. Further, domestic capital will increasingly be moved to safe guard rather than applied to more productive, growth-oriented means (such as business spending, property development, wage growth, etc). As has remained the case for some time now, trade Sterling cautiously and with a clear intent – if at all.
    A Critical Fed Decision to Set the Course of 2019 
    Top event risk over the coming week is the FOMC rate decision in my book. This final policy update of the year from the world’s largest central bank is one of the comprehensive events we expect on the quarters. Along with the routine update on rates and the monetary policy statement, this event will include the Summary of Economic Projections (SEP) and Chairman Jerome Powell’s press conference. First and foremost, the central bank is expected to hike rates 25 basis points for the fourth time this year to bring the range up to 2.25 to 2.50 percent. While Fed Fund futures project this outcome at a 77 percent probability – I would set the chances even higher. The Fed has established forward guidance as the primary tool for monetary policy even though it has raised rates at a steady pace and started to reduce its balance over the past year. 
    The utility of guidance is that it can acclimate the market to tangible policy changes before they are implemented to defuse the detrimental financial market volatility it could trigger otherwise. That is extremely important given the transitional phase global monetary policy is in following nearly a decade of emergency-level accommodation. Markets have grown more than accustomed to the support, the have grown somewhat dependent. Normalizing its essential to promote a healthy financial system, healthy risk taking and restore the buffer necessary to fight future downturns. Yet, if this fraught course is piloted poorly, a policy authority can inadvertently trigger the next crisis. Of course, if risk trends are already unsettled, a market that is seeking out threats could fixate on this disturbance readily enough. That said, the Fed may already be picking up on some strain in the economy and markets, looking to trim its pace so as not to run aground. 
    Preparing the market for that deceleration is just as important as setting expectations for its unrivaled hawkish drive over the past few years. Powell seemed to do start the adjustment a few weeks ago when the language in his speech on bonds seemed to denote greater caution and recognition of tension in the market. We have seen markets respond by  pulling rate forecasts via Fed Funds futures and overnight swaps down to only fully pricing in one 25 basis point hike – whereas previously the market had afforded three with debate of a fourth. We are due a definitive view for rate forecasts from the group in the SEP. The update for December showed a majority – by a single person – projecting three moves in 2019. Given how finally balanced that forecast was and the language from some key members, it is very likely to be downgraded. The question is whether a downgrade to just 2 hikes will then be construed as better-than-expected and if the tempo change will trigger concern amongst market participants about financial market health. 
    Was Italy Capitulation, Trade Concessions, A Brexit Vote Save Enough to Revert to ‘December Conditions’ 
    Thus far, we have witnessed a remarkable December. Historically, this tends to be one of the most reserved months of the calendar year for volatility and volume which in turn translates to steady gains for traditionally risk-leaning assets. What we have seen instead is a continuation of the previous two months were high volatility has leveraged incredible swings in popular benchmarks like the S&P 500 and Dow while the VIX holds precariously high. It is inevitable that liquidity will hit holes over the coming weeks owing to market closures, but that doesn’t mean that the markets have to drift calmly into holiday conditions. Shallow market depth and high volatility can converge to produce extreme moves. 
    It is always wise to head into market closures or known liquidity contractions defensively, but that would be especially true of our current conditions. The question now is whether some relief on a number of ominous fundamental themes is enough to soothe the beast until markets fill back out in earnest when 2019 rolls in. Some points of progress optimistic bulls can point to include the agreement by China and the United States to a 90-day freeze fire on further escalation of tariffs, Italy softening its aggressive budget position and UK Prime Minister May surviving a no-confidence challenge. None of these developments are a long-term solution to the threats they represent, but it is breathing room at a time when the markets seem to need it most. Market biases can shift the response to events and themes – from exacerbating seemingly harmless issues into the foundation for true panic or quieting fear over a looming catastrophe. Ultimately, in conditions like these, hedges are worth it.
  6. JohnDFX
    Is There an Effort to Keep Markets Uneasy in Trade Wars?
    How many times does something unusual have to occur before it is considered a planned? I have noted a number of times over the past month that some unexpected policy development was announced hours before the markets closed for the weekend. There is an unspoken commitment by central bankers and global leaders to prevent volatility in their respective financial markets. Volatility is the general definition of risk, and there is a clear connection between financial market and economy. In other words, no one wants to trigger speculative rout that could turn into tangible economic pain. And yet, that typical preservation of self-interest doesn’t seem to worry some of those in power looking to stir norms.
    One of the more common culprits of this push against norms is US President Donald Trump and those in his administration. Announcements of new tariffs on Fridays are now commonplace. And this past week would not deviate from that new norm. Two people in the administration with knowledge of the plans said the President intended to push forward with the proposed $200 billion increase in tariffs on Chinese goods despite the effort to revive talks this past week. This is not exactly surprising given the United States negotiation approach of late. They seem to prefer discussing terms after exerting pressure on their counterparts in an effort to leverage a more favorable outcome. It is also the case in this instance that the remarks are not official – as in they do not come from the President himself. Typically, Trump prefers to announce such things himself to signal he retains final say over such matters.
    Leaks are another increasingly common feature of the US political landscape which unexpectedly adds more uncertainty to an otherwise surprise-oriented policy approach – but at least one where we know to focus for answers. Whether intentional or not, the major announcements in policy from the US and other major economies into the twilight hours of the week creates a resting state of increased uncertainty for financial markets. We do not need any more reason to question our already excessive exposure to risky assets between the dependency on excessive monetary stimulus which is starting to correct, exploding levels of debt, increased speculative leverage and obvious efforts by superpowers to promote local growth through policies that curb others’. A frequency of last minute and troubling headlines just before the markets close is yet another reason traders could naturally want to curb their exposure. 
    Evaluating Fundamental Themes for Both Their Probability and Pace of Progress
    Trading fundamentals can be overwhelming for many. While there are many different motivations for market participants the world over to place or remove exposure, there are typically key reasons that draw many – if not the majority – to alter their views in tandem. If there were a first rule for trading using fundamentals, I would say it is to first establish what is most important to the market-at-large. Another functional application of this broad analysis technique (perhaps rule number 2) is to establish the nature of the theme or event itself. Is it complex or straightforward? Is there a distinct time frame for it to render its verdict or is the outcome something that can be debated through time?
    Depending on the circumstances surrounding these fundamental matters, we can determine what kind of contribution they can make towards our trading – or how effectively they can otherwise complicate the opportunities that may otherwise seem complete. We can use examples to illustrate. The Federal Reserve’s next rate decision is scheduled for September 26th. There is clear anticipation for yet another 25 basis point rate hike by the policy authority with swaps pricing in nearly 100 percent probability. That is clear time and outcomes (hike or not). Such simplicity can make for straightforward Dollar or risk trends – though it will also drain the market-moving potential of an outcome that meets deeply discounted scenario. There is still complication in the forecast for another hike around December, pace in 2019, concern over external factors and more; but those clearly are not the primary interest.
    A significant step up in terms of fundamental complication are the ongoing NAFTA negotiations between the US and Canada. While there have been a few dates of confidence thrown out by officials, there is no definitive end date. There is also substantial discrepancy in the outcome for these talks such that a compromise or dissolution of trade relations can render significant market moves. This is an even that is far more difficult to predict for timing and outcome, but it renders far more market movement. And, then there are those events that can continue without resolution for considerable time and the full impact cannot be readily be predicted until long after it is implemented. That is the situation with an event like the US-China trade wars. There are no milestones for furthering the tensions or reducing them and it can prove a systemic threat that directly leads to a global recession and/or financial crisis. Yet, without clear guidelines, the practicality of trading around it is exceedingly difficult. 
    And Now, the Central Banks with Failing Credibility
    This past week, the European Central Bank (ECB) and Bank of England (BoE) delivered their respective monetary policy decisions. These are important policy groups whose decisions carry far beyond their respective economies. The ECB marks one of the most aggressive dovish central banks amongst the majors and carries significant responsibility for sustaining the belief that market enthusiasm is borne out of the extraordinary support these groups are offering to the system. Perhaps recognizing the position they hold and uneven health of its member economies, it is struggling to decide its course. The BoE is one of the most hawkish major players with a course of inflation that is above target and could be used to evaluate the central banks’ commitment to the ‘rule of law’ for targeting price growth as a determinant for monetary policy. Of course, they are dealing with the uncertainty of Brexit which is a situation not uncommon across the world’s largest economies. So this group is acting as an unexpected template for how to deal with external pressures. These are important groups whose moves will be monitored and likely mirrored by other central banks.
    The upcoming two rate decisions this week will not be evaluated for the guidance they can offer others. Rather, they will instead be used as lesson on what to avoid. The Swiss National Bank (SNB) and Bank of Japan (BoJ) have failed to apply policy that renders the deserved effect for promoting growth and price stability – not to mention unstated goals of financial health. They are in fact both groups that have lost significant credibility in the markets, which makes their job all the more unmanageable. The SNB will no doubt keep its rates firmly in negative territory, yet the desired depreciation of the Swiss Franc is unlikely to follow years of unchanged policy. Given the dependency on exports of goods and services – and particularly to the EU – they are primarily concerned with the unfavorable level of the EURCHF exchange rate. This will not change materially until the ECB itself follows a course that allows for more appreciation of the Euro.
    While the BoJ has not done anything so dramatic as the SNB’s implementation and sudden removal of a floor on its key exchange rate, the central bank has clearly embarked on a policy course that has consistently fallen short of its mark. Interest rates in Japan have been kept near zero for decades, and the rise of QE programs was eagerly adopted by the group in an effort to stoke price growth. Despite a steady escalation of this downpour of funds, price pressures have not solidified and the markets have increasingly discounted their ability to even move the Japanese Yen for secondary favor. What we should worry about from these two is what the market response is when such groups are forced to capitulate or the recognition of how exposed the system is should another crisis arise where such groups have no hope of averting collapse. 
  7. JohnDFX
    UK Parliament Votes to Delay Brexit Deal, Now What? 
    Heading into the weekend, overnight implied volatility behind the Cable and other Pound crosses had charged to their highest level in over two years. That reflected well the fundamental weight represented by the first Saturday sitting in the Commons in 37 years. Parliament convened to debate the government’s withdrawal agreement bill which Prime Minister Boris Johnson managed to hash out with European negotiators during the EU leaders summit. The compromise came at the last possible moment as the law passed by MPs before their proroguing required Johnson had a deal in hand by October 18th or he would be required to send a letter to European officials requesting an extension for negotiations to avoid a no deal outcome. It was telling that the progress towards avoiding a hard Brexit scenario to this point had seen GBPUSD charge its biggest 7-day rally in decades yet anticipated volatility had soared in tandem. That speaks to the level of speculation going on and the very convoluted situation with which we are dealing. 
