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JohnDFX

DFX Market Analyst
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Blog Entries posted by JohnDFX

  1. JohnDFX
    This blog post is to update everyone of the themes that DailyFX expects to focus on in the week ahead. Given the focus of previous weeks, the backdrop market conditions and the event risk ahead; the three topics below will be particularly important in our coverage. 

    Risk trends amid trade wars
    If you somehow were in doubt that trade wars were already underway, the enactment of reciprocal $34 billion tariffs by the United States and China on each other this past week should banish that disbelief. For much of the world, the score is one whereby the US has triggered an opening import tax on the  world’s second largest economy for what it perceives as intellectual property theft, and China has retaliated in kind.
    From the Trump administration’s perspective, the actions are a long overdue move to balance decades of unfair trade practices. Both feel they are reacting rather than instigating which gives both sides a sense of righteousness that can sustain escalating reprisals. Yet, as discussed previously, this is not the first move in the economic engagement. The United States’ metals tariffs was the first outright move that came without the pretense of operating through WTO channels. And, in a speculative market where the future is factored into current market price; the unilateral and extraordinary threats should be considered the actual start.
    The anticipation of a curb on global growth and capital flow very likely was a contributing factor to the stalled speculative reach and increased volatility over the past three months. Yet, markets have not collapsed under the fear of an economic stall with values pushing unreasonable heights. Perhaps this market simply needs to see the actual evidence of fallout before it starts moving to protect itself. This past week, the midnight cue for the tariffs notably didn’t send capital markets stumbling. In fact, the major US indices all advanced through Friday’s session. Blissful ignorance can last for ‘a little longer’, but blatant disregard for overt risks on a further reach for yield is hoping for too much.
     
    A Brexit breakthrough…to the next obstacle
    Heading into a full cabinet meeting this past Friday, headlines leveraged serious worries that UK Prime Minister Theresa May would find herself moving further into a corner on a split Brexit view from which she would no longer be able to escape a confidence vote checkmate. Yet, the reported rebel ministers that were pushing for a more stringent position on trade and market access in the divorce procedures seemingly relented.
    May was free to pursue a ‘free trade area for goods’ with close customs ties (though bank access would be restricted somewhat). From the market’s perspective, this is a tangible improvement in the general situation as it removes at least one level of ambiguity in a very complicated web. The foundation of ‘risk’ – as I’m fond to reiterate – is the uncertainty of future returns. If your investment is 95% likely to yield a given return, there is little risk involved. On the other hand, if that return is only 10% (regardless of how large it may be) there is a high risk associated. The same evaluation of this amorphous event applies.
    With the UK government on the same page in its return to the negotiation table, there is measurably less uncertainty. That said, this was only an agreement from one side of the discussion; and the EU has little incentive to give particularly favorable terms which would encourage other members to start their own withdrawal procedures. Furthermore, there is still a considerable range of issues for which the government and parliament are still at odds. If you are interested in the Pound, consider what is feasible for any bullish exposure with the cloud cover of uncertainty edging down from 100% to 90%.

    Fed monetary policy can only disappoint from here
    We don’t have a FOMC meeting scheduled for this coming week; but in some ways, what is on the docket may have greater sway over monetary policy speculation. The US central bank has maintained a policy of extreme transparency, going so far as to nourish speculation for rate hikes through their own forecasts and falling just short of pre-committing. They cannot pre-commit to a definitive path for policy because they must maintain the ability to respond to sudden changes in the economic and financial backdrop. And, making a sudden change from a vowed move will trigger the exact volatility the policy authority is committed to avoiding.
    Yet, how significant is the difference between an explicit vow on future monetary policy and a very heavy allusion in an effort at ‘transparency’. The markets adapt to the availability of evidence for our course and fill in with whatever gaps there are with speculation. This level of openness by the Fed sets a dangerous level of certainty in the markets. With that said, what is the course that we could feasibly take from here? Is it probable that the rate forecast continues to rise from here – further broadening the gap between the Fed and other central banks?
    That is what is likely necessary to earn the Dollar or US equities greater relative value given its current favorable standing isn’t earning further gains. More likely, the outlook for the Fed will cool whether that be due to the US closing in on its perceived neutral rate, economic conditions cooling amid trade wars or the increasing volatility of the financial markets jeopardizing onerous yields. Where the Dollar may have underperformed given the Fed’s policy drive in 2017, it still carries a premium which can deflate as their outlook fades. This puts the upcoming June US CPI reading and the Fed’s monetary policy update for Congress in a different light. All of this said, this is not the only fundamental theme at play when it comes to the Dollar. There is trade wars, reserve diversification and general risk trends. Interestingly enough, all of those carry the same skew when it comes to the potential for impact.
     