     
    Ultimately, Saturday’s vote would confound the momentum that had built towards a tangible deal and in turn trip up the speculative charge that had gained such remarkable purchase these past few weeks. The MPs voted 322 to 306 on the so-called Letwin amendment which would withhold approval of the deal until legislation was in place. That would in turn trigger the ‘Benn Act’ which required to the PM to send a letter requesting an extension from the October 31st deadline out to January 31st. The government did this begrudgingly along with a second letter in which Jonson made clear he believed a delay would be a mistake. The impact that this has on the market is inevitability convoluted as the array of scenarios for the ongoing negotiations is itself complicated with options. Though the deal was not pushed through, the effort to delay is principally based on an effort to push back a no-deal outcome in a bid to permanently prevent it from ever coming to pass. Nevertheless, the intensity of the recent charge is compounding speculative appetite that will likely be frustrated by this turn of events. A swift retreat that could then turn to contemplative balance. It is possible that the EU could reject the request to push back the decision date which would send a shock of panic through both the Sterling and capital markets, but that is a low probability. 
    Granting the UK an extension that only lasts a few weeks rather than three months would leave very little time to accomplish anything other than an approval of the offered withdrawal agreement or risk reviving the no-deal scenario. Some European leaders want to know what will be the point of offering an extension – coming to agreement on the given deal, general election or perhaps referendum. The pressure will remain in all of these scenarios, but the intensity will be greater depending on the immediacy of the scenario. Meanwhile, the government officials (the Foreign Minister) have stated their belief that they have the necessary numbers to push the current deal through Parliament. It has been suggested they will call for a ‘meaningful vote’ and possible seek to work through the details of the current deal in order to find the majority that Johnson needs to move forward. To Pound traders and foreign investors, this will look like general uncertainty which is naturally reflected as volatility. Committing to a particular course for a market steeped in such instability will be exceptionally risky. That kind of scenario will draw more speculators than steadfast investors, only compounding the situation. Beware trading GBPUSD this week. 
    A Serious Escalation of the Global Trade War…Underappreciated
    Despite efforts by the European Union’s trade delegation to negotiate a compromise, the United States Trade Representative’s (USTR) moved forward with slapping hefty tariffs on certain EU imports. The White House will not be easily swayed with this push as it considers the effort to be sanctioned – at least partially – by the global community. The World Trade Organization (WTO) found that the US could pursue corrective measures against the EU to the tune of $7.5 billion for what it considers harm done through unfair subsidizations for the Europe’s principal airplane manufacturer, Airbus – never mind the group found the US guilty of similar practices in favor of Boeing, it just has yet to rule on the amounts that can be pursued. While the lack of ground the US is willing to negotiation is a general problem that the whole world is experiencing, the particular trouble for the EU is in the products that are being taxed. In addition to the expected 10 percent tariff on imported airplanes, the US has also imposed a 25 percent hit to certain agricultural products and there was also reports they were pursuing industrial goods as well (though that isn’t yet clear in the details). These unrelated industries to the initial dispute register as economic aggression that urges retaliation. 
    Remarkably, despite what this situation would insinuate, the coverage around its unfolding has been particularly light. In part that is likely owing to more immediate concerns such as Brexit, the US-China stand off and regular warnings of economic lethargy. Just as crucial to the limited impact is the lack of retaliation from European officials. That is unlikely to last. In a best case scenario – short of an unexpected compromise – would be Europe waiting until the WTO rules on the notional amount it can pursue against the US for the Boeing finding. That could keep this additional threat to the already fading growth forecast at a simmer rather than rolling boil. Yet, there is considerable debate among European officials on how to act. Germany’s Finance Minister has urged his counterparts to hold off on retaliations to allow for negotiations to work and likely to avoid a high probability path of steady escalations that seems routine with the US. On the other hand, the EU’s Trade Minister warned before the official tariff start date that they would have “no alternative” but to take countermeasures if Washington wouldn’t deal.
     
    If Europe moves to counter the US, risk trends and economy watchers will pick up on it readily. We may find some grey area should retaliation be held to what is considered like-for-like for industries unrelated to airplane manufacturing. If that is the case, the US may not be quick to cry foul and escalate, particularly when they are distracted by so many other issues nowadays. Alternatively, if they are spoiling for a fight and looking for a reason to spread their self-labeled righteous efforts to rebalance trade practices around the world, the Trump Administration could make another sharp response in a shock-and-awe approach. Ultimately, we will not be able to avoid that recession that seems to be lurking at the fringes if the two largest economies in the world decide to gouge the trade between them. 
    EURUSD Launches a Rally, But From Where? 
    There is a lot going on in the FX and global capital markets, so it is understandable that some significant movement in some of the less-trafficked corners of our charts goes overlooked. Yet, that doesn’t suit the EURUSD. The world’s most liquid exchange rate (and arguably asset) has accelerate a bullish reversal that began with the month. Technicians would recognize the move for being the strongest two-week advance in approximately 13 months. From there, the technical boundaries that we’ve overcome – like the 3-month descending trend channel – carry some weight of their own. But what makes this effort particularly remarkable in my estimation is the starting point. Through the end of September, the pair was trading at its lowest level in two-and-a-half years. Adding to the interest in the move is the context of a market that has proven remarkably stagnant. Sure, we were plumbing new lows, but the decline was coming in starts and fits with a very gradual descent which reflected well on the broad restraint this benchmark has exhibited for the past 17 months. Are we finally seeing volatility restored to a pair that has successfully avoided large swings for that long? 
    To interpret the probability of a transitional period, we need to understand what has steered the market through its restrained routine thus far. Why has EURUSD been so controlled? While some believe this is an anchor born of two reserve currencies, I suspect that we are witnessing the confluence of multiple competing forces. Safe haven capacity, relative growth and now trade war implications are just a few of the more exceptional forces jostling these currencies. It is very likely that these matters take up a bigger role in their relative performance into the future. Yet, at present, the bullish reversal from EURUSD has a few interesting properties to perhaps highlight what is the most interesting matter at present. This past week, the Euro didn’t show a broad rally across its major counterparts and EURCHF in particularly made no effort to reinforce. Alternatively, the Dollar made a fairly broad retreat. Realization of trade war blow back, recognition of the struggling economic data or political uncertainty may all be contributing to the slide; but I think a more familiar catalyst is responsible: monetary policy. Through the end of the past week, the probability of a third consecutive rate cut from the Federal Reserve rose to 89 percent according to Fed Funds futures. That is a significant escalation from a week ago and up from little more than 20 percent a month ago. If this is indeed the root of this ground swell, thing should get more and more interesting as we approach the Fed’s October 30th meeting.
  8. JohnDFX
    Make or Break for Brexit? 
    There have already been so many twists and turns in the UK’s efforts to negotiate its separation from the European Union that that investors are getting dizzy. It is troublingly difficult to gain a reliable bead on a probable outcome for this stalemate, but the lack of time and dwindling hope of an outcome that will satisfy the majority of those involved raises the threat of a ‘bad’ outcome and even worse market response. This is not one of those events where ignoring the risks can prompt complacent gains. Once again, we are coming up to a key milestone in this saga where conditions can continue with a narrow course forward where the best case scenario still reflects considerable uncertainty and no small measure of market fallout. Or, it can be pitched into disarray. If you are monitoring the march forward of this fraught Brexit divorce – and you should whether you have direct Pound or UK investment exposure or not – highlight on your calendar Parliament’s vote on Prime Minister Theresa May’s proposal Tuesday. 
    The draft was made in concert with EU negotiators which produced a result that theoretically both sides could sign off on. That would seem a viable course forward if not for the level of discord in UK politics. Rhetoric surrounding the Prime Minister deal is distinctly harsh from both the conservatives who found vindication in the referendum outcome as a sign of a clean break as well as Labour and other groups who are attempting to keep economically supportive elements of EU access or do not support the withdrawal altogether. It is likely that Parliament votes the plan down which will open up a range of scenarios – very few of which are will avoid deeper trouble.  After a rejection, the government has three weeks to work another deal, but the EU will be far less interested in an agreement that asks for more and the rapidly diminishing time frame will leave little opportunity to warm counterparts to their side. 
    Parliament voted this past week – after finding the Prime Minister in contempt for refusing to release official legal advice on Brexit – to give itself greater say over the proceedings should her plan be rejected. This is likely to empower the MPs to demand more favorable – but perhaps ultimately unworkable – terms. It may also raise the pressure for a second referendum. Previously May has rejected the option outright, but recently she has floated the idea. It comes off more as a threat for conservatives to get in line, but she has said there is a choice of “my deal, no deal or no Brexit at all”. Two of those three options are considered assured crisis to all the relevant parties involved; and unfortunately, that third lesser evil is different for all of them. Beware Pound volatility and the risk of fast moving local capital markets which can be exacerbated by the waning liquidity in these final weeks of the year.
    This December is Already Bucking Seasonality Expectations
    As we have discussed more and more as of late, there are seasonal norms in capital markets. These unlikely cycles arise through a few different practical market occurrences. Mid-day direction changes in individual trading sessions, summer doldrums, quarterly earnings runs and more draw on reliable conditional developments that can shape conditions – though specifics like direction are still up to the unique circumstances that play out in the given period. In the final weeks of the calendar year, we have one of the most reliable norms in trading. For those that want the scene described in a short phrase, ‘Santa Claus Rally’ usually suffices as they can fill in the circumstances with their imagination. A reduction in liquidity for western holidays and/or a general sentiment is seen as the foundation for a market’s performance. The liquidity aspect is at least correct and conditions earned through collective habit can often fill in the rest. However, when we follow this theme to the assumed bullish-backed trend, there are certain environmental criteria that need to support the outcome. 
    Normally, the pending risks column needs to either be small or populated with issues that can readily be deferred until more convenient market conditions return. That is not the case now with growth forecasts slowing, warnings of financial risks growing more numerous (from the likes of central banks and IMF), trade war consequences kicking in and political risks splashing the headlines. These are not issues that can readily be shelved and they are receiving media attention on a regular basis. With this backdrop, there are frequent sparks that can provoke panic which makes the backdrop all the more threatening. If an otherwise contained crisis arises somewhere in the world, the thin market conditions can amplify the ill-effects of panic to spread well beyond its normal reach. And, while it may not be capable of a lengthy collapse of the financial system through such diluted conditions, it can lay the groundwork for a vicious cycle that begins the process only to catalyze fully when markets fill out – much like a nuclear reaction. 
    In portfolio and statistical theory, it is not advisable to position for collapse against these seasonal norms as the probabilities are still skewed in favor of the norms. However, it doesn’t mean that we need to be utterly complacent with the risks that we hold. Reducing size, diversifying away from ‘risk’ markets or buying hedges reduces your beta exposure, but it isn’t like we are missing out on opportunities through a period that will be ‘dead’ in the base case scenario. The volatility we have experienced this past week, the past two months and in two distinct periods over the year (Feb-March and Oct-Nov) are a reminder that we should be more proactive with our reducing our exposure to the capricious unknown.
    Who Faces the Greater (Probable) Systemic Threat: Dollar or Euro?
    Everything in investing is a probability – that is a mantra I repeat to myself to avoid the delusion of certainty in a view or position. To put belief into action, I try to always lay out the probable scenarios for a particular market, asset, event, etc. Even if I consider a certain outcome more likely, considering the alternatives can help to identify earlier when the theory isn’t panning out and to even help stage an actionable strategy for a lower probability path. Most of the time in trading, the focus is to identify best case (the most productive bullish) scenarios, but there is just as much value in projecting worst case outcomes and their probabilities. This can help us avoid markets with a severe probability/potential imbalance or even identify better trading opportunities – I would rather pursue a short in a productive bear trend than suffer a long exposure in a choppy bull market. In evaluating the majors for their practical ‘worst case scenarios’ (those outcomes that are severe but not wholly unlikely – or qualifiers for a true ‘black swan’ designation) I think the Dollar and Euro deserve closer observation. 
    For the Pound, the market is well aware of the possibility of a bad fallout from the Brexit which puts investors on guard and making moves that help to hedge risk. The Japanese Yen is so inextricably tied to risk trends and the Bank of Japan’s policy so open-ended that other issues struggle to compete for anxiety. For the Euro, a return to existential rumination on the currency union with the Italy-EU budget standoff is a still-underappreciated issue. The bulls in the market likely look back to the situation with Greece and assume a routine path for any future confrontations to be resolved in the same way. That is presumptuous to be negligent. The fact that this is occurring after Greece and during the UK’s bid for a withdrawal (admittedly from the EU and not Eurozone) should raise the level of concern significantly. It hasn’t. Perhaps the lingering premium afforded the currency for the eventual turn from extreme accommodation by the ECB will be the first dashed enthusiasm to awaken market participants of more unfavorable outcomes. If a country were to leave the currency union (EMU or Eurozone), it would fundamentally change the appeal of the currency as a global unit by significantly reducing the size of its collateral (GDP and capital) which would in turn significantly increase its perceived volatility. And, those are critical properties of a currency. 
    The situation is unusually similar for the US Dollar. The pursuit of trade wars inherently encourages the world to redirect funds away from the US Dollar to avoid the policy conflicts that it brings (in trading terms, the volatility). Meanwhile, the rising deficit becomes increasingly problematic as the cost to service the massive debt rises and outside demand dries up. This can lead to a general shift away from the Greenback’s use permanently which the market won’t fully appreciate until much deeper into the situation. Similarly here, the market may more readily recognize something is wrong via monetary policy as the Fed adjusts to some form of the systemic risks by slowing its pace of policy normalization. So, which currency faces the longer-term – but still reasonable – risk? The Dollar. The ubiquity of the currency globally (nearly two-thirds of all FX transactions) means that it has far far more to lose should its use diminish. And that is very likely as the threat of further credit quality downgrades occur owing to its appetite for debt and its withdrawal from the global markets. 
  9. JohnDFX
    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. 
    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. 
    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. 
    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. 
     
  10. JohnDFX
    The Economic Costs Versus the Sentiment Costs of the Coronavirus 
    Interest in – or really, fear of – the spread of the Wuhan China-based coronavirus ballooned this past week. We could take an anecdotal peruse of the headlines, but I prefer something a little more quantitative. The global, financial-related search for ‘virus’ this past week hit its highest level in over 15 years according to Google. Their data only goes back to 2004, but there is a good chance that the SARS epidemic the year before gave it a run for the proverbial money. This level of attention will naturally draw out the speculation. In an environment defined by better balance, the investors could be a little more sanguine about the impact such an event would have on their portfolio as it can indeed be difficult to evaluate the direct economic toll such a situation will exact. Unfortunately, the status of the global financial situation is anything but poised. 
    Benchmarks for speculative exposure (like US indices) are pushing record highs while traditional measures of growth and return are struggling. As we discussed last week, these more ambiguous risks can extort a heavier tax on a market. The imagination of the masses and the threat of a worst-case-scenario trepidation. Looking back to 2008 and 2000, the systemic risk was not necessarily US low-credit quality housing loans nor the exorbitant highs of tech stock shares – though they were certainly high visibility sparks. Consistency across these periods is the over-reach of enthusiasm, supporting a build up of exposure. 
    I consider this a thematic extreme in leverage whereby we take on greater and greater exposure while the risks associated with the situation are progressively downplayed. Until, of course, the tipping point is reached. What do we look for from here if we are indeed transitioning? Aside from progressive retreat in capital markets and focus on the coronavirus headlines, look for evidence of liquidation and pressure in financing. 
    The Implications of a Sentiment Plague on Growth, Trade and Monetary Policy 
    As we look for the mutation of the global health threat into a full-tilt financial hazard, my focus is back on those principal themes I’ve been tracking for the past few years. Recession fears, trade wars and questions over the effectiveness of monetary policy have popped up with consequences for volatility at various times over the recent past; but they have generally fallen short of truly sending the global capital markets reeling. The decade-long bull trend persists. Yet, as genuine concern starts to take among otherwise optimistic investors, the cracks will become more visible. 
    My chief apprehension rests with the state of global economic health. If you recall, back in August, there was a swift and sweeping faint in confidence around very public concern over the bearing of the global economy. Headlines and search interest in ‘recession’ spiked to the highest levels since the financial crisis at the time. The situation was such that the 10-year to 3-month Treasury yield curve inversion – an event and measure of wonks – suddenly because a main talking point among the average retail trader. Of course, the situation at the time was prompted by data that showed the now familiar ‘technical recession’ in manufacturing and worsening of the trade wars, but it was the outcome rather than the catalyst that upended the market. It is therefore worth noting that the same yield curve returned to inversion this past week. Growth-linked commodities crude and copper have also tumbled. This will likely intensify the focus in the week ahead on data that will range from Chinese PMIs to Hong Kong GDP to US service sector activity (ISM) to global auto industry activity (also in technical recession). 
    Basic growth is not the only concern that will be exacerbated by a possible turn in sentiment and the virus that has urged the about face. We have already seen China take drastic actions to spread the spread of the contagion, but it still did not like the call by US authorities from announcing a health emergency and warning that travel between the countries could be more significantly restricted. As China and other countries feel the economic pinch, added pressure from steps like this will raise tensions. And, should a country like the US feel the blowback, its tendency has not been towards opening trade conditions but rather the opposite. Meanwhile, should conditions prove more difficult for investors, the assumptions of outside support to ease the pain will grow. There has been no more relied-upon source of respite for the markets over the past decades than the world’s largest central banks. It would be natural for the cries of help to be redirected towards them. And that would be the risk as these groups are already sporting extremely low – sometimes negative – rates and large stimulus programs. Their capacity to offer more help is severely limited and nothing would highlight that more than a fresh crisis.  
    Consult the Technicals and Correlations for Sentiment 
    We once again find ourselves in a situation where the market’s confidence is under significant strain but it is unclear whether this could be the tension that finally ushers in a lasting bear market. There are plenty of fundamental observers and traders that are willing to point to issues underlying economy and financial system to say this is it. However, value is always in the eye of the beholder. Should the historically tepid return still appeal and headline-worthy risks find a crowd willing to downplay, the run can persist. One of the difficulties to the balance in our system is that sentiment is not founded on the belief of a single person or entity but rather the collective view of a broad market of participants with different risks profiles and incentives. We are at the mercy of often-irrational speculative appetite. 
    How do I deal with this irrationality? I like to incorporate technicals into the mix. Trying to apply tangible milestones of progress to key global market benchmarks can help reduce the discretionary we naturally apply to our probability assessments around a reality where the future cannot be intuited. There is as much flexibility in technicals as fundamentals particularly when we consider risk profiles. For example, if you were more risk tolerant, you may be willing to be more convinced of a sentiment reversal with a more proximate support. I am more conservative in this regard. That said, there are certain elements that I believe can be more generally applied when assessing global sentiment. At the top of my list is the collective performance of ‘risk-leaning’ (higher return via capital gains or yield) assets. The stronger the correlation and the further the progress towards a technical bear markets (20 percent correction from highs), the more stout the signal in my book.
  11. JohnDFX
    Coronavirus Adds Another Wild Card for Sentiment to Absorb 
    When it comes to the standard themes I have been following closely these past few months – growth fears, trade wars and monetary policy effectiveness – there have been frequent updates and it hasn’t been particularly challenging to take their temperature at any particularly time. While the threat of a recession or trade war that threatens to encompass much of the world will not exactly inspire confidence among investors, the knowledge that there are regular updates along the way offers at least some relief. And, as we have seen through this economic and financial cycle, any relief is interpreted by a class of complacent speculators to push their advantage. Yet, the formula changes when the risks are more vague in terms of timing, duration and intensity. That was initially the situation with the US-Iran escalation earlier this month when the former executed an airstrike on the Quds Force general’s convoy and the latter retaliated with an missile attack on US bases in Iraq. However, when both sides  offered their unique brand of conciliatory boasting, the market returned to its risk-seeking self. 
    Looking out over the coming months, the approach of the US Presidential election will represent just such an abstract risk. For now, the focus is on something more erratic by its very nature: the spread of the coronavirus. Since the highly communicable virus first made the international headlines a little over a week ago, cases have spread well beyond the Chinese city of Wuhan where they were first reported and have seen people fall ill in surrounding Asian countries, Australia, France and the United States among other nations. It is difficult to determine exactly what impact this medical and social threat can have on markets and/or the economy, but highly-tuned sentiment can certainly amplify the reaction. Consider the cases of SARS in 2003 and swine flu in 2009 which had a material impact on market-based headlines – though whether that was owing to an already ‘raw’ confidence is up for debate. As more cases are reported of this pandemic are reported, it is worth watching whether the market responds to the additional uncertainty by de-risking any further. 
    The Pull of the EURUSD 
    The FX market is very large in terms of sheer liquidity. It is easy to group the entire asset class into a certain category of depth that adds an innate stoicism and inactivity that seems natural. While the ‘majors’ in the currency market are typically far less volatile than indices, commodities and a range of other popular asset classes on average; they are not themselves quiet. History has shown substantial volatility from even the deepest of the exchange rates, EURUSD – just look at the tumble the pair suffered from May 2014. That said, there is little doubt that currencies have suffered from the same lethargy that has overtaken most other financial markets. While the S&P 500-based VIX has consolidated back down around 12, the FX market equivalent has notched an even more extreme. The popular currency volatility measures from JPMorgan and Deutsche Bank have dropped back to record and near-record lows respectively. My own measure of an equally-weighted implied volatility of EURUSD, GBPUSD, USDJPY and AUDUSD has done the same. Naturally, when these conditions hit, defenses are progressively dropped. Traders don’t expect significant moves so default to either positioning for the carry (for which there is very little nowadays) or trade the range. 
    That is the context with which we saw just a glimmer of activity from the EURUSD to end this past week. The ECB rate decision and then global January PMIs seemed to stir in investors enough attention to push the pair through its narrow three-month rising trend channel and what happened to be a 100-day moving average that was hovering around 1.1070. As far as technical developments go, few chart traders would likely consider this a systemic shift for the benchmark. Sure, it was running out of room with the much larger channel resistance capping upside progress below 1.1250, but the drop seemed a path of least resistance resolution with 1.0900/0875 still intact below to cap any serious concern of bearish momentum. Nevertheless, the boost to activity seemed to generate some serious attention in FX circles. This makes sense given the pair is the baseline for all of the FX market. According to the BIS, EURUSD accounts for 24% of all FX transactions while the Dollar is one side of 88% of all trades as of April and Euro 32%. Given that it has moved deeper into an established 2019 range, we should watch to see whether implied volatility settles. That said, there is some heavy event risk ahead to beat back the dark of inactivity. The Fed rate decision along with the US and Eurozone 4Q GDP readings are top events on this week’s docket. 
    S&P 500 Goes 72 Days Without a 1 Percent Daily Change 
    The world’s most heavily traded index (through derivatives and financial agents) has signaled extraordinary quiet through a number of remarkable statistics earned these past months and years. That is a understandable consequence of a market that continues to push to record highs. While the financial system has suffered very few shocks over the past decade and growth trends are generally steady, the environment doesn’t exude the economic potential nor the yield that normally encourages market participants to play down their risks and continually build their exposure to progressively lower rates of risk-adjusted returns. Eventually, the quiet will be so threadbare that speculators will see little choice other than to significantly reduce their exposure. Of course, the question is always “when”. 
    For most, the spark is expected to be a trigger from the headlines like the failure of the Lehman Brothers back in 2008 was for the financial crisis that followed. Such developments can certainly rock the financial system and send markets careening. On the other hand, I think there is something to say about the environment that builds up to the symbolic lighting of the future. The SPX pushing record highs and the VIX settling back towards the lower bounds of its extreme range are one thing, but experiencing a long stretch of extremely quiet days adds incredulity to the mix. The same index has passed 71 consecutive trading days without a 1 percent move either higher or lower (see SPX_1pct_71 attached) . That is two days shy of the period through Oct 8th, 2018 just before the tumble in the 4Q accelerated, and still well short of the 95 day run through Jan 25th, 2018 that preceded the near-bearish shift (20 percent correction from highs) in that period. Looking further back, we have to go all the way to 1995 and then 1972 to find anything comparable. Clearly enough, this is exceptional; and market activity is mean reverting. When we see a balancing from extreme quiet, it isn’t usually a slow pickup to more reasonable levels but rather a dramatic restoration that eventually settles.


  12. JohnDFX
    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’.
    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.
    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.
    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.
  13. JohnDFX
    Market Conditions in Data Overload 
    Markets often struggle for traction when there is a lack of a clear motivator such as meaningful event risk or an evolving systemically important theme. On the other hand, there are times when a surfeit of important events, indicators and headlines overwhelm the clear speculative picture, leaving us with an abundance of volatility without the benefit of a reliable course. We have dallied with this latter scenario these past weeks, but the constant redirection of our attention will be in special form in the week ahead. There is a near constant run of high-importance events scheduled for release moving through the next five days of active trade. What’s more, many of these various measures will tap into the top level themes that have stood as the undercurrent for economic and financial conditions for months, if not years. 
    For trade wars, much of the critical development rests in the hands of a few officials who are weighing policy decisions that could significantly alter the course of the global economy. Washington and Beijing continue to negotiate after verbally agreeing to a ‘phase one’ deal back on October 11th  but the details and sign off are still  vague. The EU meanwhile is weighing whether to retaliate against the United States for the Trump Administration using the WTO ruling of a $7.5 billion ‘allowance’ for tariffs to recoup losses owing to unfair Airbus subsidies with a 25 percent tax on imported European agricultural goods. Meanwhile, data like the US trade balance and Chinese industrial profits figures on Monday will build upon trade-dependent earnings from the likes of AMD, United Steel and Alibaba. 
    More tracked out for the timing of its updates is the wave of monetary policy updates we are due over a particular 48 hours period. There are a number of supportive updates such as the October US NFPs due Friday, but five central bank decisions between Wednesday and Thursday will make for a far more incisive view of our financial system. In chronological order, we are due the Bank of Canada; Federal Reserve; Brazilian Central Bank; Bank of Japan and Hong Kong Central Bank. Stacking these events so closely together will cater to the relative comparison of the currencies and their assets, but it may also stir further collective discussion of the distortion and costs associated to the extreme easing. 
    The fundamental theme that will pack the most obvious punch in my view is the run of official (government-derived) GDP updates on tap. The United States is the world’s largest economy, so its Wednesday release will draw particular scrutiny. The Eurozone, French and Italian figures will be similarly important - particularly given the chatter about recession risks and the added pressure of external pressures like Brexit and the US tariffs. Two additional updates that are worthy of reflection for the big picture is the health reports for Mexico and Hong Kong. These are two large economies that stand on the cusp of the developed/emerging market designation with particular exposure to trade wars. This data can potential thaw fears of recession that have hardened over the past year behind data and increasingly complicated diplomatic situations, but the potential definitely skews the opposite direction. If this run of data reinforces the reality of economic struggle, it will serve as another cut to a speculative reach that seems divorced from fundamentals that are traditionally assumed to reflect value. In general, all of the thematic risk represents a greater role of risk rather than relief. 
    Redressing the Limitations and Costs of Extreme Monetary Policy as Fed Arrives
    With the world’s largest central bank and its most dovish both on tap for this week, it is important to consider what is driving these groups to loosen navigate into uncharted dovish waters rather than just go along for the ride by trading relative yield advantages in FX or capitalizing on a familiar speculative equation that suggests more external support buys more lift from favorite capital market benchmarks. There is little denying the years of connection between the amount of accommodation (low interest rates, negative interest rates and quantitative easing programs) and the enthusiasm from the investing masses. This is a relationship forged originally in ‘monetary policy in capital markets’ textbooks, but the connections have grown more than skewed in the latter years of this extended cycle of easing. First and foremost, the overriding intent of monetary policy to foster economic health have been proven to be lacking. It could be argued that the dovish shift after the 2008 Great Financial Crisis / Great Recession stemmed the bleeding. Yet, the exceptional support has only grown over the years and we find ourselves on the cusp of another economic stall. This is a feature of the landscape for most of the major groups, but it is perhaps a lesson that should have been learned earlier through the Bank of Japan’s own experiences. The central bank has failed to return inflation to its target for any period of consistency for decades – not just years. So, though it is not considered one of the most prescient groups for a global overview, there is much to learn here. 
    Though an inability to reach their principal economic objectives is a significant problem in itself, it may not be the straw that ultimately breaks the camel’s back. That is more likely to be the consequences to come out of the financial market influences from these extraordinary measures. Though it may not be their intent, the central banks’ easing has inflated capital markets substantially. The pressure is not even, but we have seen risky assets hit record highs at various points with different levels of excessive price to value. Few places is the extravagance more evident than with the US equity indices. At record highs, we should consider that the equity market is pricing in perfection for growth, earnings and returns. It is not very controversial to say that is not the case now. Far from it. Stimulus and low rates has not improved circumstances that remarkably rather the lack of significant return and a tepid economic environment has left investors starved for opportunities that can provide substantial growth at a reasonable risk. And so, they accept greater and greater risk to make ‘ends meat’. Propping capital markets higher may seem a net benefit in the absence of genuine growth, but there are serious risks associated to this state. Expectations for more support will grow exponentially with time. Capital distribution outside of the healthy business cycle will encourage funds to underperforming or zombie businesses that will further weaken economies. And, the growing disparity will inevitably lead to a point at which recognition of risks will force an acceleration of deleveraging which will manifest as a financial crisis that more readily turns into an economic crisis.
    This troubled state is growing increasingly apparent to investors and business owners, but now the concern seems to be permeating the central banks themselves. Outgoing ECB President Draghi admitted concern late in his tenure, though not as loudly and directly as some of the more hawkish members of his board who will remain with Lagarde at the helm. Some of the Fed officials have stated concern along these lines as well, but the group is not yet as overextended as most of its counterparts. In previous years, the US group’s tightening was viewed as a sign of optimism around the potential of self-generated growth. That perspective may hold as the circumstances change. If the Fed seems forced to loosen the reigns to match the ECB or BOJ, it may not be interpreted as a uniform source of speculative liquidity but rather admission that all economic traction has been lost. It is not wise to cheer negative rates and QE.
    A Brexit Solution Seemed So Close 
    Less than two weeks ago, a breakthrough between the UK and EU teams in their negotiations for a quickly approaching Brexit cutoff date seemed to have changed the dynamic of an impending crisis. With Prime Minister Boris Johnson repeatedly stating the Article 50 extension date of October 31st would be held to ‘one way or the other’, there has been an understandable intensity by all those involved to find a compromise to avoid an economically-painful ‘no deal’ outcome. As such, the concessions found between the UK government and European representatives to form a Withdrawal Agreement Bill seemed the most important hurdle to overcome and sentiment understandably swelled after the developments. Yet, that optimism has significantly deflated this past week. First, it was the previous weekend’s extraordinary Saturday Parliamentary session which delayed the Government’s implementation of the deal which started the decline in ambitious optimism. Tuesday’s ‘second reading’ further delivered PM Johnson a blow when he was outright rejected on pushing forward to meet the short time frame. What was more remarkable to me than the familiar trouble to find an agreement exit from such disconnected parties was the Sterling’s ability to hold onto the gains of the previous weeks – prompting GBPUSD to an incredible 6.5 percent rally in in just a few weeks. 
    Trading not far from multi-decade lows, it may not seem that difficult for the Cable to hold some of its recent buoyancy even if progress seems to have dangerously stalled. Yet, the real fair value question is to be found in the array of possible outcomes and their market influence. A divorce with no terms is still a serious probability and its economic and financial impact is not likely priced in even after the slide of the past three years. An extension is nevertheless a greater probability than a cliff on Thursday evening. That said, we are inviting more complication and additional cutoff dates while maintaining the same mix of impasses. Prime Minister Johnson, frustrated by the lack of progress, called for a snap election for December 12th this past week. That request will be considered in Parliament Monday. Presently, polls suggest conservatives could gain support but it is not clear if he will be granted his wish. Further a complication is the EU’s allowance for an extension. The PM sent a request for an extension to January 31st according to the Benn Act back on October 19th , and to this point no reply has been given. France is reportedly skeptical of giving the disgruntled country so much additional time without clarity on what they will actually do with it. Uncertainty is having tangible economic impact, and the discount is increasingly permanent even if the next steps are still fluid. So, this week, we will have to find out what Parliament will agree to concerning the election on Monday and the EU will have to grant an extension before the deadline on Thursday night. Mind your UK/Sterling exposure. 
  14. JohnDFX
    Important European Central Bank Rate Decisions
    As we find distraction in trade wars and political risk, it is important to remember that we are still dealing with more traditional fundamental issues in the background. One of the most systemically important and extremely underpriced risks is the global market’s long-standing dependency on massive stimulus from the world’s largest central banks. That wave of easy money through massive rate cuts and largest stimulus programs has noticeably receded while recognition of more recent iterations of the collective effort have failed to earn the impact that it was pursued for: a return to steady inflation, faster economic activity and wage growth that outpaced the cost of goods. Instead, we are just left with the very effective but increasingly unwanted side effect of artificially inflated speculative assets. 
    Eventually, this big-picture fundamental gap will be reconsidered by the investing masses; and if that occurs amid a financial unwind, it could readily turn mere risk aversion into full-scale panic. As we await the inevitable reckoning, we will take in two important monetary policy updates from major central banks on opposite ends of the spectrum: the Bank of England (BoE) and European Central Bank (ECB). The BoE’s policy meeting is not expected to deliver another rate hike, and anticipation for forecasting is likely rather restrained. Currently, swaps are pricing in less than a 50 percent chance that the central bank will hike rates again before mid-2019. Given that this is a group that has already hiked a few times and has inflation figures to justify further moves if Governor Carney and Co want a reason, this decision can help establish the outlook for global monetary policy as a baseline for economic expectations. 
    Alternatively, evaluation of the ECB’s decision comes from the opposite perspective. The central bank is still employing its stimulus program but is expected to cut if off later this year. Following that, the expectation is for a rate hike to be triggered sometime mid-2019, but swaps currently put that outcome at a sparse 20 percent whereas a few months ago, it was supported by a more than 80 percent probability. Beyond just the rate decision and press conference, we are also expecting macroeconomic projections from the group. If one of the world’s most prolific (profligate?) policy groups deems the outlook does not deserve a steer away from crisis-level settings, what would that say about the health of the economy and financial system?  
    Another Week in the Trade Wars
    Another week and another escalation in the ever-expanding global trade wars. From the heaviest front of the economic confrontation, the period for public feedback on the Trump administration’s proposed $200 billion increase in tariffs on key trade counterpart China came to a close. It is not clear how quickly this will be turned from theory into action, but the markets certainly aren’t simply discounting this marked intensification of the trade war between the two super powers as mere bluster. As remarkable as this threat is on its own, President Trump wasn’t content to leave the heavy threat to linger in the air. On Air Force One, the ‘leader of the free world’ said he was in fact considering a further increase in the United States’ pressure against its rival to the tune of $267 billion. That is $267 billion in addition to the as-yet realized $200 billion. A few months ago, the President – following on the initial warning of the $200 billion jump – said he was prepared to tax all Chinese tariffs. 
    With these successive programs, he would be taxing more than the United States total imports of Chinese goods through 2017 – over $517 billion with the $50 billion and metals taxes already in place versus $506 billion actually purchased. If we only realize the first massive slug of additional taxes, the retaliation from China will further complicate this situation. It will not be able to do a like-for-like retaliation as it will soon eclipse the total imports the country consumes from the US. Resorting to other measures to approximate can easily be construed by this administration as not just response but escalation. Meanwhile, not content to keeping the fight on one shore, the US failed to find a compromise with Canada in its ongoing negotiations to shore up – or more likely replace – NAFTA. If a breakthrough is found next week, the Canadian Dollar is still significantly discounted and could generate a hefty rally in response to the good news. And yet, settling the dispute for the North American trade partners will not raise much enthusiasm for the rest of the world. 
    In addition to Trump’s threats to raise the bill on China, he also made a very thinly veiled threat aimed at Japan who the US is currently engaging in trade discussions. A ‘good deal’ for the US is likely one for which Japanese officials will balk at even with the obvious risk of having to engage in a trade war. On the bright side, the US and EU have not furthered their war of words (autos tariffs, accusations of currency manipulation, threats to circumvent the other’s currency for causing systemic trouble)  to one of action. Yet, considering much of this seems to move in cycles for who is targeted each week, give it time. 
    Global Political Risk Always Simmering and A President That Lashes Out Under Pressure 
    Political risks seemed to deflate in the US, UK and Euro-area this past week, but they certainly haven’t been resolved. Far from it. The coalition government in Italy is starting to run out of room for making commitments to both live up to campaign promises of increased government spending and checks on EU influence will simultaneously meeting obligations to control budget that will not send European officials and financial markets into a panic. From the UK, the Prime Minister Theresa May continues to find pressure from her government, cabinet and EU counterparts in navigating a Brexit negotiation that would somehow please all parties involved. This is ultimately impossible as the groups are in essence demanding outcomes that the antithesis of each other. 
    What we are left with when trading the Pound is a sentiment that seems to oscillate regularly but keeps landing back into the realm of firm warnings to prepare for a ‘no deal’ outcome. In the United States, President Trump is continually bombarded by the news media with scandals that are coming dangerously close to the leader himself. His penchant for retaliating on social media and in rallies is doing the opposite of quelling the storm. In general, it is important to leave our own political beliefs out of our investing – and especially out of our trading (short-term). There have been both economic booms and recessions under both Democrat and Republican administrations – and through various combinations of Executive and Legislative concerns. 
    However, political risks can spill into more immediate financial and economic issues which in turn can charge the market. Trump has said recently that he has considered shutting the government down again if Congress does not curb the rebellion against his agenda. There is also suggestion of a second tax cut being floated and we are still awaiting word that the fiscal stimulus promised on the campaign trail will be revived. What is particularly unique to the US President is his tendency to react to personal pressure from the Mueller investigation and news media’s general criticism with aggressive policy on other fronts. Would he have made the $267 billion threat of escalation against China this past week if the scrutiny over his actions were not so intense? It is difficult to argue that he is too level-headed for that retaliation against the world as there are too many examples to suggest the opposite.
     
    USD price action ahead of ECB and BoE
     
  15. JohnDFX
    The Global Importance of the ECB Rate Decision 
    Top event risk - both for concentrated volatility potential for its local currency and global influence via systemic means – over the coming week is hands down the ECB (European Central Bank) rate decision. Under normal circumstances, the monetary policy decision by the world’s second largest central bank is occasion for significant response from local currency and capital markets. For the Euro, the event is made far more potent at this particular meeting owing to the market’s aggressive speculation for a further infusion of support to their – and the economy’s – cause. Looking to overnight swaps, market participants are certain of a further lowering to the benchmark rate that is already set at -0.40 percent. Further, the group is expected to restore quantitative easing (QE) having only ended the previous effort back in December and failing to wean appetite for extreme accommodation with another TLTRO (targeted long-term refinancing operation). This would represent a virtual ‘all-in’ upgrade to an already-extreme support effort and is likely aimed at surpassing the market’s expectations. Yet, it would be difficult to live up to such lofty forecasts – much less best them. The Euro has already pushed to a more-than two-year low against the US Dollar so is already pricing in a substantial dovish view. Yet, beyond besting or falling short of the market’s expectations for the Euro’s purposes, we start to get into potentially systemic matters.
    If the central bank does depress the accelerator fully, outgoing President Mario Draghi will leave incoming Christine Lagarde with few reasonable options left to navigate any further tumultuous waters that occur early in her term. Just this past week, she was attempting to sooth German officials skeptical of unorthodox policies such as negative rates saying she would investigate the costs more thoroughly alongside the presumed benefits. She remains a firm advocate of easy policy however. That said, regardless of her commitment to carrying on Draghi’s regime, the question of the market’s willingness to respond to the effort is far more important to the health and stability of markets moving forward. We are already seeing the ‘effectiveness’ of central banks’ efforts wane in more recent iterations, a dangerous scenario if we ever genuinely need their (the ECB and its peers) support to stave off a crisis. If the ECB earns its near-term relief, all will not be immediately fine. If the markets respond favorably, economists adjust for the ‘stimulus effect’ and the Euro drops; it will instantly catch the attention of US President Donald Trump. He already uses the European authority’s policy as evidence of what he considers manipulation to afford an artificial advantage in his regular badgering of the Federal Reserve. Chairman Powell and crew have weathered the accusations thus far, but the President is being pushed by the pressure of an economy weighed by trade wars. If the Fed doesn’t indicate its willingness to follow the ECB down, he is likely to take measures into his own hands to – perhaps inadvertently – start a currency war. 
    Brexit: All We Need Is More Time for a Pound Rebound 
    The British Pound mounted an impressive rally this past week – and with no technical time to spare. GBPUSD through Tuesday dove to levels not seen since the post-Brexit flash crash back in October 2016. In fact, sliding any further would have put this benchmark currency cross back to its lowest levels in over three decades – more than just a simple drift in contrasting value and much more a statement on the troubled view of the British currency. Yet, just as the markets were nervously eying the exchange rate for perspective on the British currency, a short-term relief rally kicked in Wednesday. Part of this pair’s performance has to be assigned to the Greenback which started to slip across the board. Nonetheless, the Pound was rallying universally and it had a very clear fundamental cue with which to anchor its performance.  Prime Minister Boris Johnson has been maneuvering these past weeks to ensure a ‘no deal’ option on Brexit be kept firmly in the mix in a bid to keep pressure on the EU to force concessions – if at all possible. Yet, his move to suspend Parliament for weeks before the official Brexit deadline on October 31st spurred new problems when his support from a razor thin majority in Parliament faltered. 
    Now, the two institutions – government and parliament – are jostling for position in chess-like moves and countermoves. There is still significant risk that the country leaves the Union without an agreement to offer some economic and financial access – especially with weekend reports that France has no interest in offer an extension to negotiations even if the UK requests as they believe there is little sign they will work towards a genuine compromise. That said, merely tempering the threat of high probability ‘no deal’ outcome can afford significant lift for the Sterling. While it is possible the currency can always drop lower given its own situation and the context of its global counterparts, it is generally pricing in the ‘worst case scenario’ of the known circumstances at present. While buying time would not reset its long-term course, it can bleed some of the aggressive, short-term (short side) speculation and inspire more of the optimists to be opportunists. 
    What Matters More to Fed: Consumer Inflation, Sentiment or the ECB 
    While this week will be topped by the ECB’s monetary policy decisions, the looming event scheduled for Wednesday the 18th will pull at global investors’ fears and anticipation. There is even more riding on the US central bank’s policy choices. Beyond the practical consideration that it is directing the world’s largest economy and financial system, Jerome Powell and crew are directing the pace of retreat from the most progressive effort to ‘normalize’ extreme policy among the major central banks. This reflects how far the world’s monetary policy authorities are willing to go in a bid to prop growth, which will contribute to risk trends; but it will also set the baseline for effectiveness/ineffectiveness of their collective efforts. With 200 basis points available to ease and a reduced balance sheet that can carry the sentiment-based impact of a rebound, there is reason to watch even the fine tune adjustments in expectations. With that attention, there will be considerable weight afforded to the interim event risk that could possibly alter the ultimate decision a week forward. Through this week, the most traditional measure to keep tabs on will be the market’s favorite inflation indicator, the consumer price index or CPI. If there is an allowance for the group to resort to policy that under normal circumstances would be labeled ‘extreme’, they would have to find it in the price measures of their dual mandate as employment trends are on a decade-long expansion. As it stands, the Chairman and minutes have projected inflation pressures to reach target levels through the medium-term – which would suggest they do not intend to meet the market’s (and Trump’s) demands for aggressive easing. 
    Another tangible event that isn’t part of the Fed’s official policy criteria but is of significance to the group’s forecasts and market’s divergent expectations is the University of Michigan’s consumer confidence survey. When the central bank says it is evaluating trends in employment and price growth through ‘the medium-term’, they are projecting out over the next two years on average. Of course, a lot goes into the change in these measures over that period, but few things are as informative of the outlook as sentiment surveys that state intention to alter course. Given the consumer is the backbone of the US economy and this particular survey has so many beneficial components – including measures like expectations for market performance – there is considerable influence in this indicator. Intention to reduce consumption, lower inflation expectations and fear of a financial retrenchment could sway the Fed to act ‘preemptively’. Now, even more untraditional but what may ultimately be the most important driver of US monetary policy moving forward is the actions of the ECB. Officially, the US central bank (and most of its largest counterparts) do not take into consideration external factors when making their own policies. In practice, the disparity in course of these major banks can lead to issues such as capital diversion. If the European authority cuts rates deeper into negative territory and restarts QE, further charge in the Dollar and market demand for US support to balance out the global spectrum could raise pricing risk to levels that trigger volatility and speculative fallout if the Fed doesn’t act. 
     
  16. JohnDFX
    Growth Takes Center Stage with Peoples’ Congress and OECD Forecasts 
    Most investors and traders attempt to project into the future in order to take advantage of large market moves before they are priced in and the trend potential is spent. That is perhaps the most basic precept of speculation, yet it also brings with it a range of collective cognitive biases. One such mass psychological distortion is a prioritization of the means over the ends. When looking back to the 2008 financial crisis, there is often specific reference to the US subprime housing market implosion while 2000 is referred to as the Dot-com bubble owing to the remarkable outperformance followed by decline of technology shares. Both situations were charged by excessive leverage and resulted in both financial and economic pain, but they are best remembered by their ‘touch off’ event. Why is that? As pattern recognition machines, humans want to avoid a repeat of a painful event from the past, but we don’t always bore down to the root of the problem – especially when the situation is complicated or inconvenient (such as chasing mature and fundamentally dubious trends). At present, we have a range of high-profile fundamental themes that could ease experience another flare up that coincides with the eventual turn of the markets (trade wars, monetary policy flub, fiscal policy flub, political crisis, diplomatic relationships breaking down, etc). 
    Yet, in a neutral market environment, all of these issues could be absorbed readily with little more than a brief injection of volatility. To see the market reverse course systemically, the fuel is more important than the ignition. As with most other periods of extravagant speculative reach – which have subsequently turned to collapse – we are dealing with an overabundance of leverage across the global economy. It doesn’t matter if we reference location (US, Europe, Asia) or participant segment (consumer, investor, businesses, governments), there is an exposure issue. As extensive as the risk may be, it doesn’t necessarily reach an obvious or quantitative level of critical mass whereby it collapses upon itself. As the saying goes: ‘the markets can remain irrational longer than you can stay solvent’. That said, recognition across the market that the ‘fundamentals’ are extremely divergent from the prevailing levels in the market will eventually trigger a cascading of hold out sentiment capsizing under the recognition. Arguably the most incontrovertible evidence that value does not align to speculative ambition are broad measures of economic health like GDP. We have absorbed most of the 4Q GDP readings from the US, Europe and Asia over the past month, and the general consensus is one earning clear caution. Of course, the period may prove a lull or a true turning point, but only time will bear that out. 
    Yet, the impatient, speculative nature of the market may dictate determination before the data has a chance to verify months after it occurs. More timely data and surveys are therefore consumed veraciously as market participants perform their qualitative or quantitative assessments. References to historical, market-based patterns (such as the yield curve) grow in popularity. All this said, there is still greater weight attributed to ‘official’ figures. In the week ahead, we have a few important updates that will represent ‘official’ benchmarks. For the trade war-racked Chinese economy, the effort to throttle a debt-fueled explosive expansion threatens to trigger an unwanted rapid economic slump. How genuine a risk is this from a country where data is just as regularly second guessed? Their own growth target provided in the official Peoples’ Congress is one of the most insightful measures we find from the world’s second largest economy. In the meantime, the developed world will see a more comprehensive update to its growth forecast from the OECD who will release its updated projections mid-week. The more sensitive the reaction to these data points, the more worried about basic growth the market is. 
    Monetary Policy and a Possible Repeat of History for the ECB
    The world’s largest central banks have taken a noticeably dovish shift over the past year. Many were unnerved by the disruption in global markets through the first half of 2018, but the second extreme bout of volatility in the fourth quarter and subsequent downturn in the economy in that same period has pulled most holdouts into the same camp. In recovery that unfolded after the Great Financial Crisis, monetary policy authorities played a critical role in fostering the revival of investor sentiment and economic stability. Yet, their efforts over the past five, where the more extreme expressions of monetary policy hit their stride, resulted in far less productive economic return (inflation and growth). Not official objective, but nevertheless a sought-after result, additional waves of stimulus have also seen progressively less appreciation for local capital markets (targeting a ‘trickle down wealth effect’) and even a disconnect from forcing a trade-supporting depreciation in currencies. While in previous years this was not a mainstream topic of conversation as the impact was nuanced and there were supporting factors concealing the erosion of efficacy, it is now a glaring disconnect that the market is instantly wary of should reliance of economic health shift back onto the banks’ shoulders. 
    This may be a trial that we are not able to avoid as the global economy sputters and the world’s governments’ show little interest or capacity to collaborate on a scalable solution. Thus far, most of the movement towards a more accommodative monetary policy position – from the already ‘crisis’-level setting for most – has been verbal. However, action may soon be on the way. Swaps are pricing in modest probabilities of rate cuts from the Fed and RBNZ with the RBA sporting a high probability while the Bank of Japan continues to inject stimulus with reckless abandon. The most overt signal to the global financial system that central banks have lost control would come from the European Central Bank should it decide to act. The group has just capped its progressive easing effort as of December and it finds itself already at the extreme with negative rates along with a massive balance sheet. Unlike the Fed, the ECB hasn’t given itself enough time to reestablish a buffer to employ further support should push come to shove. That said, the group has started to signal growing caution and seems to be testing the market’s reaction with thinly veiled suggestions of another policy adjustment. 
    Despite this, going back to the QE program is not an option while further rate cuts deeper into negative territory would only prove the current settings are ineffective. Another tool has come back into the conversation from the Eurozone debt crisis days: LTROs. While not the same stigma as quantitative easing, it is nevertheless a tool looking to do the same thing – coax along stubborn economic recovery. The last time this central bank connected policy to economic trouble (at the time, it said the interest was deflation sustained by a too-strong currency), the side effect was an incredible 3,500 pip slide in EURUSD. If even a portion of that depreciation were realized today, the competitive trade environment would almost certainly trigger a currency war. And, in this environment, that would almost assuredly result in a stalled global economy and financial crisis. 
    There is More to Trading Than Spotting Explosive Breakouts and Trends 
    This is something I have written on before, but it is so important that it bears repetition. There is more to trading than spotting fantastic breakouts or riding enormous trends. These are the kind of market developments that can result into large profits if properly navigated, and the former tends to render those large returns more quickly. Large returns in a short timeframe is what every market participant is looking for, but these events are statistically infrequent and require considerable discipline to exploit. So, those seeking these conditions are projecting improbable regularity and they more-often-than-not do not have the experience to properly pilot. That is not a successful strategy. 
    In contrast, range or congestion-based markets are historically the most common environment. Further, the shortened time frame of market moves, the greater compliance to technicals and a more forgiving connection to fundamentals (events and themes) makes for a backdrop that is far more aligned to the average traders’ tendencies. So, why do so few traders look to take advantage of these conditions? There are a multitude of reasons but among the most common are an unrealistic appetite for extreme returns in a very short time frame as well as a misconception of what successful investors are (everyone wants to be the hedge fund manager that makes an incredible account doubling return on one trade). 
    This digs not into the conditions of the market or even strategy in particular but rather it speaks to trader psychology. If we can change our objective to more timely trades with reasonable objectives that lead to respectable returns over time, we will naturally align ourselves to more readily take advantage of the market. Now, this is not to say that we are always navigating a range-based market – only that such settings are the most common. The most prepared market participant is the one that has a different strategy or adaptations of a single strategy that are more appropriately attuned to range, breakout and trend environments. Of course we also need the tools to assess which setting is currently on display. 
  17. JohnDFX
    Just When You Think Trade Wars Can’t Grow More Extreme…
    The last we left global trade wars heading into the close Friday July 13th (the week before last), the situation was already firmly planted in worrying escalation with little sign of relief in the sidelines of diplomacy and political cheerleading. The United States was still applying its metals tariffs against competitors and colleagues alike, the $34 billion intellectual property oriented tariffs were in place against China (not to mention China’s retaliation upon the US), and threats of a massive escalation by the Trump administration to the tune of $200 billion in import duties on China and a 20 percent tax on all imported European autos was still hanging in the air. It would seem near-impossible to inflame the situation further than that.
    And yet, they have found a way. Looking to truly turn the screws in the face of retaliatory threats by China and WTO complaints, the US President warned Friday (and his Treasury Secretary echoed Saturday at the G20 meeting) that they could introduce tax on all of China’s imports – amounting to more than $500 billion. Normally, we would assume these are mere threats meant to prompt compromise out of shock, but this has been a threat issued and executed upon too frequently. While this just seems a self-defeating game of chicken where all participants suffer economically, there is certainly a strategy to this effort.
    There are hints of Eco Adviser Kudlow and National Security Adviser Bolton in this effort; but it should be said that regardless of what their intent may be, the outcome is likely to hasten an inevitable turn in the global economy and financial markets – whether they relent last minute or not. Ahead, there are two important meetings scheduled for trade talks: President Trump is due to meet the EU’s Juncker and Malmstrom Wednesday while the US Trade Representative is set to talk trade with the Mexican Economy Minister on Thursday. Good luck to us all. Watch my weekend Trade Video to see more in this topic. 
    Is President Trump’s Dollar, Euro and Yuan Comments Pretense to a Currency War?
    This past Thursday, President Trump sent the Dollar reeling after he weighed in on the path of higher rates and the level of the Dollar. With a background in real estate (and thereby debt financing), he lamented the Fed’s gradual pace of monetary policy tightening amid the trade wars his administration had pressed and the growing debt financing the country was facing – again increased with the recent tax cuts. He said the rates and currency rise that followed made other efforts the government was pursuing more difficult and ultimately made the US uncompetitive. The White House later moved to clarify that the President was not questioning the Fed’s independence or competence, but he would take to Twitter to double down on his remarks Friday.
    A perception that the Dollar is low and claims that the Yuan and Euro are being lowered by their respective policy authorities looks suspiciously like pretext for starting a currency war. When it comes to the Chinese currency, there is little doubt that policy officials have a hand in its performance; but that is more and more likely a measure to dampen volatility rather than wholesale steer. Officials pointed to the rapid drop in the Yuan these past few months as evidence, but wouldn’t such a move arise if the trade war were having the intended effect? In fact China has shown over the past few years that too sharp a decline in the local currency was reason enough to step in and bid the CNH so as to curb fear of a capital flight.
    As for the Euro, there is little ground in their claims of manipulation now as monetary policy efforts have disconnected from exchange rate movement – though had they made this accusation back in 2014, I would have agreed. Whether this claim is just rising out of the blue or indicates a strategy, it should truly concern us. Currency wars do not end well for anyone, they are more likely to trigger a fast-tracked financial crisis and it can be yet another systemic risk that sees the Dollar permanently lose status as the world’s dominant currency long term. 
    Evaluating How the ECB Rate Decision and US GDP Will Hit the Markets
    It is clear that the week ahead will find its market winds determined by themes (trade wars, currency wars and perhaps even systemic risk trends). However, there are high profile events scheduled that will certainly carry important fundamental weight for the big picture evaluation – even if they don’t trigger the same definitive direction and short-term volatility that have in the past. That said, fundamentals must be evaluated as a hierarchy: the most pressing theme to the largest swath of the market will more decisively define the market’s bearings (whether higher, lower or sideways).
    This in mind, two particular events should be watched closely whether they overcome the gravity of trade wars or not. Thursday’s ECB rate decision is very important. Over the previous meetings, there has been heavy speculation that the central bank is heading into an eventual and inevitable turn from its extremely dovish policy path with rhetoric clearly setting the stage. Speculation around this eventual hike has led to remarkable lift for the Euro even when the anticipation for the first move was 12 to 18 months ahead (as was the case throughout 2017). Yet, recent developments will make this policy gathering even more important. Will the central bank take into consideration the accusations by President Trump that it is fostering exchange rate manipulation? Will concern over trade wars’ curbing economic and financial health show through?
    As for the US GDP reading on Friday, we will see the general health of the world’s largest economy as trade wars started to go into effect and the tax cuts hit full stride. A weak showing here could add considerable fear to the already existing concern that retaliations to tariffs could tip the US economy into correction and reinforce reports that the tax cuts had little effect on US consumption through the middle and lower class American households. Context will definitely paint these events, but that doesn’t diminish their relevance at all. 
  18. JohnDFX
    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. 
  19. JohnDFX
    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. 
    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. 
    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. 
    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). 
  20. JohnDFX
    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.
  21. JohnDFX
    And Now, the Fed
    The market has monetary policy on its mind heading into the new trading week thanks to the actions of the European Central Bank (ECB) this past Thursday. One of the world’s largest central banks, the group is making a bid – perhaps unintentional and perhaps not – to be the most accommodative group of its size. Already sporting a negative rate, a large balance sheet and a T-LTRO program; President Draghi steered his team back into an expansionary phase of dovishness despite his retiring in a few months. Testament to their forward guidance efforts, the market largely expected the 10 basis point cut to its discount rate (to -0.50 percent), the restart of quantitative easing or QE (20 billion Euros per month starting Nov 1) and the introduction of tiered lending aimed at helping banks struggling with profitability. In fact, the move was so thoroughly baked in that the Euro’s initial tumble reversed to gains and capital markets seemed little charged after the effort was made official. On the one hand, the ECB will be happy that it avoided triggering a volatility event which could create more difficult conditions to support moving forward. Alternatively, there is more than a little ‘wealth effect’ assumption to the transmission of current monetary policy. Underwhelming response from the markets could signal monetary policy is reaching the limits of its effectiveness. That is the unpredictable scene we are met with as we approach the Fed’s policy event.
    The Federal Reserve’s policy event is scheduled for Wednesday at 18:00 GMT. Even putting aside the existential crisis traders are facing with the concept that monetary policy may be losing its effectiveness, this was due to be an important meeting. September’s meeting represents one of the ‘quarterly’ events whereby we are due the Summary of Economic Projections. That includes the updated forecasts for interest rates that the markets watch so closely. Even more pressing with this particular meeting, is the question as to whether the Fed will follow up with its first rate cut in a decade this past July. After that meeting, Chairman Powell said the move was a ‘midcycle adjustment’, a phrase repeated in the official perspective of the group in the meeting minutes. That would insinuate that the next reduction – if there would be one – depends heavily on data. As it happens, recent jobs figures weren’t gangbusters but the trend is still the best in decades. Further, core inflation registered by the CPI was accelerating above target. These are not the developments that would signal easing is urgently necessary. Nonetheless, we are facing a serious difference of opinion on the subject with the market still pricing in a robust 80 percent probability of a rate cut  - though down from certainty just a week ago. Does the Fed dare disappoint the market and trigger capital market fear that will in turn necessitate central  bank support later regardless or will it cut despite its explicit remarks that it was unnecessary and tarnish its credibility?
    Many market participants – especially those that have benefit from the zombie-like complacency bid these past years – would advise protecting market gains to avert any speculative slump that can make more tangible the economic pain. Yet, the long-term risks of satisfying risk takers can be severe and irreparable damage to credibility and ultimately an inability to fight serious fires in the future. The global market is struggling under trade wars and the natural flagging of the economic cycle. There is certainly appetite for the world’s most hawkish, large central bank to make a more consistent distribution of support, but satisfying these appetites would only draw attention to the state of dependency growth and market performance attached to stimulus and negative rates – not to mention dissuades fiscal powers from taking on the responsibility themselves. If the Fed refuses to act and there is investor fallout globally, those central banks already all-in will find their own credibility razed to the ground. A lot rides on the Fed, and not just for the Dollar or Dow. 
    Good Will and Rumors of Economic Pressure Points in Trade Wars 
    There is an unmistakable enthusiasm around the state of the US-China trade war over these past two weeks. It started slowly enough with the suggestion that the two sides would return to the negotiation table in earnest early next month with leaders from each camp suggesting they were optimistic. As far as inspiration goes, that doesn’t even rank as a far-fetched cue for optimism. We have seen far too many slow starts of this exact type flame out and ultimately result in a worsening of relations between the two. Thankfully, there were more tangible efforts of good will to build momentum upon. China announced that it was waiving tariffs on 16 US imports that were previously taxed – the first such course reversal since the trade war began. Despite the relative minimal move, the US responded by announcing that it would delay the increase of tariffs on $250 billion in Chinese imports from 25 to 30 percent by two weeks, pushing it from October 1st to the 15th. Looking to surpassing that frequent trip point after the first round, China then followed up with the announcement that it would exempt US pork and soybeans from tax at the ports. 
    This is indeed tangible progress, but recall that the higher level officials are not due to meet until early October. Further, there have been frequent false dawns whereby the absence of a compromise has not resulted in status quo but rather an escalation.  Nonetheless, there is clear evidence that both sides are interested in boosting market sentiment – such good will reciprocation would never have occurred previously as each would have deemed it an overdue step by the liable party. For China’s part, it is concerned about the state of its local economy and financial system already under significant pressure. In the US, the Presidential elections are over a year away, but the campaign is already starting; and the rising fear of recession is posing a serious problem for Donald Trump. Fully reversing the trade war actions and striking a trade agreement would take serious time and capitulation from states and personalities not commonly known to ‘surrender’. It is still possible however. The real question we should ask though is: will the lifting of trade wars recharge growth or investment appetites? The absence of a ballooning crisis is not the same thing as seeding GDP or returns. Trade wars have taxed an already threadbare global economy while highlighting the dependency on external sources of support like central banks simply to keep the masquerade going.  It is not a good point in time to look at markets through rose colored glasses.
    Repeated Accusations of Currency Manipulation Will Spur a Currency War
    There were a number of skeptics of the value added and intent from the ECB’s decision to escalate the support this past week – including some of the key bank members themselves. However, one person’s criticism that was fully expected as they took their rates deeper into negative territory and announced the restart of the QE program was US President Donald Trump. He has reflected on their efforts more often these past months as a platform to critique the Federal Reserve. Rather than decry their efforts as purely manipulative in a bid to earn growth at the expense of more virtuous trade partners, he has held their course up as a template for which the Fed is falling behind on. His berating of Chairman Powell has been relentless, but the haranguing hasn’t changed the central bank’s course – well, not as much as intended considering the President’s policy mix has weighed markets which the Fed is less capable over ignoring. At what point will a President frustrated by slowing growth and a central bank that is unwilling to supplement for the pain the trade war is causing – and ultimately incapable of holding back any serious collapse in economy – decide to take exchange rates as a tool into his own hands? 
    The ECB’s moves will raise his ire, but the rebound in the currency will frustrated his claims that they are principally a move to devalue the currency. Such details haven’t held him back before however. With the Dollar holding near two-year highs with Euro, Yen and Yuan at the very lease employing serious policies that have at least a secondary result of FX depreciation; this will stand out as a genuine option in the event of emergency (a fading campaign in the face of economic struggle). Adding to the pressure, the Swiss National Bank (SNB) and Bank of Japan (BOJ) will likely hit upon the POTUS’s radar in the week ahead. Both are due to deliver policy updates. The SNB is not expected to cut rates further, but it is already hovering at a -0.75 percent rate and attempts to simply keep pace with the ECB so as not to allow EURCHF to drop. Meanwhile, the BOJ is similarly expected to hold course, but recently its officials have stated they were looking into the option of plumbing negative rates in a bid to finally earn the policy response they have failed to render thus far through a dovish mix anchored by an open-ended stimulus program. 
  22. JohnDFX
    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. 
    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 
    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. 
    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. 
  23. JohnDFX
    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.  
  24. JohnDFX
    Opening Week Liquidity – We are heading into the first trading days of the new year 
    though it is not the first full trading week of 2020. That is an important distinction for those keeping tabs. Consider the throttling in activity and speculative appetite through the past week. The holiday conditions of the Western World drained market depth to effectively hobble any effort at establishing or extending trends – though there were a few notable sparks of volatility that were the result of the same illiquid backdrop. That is going to be even more pronounced in the week ahead. New Years is a bank holiday for virtually the entire financial system. That will make conviction even more difficult to muster. When trend development (momentum) and follow through on breakouts is difficult to muster, my default is typically to filter for opportunities that are more convincing range trades. However, the shallow markets will make volatility even more a complication to probability-based trading than normal. For anyone with less than a high level of risk tolerance, it may be better to sit on the sidelines until the follow week restores markets in earnest.
    Though market conditions are unusual this week, that doesn’t mean that there is an equivalent lack of technical or fundamental event risk. Consider the Dollar for example. The benchmark currency is on the verge of a reversal to a more-than 18-month bullish trend channel that also sports the most remarkable restraint in terms of activity level (ATR) seen on record. At the other end of the spectrum, you have the US indices which have pushed to record highs both through periods of low and high liquidity. On the fundamental side, there are a number of scheduled events that should register. Proxy growth readings are on tap for the largest economies with the run of Chinese government PMIs and the ISM’s US manufacturing report both due. The former is an overview of a country being pushed on too many sides and the latter reflects an actual recession in factory activity (not an isolated malady for the US). Manufacturing reports for other countries, the FOMC minutes, US trade report and a range of auto sector reports will also register on my radar. However, a more systemic matter to keep in mind is China’s plan to lift a range of tariffs on a host of global counterparts starting on January 1st – though this list does not include the US. Is this a shift towards more growth-supporting open trade or does it end up adding to the provocation with the US? 
    Top Events for January
    Looking further ahead to the first full month of 2020, there is the regular density of high-level event risk across global powerhouses in both the developed and emerging market worlds. That said, I will keep my attention more actively directed towards systemic themes whose threat has posed serious threat to the long-disputed stability of a ten-plus year bull market. The most representative matter seems to be trade-related concern. Beyond China’s plans to lift tariffs against a range of counterparts this week, we should keep a close tab on release of details on the Phase 1 trade deal. Both sides have hailed their compromise since October yet we are still critically lacking for the practical terms that will usher us to a full de-escalation of economic tensions between the two largest players on the board. According to US Treasury Secretary Mnuchin, the two may sign early January. 
    Trade issues aren’t unique to the US and China relationship. There are a number of active import taxes between the US and Europe at present. The US quickly slapped tariffs on certain provocative European imports (particular agricultural goods) after the WTO ruled this past year that the country could pursue over $7 billion in restitution for unfair subsidies afforded to Airbus. After a ruling earlier this month that the EU has still not lifted support for the airplane manufacturer, the US said it would consider escalating its effort. That decision could come in January. To add further complication, the WTO may deliver its decision on the US’s support of Boeing which could greenlight European tariffs which they would likely pursue wholeheartedly. Further, we are also waiting for the US to follow through on stated plans of retaliation for France’s digital tax that is raising cost to large US tech companies. Yet another front on trade to mind is the Senate’s decision to take up the USMCA agreement which could finally write off the replacement of NAFTA for a clear North American relationship – the first true resolution (for better or worse) of trade disputes. And of course, lest we forget, the extension of the Brexit decision expires on January 31st which is expected to see the previously struck withdrawal agreement push through after the conservative’s victory in the general election three weeks ago. 
    The two other prominent themes that I’ve been following through 2019 find far less top level event risk to trigger provocation – though they can hardly be written off. Recession fears have notably abated since the US and China revived their confidence on the Phase 1 deal. That said, the quality of growth-related data has not improved materially, rather the interpretation of the same data has taken a more notable optimism. That could quickly fade by seeing capital market performance stagger. The markets are indeed that fickle and superficial. As for the effectiveness of monetary policy, there is one particular rate decision that is on my board: the January 29th FOMC rate decision. After reviewing its objectives through this past year, the world’s largest central bank is due to offer its assessment of what may need to change in its targets and policies. Depending on the mood of the market, this could be readily interpreted as evidence that monetary policy has lost its potency – and perhaps even its ability to maintain calm and buoyant asset prices, which would be a disaster if ever realized. 
    Top Events for 2020 
    In the scope of an entire year, many fundamental developments will transpire that take control of both volatility and direction regionally and globally. Through that 12-month span, many of the most meaningful drivers are likely to be completely off the script that we have in scheduled events that we start off with in January. These developments that are related to generally known themes and carrying a significant level of impact can fit into the category of ‘grey swans’. Most are familiar with term ‘black swans’ which refers to extreme developments that were largely unexpected by the vast majority of market participants – and which are readily interpreted and retroactively explained to have been ’obvious’ after the fire is put out and the dust settles. We cannot reasonably speculate and trade around black swans because their extremely low probability makes for very bad trading statistics and worse timing. Grey swans on the other hand are far more reasonable. 
    Through all the open-ended matters, there are a few particular matters with rough scheduling that I will watch as inordinately influential on local currencies and capital markets. The first is the Brexit transition deadline. According to the original timeline for transitioning from member of the Union to independent country with trade relations aligned with EU members, the situation should be wrapped up by end of December 2020. After the delays in agreement to the exit, it would be expected that there also be an extension requested of the transition – a period for which the UK would still be beholden to some unfavorable European laws. However, Prime Minister Johnson suggested after the election that he would attempt to make a request for extension illegal. This is a decision that is far out, but its impact will be felt constantly with interpretations of remarks and negotiation updates, with sudden spells of volatility and proactive restraint in progress for the Sterling. Another matter that is well accounted for is the state of the US-China trade war. Taking the optimistic interpretation and say Phase 1 is finally signed off on by all those that hold sway, we still need to move to Phase 2 which is the real heavy lifting. A demand of full tariff roll back by China and the US requiring committed purchases along with intellectual property protections are difficult to come to terms on. Will they accelerate progress to ward off an unintended recession or will China wait until after the US election before it takes the cost-benefit seriously? 
    Speaking of the US election, this event will likely prove a global event with considerable build up in capital market performance. Generally speaking, the market is agnostic to party, however, the influence of protectionism amid populism that has taken hold in different regions of the world are difficult to miss at this point. Trade wars – at least in their present form – are a direct result of the ruling parties’ policy mix. What’s more in the US, the extreme bifurcation in political norms has created a familiar state of gridlock when it comes to pushing growth-supporting initiatives like the infrastructure investment fiscal stimulus that was part of the 2016 campaign trail while government shutdowns are a near constant threat as the deficit balloons to record highs. These are serious matters, but the market can decide to play the risks down as they have in the past. Yet, with a prominent election ahead, I suspect these matters will draw far more attention in 2020.
  25. JohnDFX
    A G20 Meeting of Extreme Consequence
    As far as summits for leaders of the world’s largest economies go – in other words, an already very important affair – the gathering in Argentina this coming Friday and Saturday is crucial. There are a host of global conflicts that will inevitably be addressed at this gathering, but certain aspects will preoccupy the market’s immediate focus. It will be important to recognize what will carry the weight of speculative interest. On the one hand, there are discussion points of great consequence socially and culturally, but those issues will not show their economic consequences much latter and therefore will be largely ignored but for niche corners of the market. An example of this type of discussion point is climate change which has taken on greater importance with countries pleading with the US following its withdrawal from the Paris Accord and the strong of recent, dire scientific reports. In contrast, trade wars, is an ongoing threat to global economic and financial health inevitably drawing an inordinate amount of attention from market participants. 
    Of course, the elephant in the room will be US President Donald Trump who has pushed ahead with the most consequential conflicts on international trade. There will inevitably be numerous pleas made to the leader of the free world to rethink his aggressive approach towards peers. That said, he likely has little interest to hear out there concerns. The mid-term election results will likely redouble his commitment to his current course. To be fair, nearly any outcome would have rendered such a result. Had the GOP swept the polls, it would have been taken as America showing its support. Yet with the outcome that was realized, there is a greater interest in pursuing those courses of action for which he can affect change without the of a divided Congress. And trade is just one such outlet. Alternatively, finding a course out of a discounted crisis could be registered as a political win – though what it would earn for the US markets is another matter. Avoiding a crisis (some would argue one self-manufactured) is not the same as inspiring genuine enthusiasm and speculative run. 
    In particular, this summit should be watched for official and sideline commentary from the US-China discussions. Leaders of the two countries (Trump and Xi) are scheduled to discuss trade at the summit providing an ideal high-level opportunity to afford each an opportunity to claim a political victory. If they change decide to reverse course, it could offer considerable speculative relief and perhaps no small amount of recovery. This could very well be the strategy as Trump has voiced increasingly confident views of the relationship these past weeks that have been walked back by his administration – perhaps to build pressure. If we do see these two countries make nice and start the path towards recovery, yet markets do not translate the news into recovery, I would be concerned about what it reflects for sentiment. Alternatively, no encouraging course correction would be a ‘status quo’ outcome and keep our troubled outlook on its wary course. If the politicians involved want, they can render this event an obfuscated non-mover even without an official communique. Yet, subtly seems less and less standard a virtue of late. 
    Liquidity Restored, Seasonality Conditions and Key Events
    The liquidity tide will roll back in over the coming week. As expected, the drain of US speculative interest this past week due to the Thanksgiving holiday played an effective role in sidelining a concerted effort to mount a system-wide advance or retreat in risk trends. However, the period didn’t end without its troubling signals for the future. The S&P 500 closed a thin Friday trade session with one of the least encouraging candles possible – a gap lower, larger ‘upper wick’, no ‘body’ between open and close and anchored to a noteworthy trendline support. The losses leading up to the US holiday reiterate a troubling frequency of painful losses for the benchmark US indices this year. What’s more, it serves to remind us of the fact that many other corners of the financial system – both in terms of region and asset type – have already trekked much lower. A retreat in US equities would be a general convergence towards significantly weaker global if that were the course that we took. 
    Yet, there is still the natural hold out for seasonal mood disorder – otherwise assumed to be a holiday rally. There is good statistical data to give weight to such expectations but of course there are exceptions to this norm. And, if there were ever a time to worry about a passive climb in speculative positioning, it would be amid a wealth of overlapping and systemic financial risks. From trade wars to the collapse of ineffective monetary policy regimes to growing evidence of excessive leverage (loans, debt, investor exposure), we are dealing with a potentially-toxic environment. As more factions in the global markets recognize the precarious environment for which we are exposed, there is greater threat to fragile stability in key event risk. There is a range of key global events and data due over the coming week.
    In the US, the Fed’s favorite inflation reading (the PCE deflator) will work with the FOMC minutes and Fed speak to set expectations for rate hikes in December and the pace in 2019 which have already suffered in recent weeks. In Europe, the Euro-area sentiment surveys and BoE’s financial stability report will anchor the focus on the region’s quickly fading sense of stability. Chinese and Japanese PMIs will give good proxy for recent GDP in Asia while actual quarterly updates are due from Brazil and India. Now is not a good time to embrace the comfortable warmth of complacency. 
    As the Clock Winds Down for a Brexit Deal, Events Look More Ominous
    There have been a number of notable reversals in fortune for UK Prime Minister Theresa May and the course of the Brexit deal over the past month. And, with each successive ‘breakthrough’ the market has hardened its skepticism over the authenticity of a favorable path for the country’s divorce. We will see just how cynical the speculative rank and general public are at the start of this new active trading week. Over the weekend, May attended the EU27’s summit to discuss the Brexit proposal backed by the Prime Minister. European Council President Donald Tusk announced on twitter that the collective supported the bill, but enthusiasm was held in check with both lawmakers and observers alike. Top EU negotiators reportedly met May on common ground the week before, and the effort was ultimately doomed owing to PM’s own cabinet failing to offer up necessary support to move the effort forward. After the shakeup forced by the resignations of multiple cabinet members, there is little to suggest that she will have any easier a time of navigating the straights. 
    In a few weeks, Parliament will put the deal to a vote; and confidence amongst its members has been shaky at best. Some – even key members to the Prime Minister’s support network – have suggested the current proposal would be not make it through. Should the deal be voted down, the clock will look beyond dangerous to the safe and stable withdrawal for the UK. At that point, May could stick it out and attempt to return with small tweaks latter which may not sway her government or will be too substantial and knock out the EU’s support. That would leave little-to-no time to earn agreement from all parties and scramble to get the passage approval with all governments along with the technical groundwork to set the dissolved relationship up for the March 29th cutoff. Either this course or an explicit refusal to back down on key items can push forward a ‘no deal’ outcome which Parliament has said it will rule against on – though it is not clear what the course will be from that point with so very little time left. 
    There are also a variety of possible courses that end with May be ousted: from her offering up resignation, being pushed out by backbenchers, Labour mustering enough weight to force an election or the PM calling a general election herself in an attempt to gain support. All of these would burn precious time that they negotiations do not have. And, then there is the outlier chance that Theresa May finally entertains the idea of a second referendum which she has adamantly rejected so many times before. That would stop the clock if it were to end with a vote against Brexit or perhaps be used to strategically reset the clock. Whatever course we take, the clock has dwindled and all developments that are genuine progress register as a step to serious pain. 

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