    Any questions, just ask.
    John Kicklighter
  2. JohnDFX
    Trade War Relief, But How Much?
    Finally, some trade war respite. Or at least, what looks like relief. Following week after week of steadily escalating threats and a few decisive actions (and retaliations) along the way, there was finally a joint statement of agreement between key global leaders. Following their meeting in Washington DC, US President Donald Trump and European Union President Jean Claude-Juncker issued a statement of success this past Wednesday. Any pause in this quickly ballooning threat to the global economic and financial order is welcome, but that doesn’t mean we should accept the event at face value.
    Did this summit result in a legitimate course correction for the growing destructive force was the press conference a political event designed to allow both leaders to claim a victory for their constituents? To evaluate that, we need to consider the terms. There was a commitment made by the EU to purchase more US-produced soybeans and natural gas. That seems encouraging at first blush, but pressing individual members to increase consumption is not reasonable. Vows to continue working towards solutions to the metals tariffs and avoiding tax on autos along with the suggestion that  they would work together towards ‘zero tariffs’ is likely more enthusiasm than a plan of action. Not everything was a means to score political point. The agreement not to introduce new tariffs so long as they were negotiating is material as it curbs fear of an impending 20 percent tariff on European autos by the US and the $300 billion retaliation threatened by the EU. This glad-handing may be lacking for tangible action, but it can help curb fears of imminent escalation.
    That said, general capital market benchmarks – such as US equity indices – seemed little perturbed by actual progress in the economic fight these past few months. Let’s hope that aloofness and the fresh optimism holds moving forward, because this theme has not likely hit its crest. The largest threats have been made by the US against China. The Trump administration is likely putting tension on other fronts besides China as a means to amplify the leverage on this economic powerhouse. When the US eases back against developed world counterparts like EU, perhaps they expect those countries to ingratiate themselves to the US and head off critique for their handling of relationships with China. Don’t expect trade wars to truly be on the decline – much less resolved – with last week’s developments.
    Fed, BoE and BoJ Rate Decisions for Individual and Collective Influence
    The ECB rate decision this past week didn’t earn the Euro much in the way of productive volatility. Compare that to the speculation it drove – much to the central bank’s chagrin – throughout 2017. For many traders, that makes it an event to disregard. However, market participants would be wise to keep tabs on these fundamental themes for both their longer term influence on the target currency over the coming weeks and months; but it is arguably even more important to account for such events collective sway over more systemic matters like the inextricable link between global monetary policy and risk trends. It would be wise to consider these larger concerns through the week ahead as we wade into a run of central bank decisions.
    On tap, we have five large central bank rate decision, but only three of them are ‘majors’. The greatest weight will be hefted by the Federal Reserve. In monetary policy terms, everything about this meeting will be well fleshed out by speculators. Through exceptionally transparent forward guidance, we know the group expects to hike four times this year and that they have operated ‘on the quarters’. This meeting is out of sync for that trend. The real interest is the language used to either maintain path to a September rate hike or to start pulling back from it. Furthermore, there will be some degree of interest to see if the Fed replies to the President’s critique of policy and the currency – though that may be more appropriate for individual members’ reflections. Meanwhile, the Bank of England’s (BoE) Super Thursday meeting is expected to deliver a hike (77% chance according to swaps) and the Quarterly Inflation report. This is the most action-oriented event, but it will compete with Brexit for Sterling momentum and scaling up to global risk trends is not something this group’s policies have been capable of in this cycle.
    Finally, the Bank of Japan will no doubt keep its rates in place and the size of its stimulus program untouched. However, last week, reports surfaced that the group was discussing changing its stimulus approach to make it more ‘sustainable’. It is unclear exactly what that would entail, but given they are already at an extreme, it was read as a ‘hawkish’ shift. While these events can generate movement in their own currencies and local capital markets, do not underestimate the malleability of global risk trends under monetary policy. Years of excessive (extended well beyond the needs to stabilize growth and past the point of proving it would not readily translate into desired inflation) monetary policy has inflated market levels. It won’t be the wholesale withdrawal of stimulus across the board that will prompt sentiment rebalance but rather the anticipation normally associated to risk trends. 
    FANG Has Set Up Apple as a More Important Capital Market Driver
    Earnings season has been mixed in the US thus far, but more important than the report of corporate numbers each trading session is the shift in bias surrounding these updates. There is considerable amount of ‘fudge’ room in reporting quarterly figures due to the dubious accounting allowances in GAAP (I obviously am not a fan). Yet, the details in questionable figures can be played up or played down depending on what the audience is willing to tolerate – or is actively seeking. With benchmark US indices struggling to regain the remarkably progress of 2017, sentiment has notably shifted towards earnings.
    No longer are the impressive elements of comprehensive reports amplified and the disappointing downplayed. The shortcomings are starting to be interpreted more readily in the general shortcomings that are more apparent in other areas of the economy. It is against this backdrop that we have had a troubled quarter from the concentrated speculative leader in the FANG. For those not familiar, it is an acronym of Facebook, Amazon, Netflix and Google – some of the largest and fasting growing market cap stocks in the world. The fact that they are also tech, which is the sector that has outperformed in US markets; and US equities which have outpaced most other liquid ‘risk’ benchmarks speaks to the concentration. As important as this group is, there support is starting to turn to borderline burden. Where Google and Amazon’s figures were positive (though they came with very clear caveats in fines and income), the Netflix and Facebook reporting were outright pained. The former dropped while the latter collapsed from record high to official bear market in a day.
    Given what the FANG represents, the market has paid closer attention to the state of earnings and perhaps the bias that has been applied here so consistently. How to settle a 50/50 split in the FANG updates and the plateau established in the group’s price indexing? Add an ‘A’. Due Tuesday after the bell, Apple’s earnings will tap into key US tech firms and it has its own innate amplitude as the world’s largest market cap stock. It will be important whether it beats or misses, but even more crucial is how the market treats a better or worse outcome than expected. This event can carry far more weight than just the immediate reaction for AAPL shares. 
     
  3. JohnDFX
    So Much Risk, Status Quo is an Improvement
    In individual trading sessions or entire weeks where there is an overwhelming amount of important, scheduled event risk; we often find the market frozen with concern of imminent volatility. Even as a remarkable surprise prints on the docket early in the week, the impact it generates is often truncated by the concern that the subsequent release can generate just as much shock value but in the opposite direction. Many opportunities have been spoiled by such situations.
    Yet, what happens if we face the same situation on a grander scale? What if the threats are thematic, global and frequently lacking a specific time frame? We are facing just such a scenario now. The most troublesome subject is the unpredictable winds from the global trade wars. For influence, this is a systemic threat as the economic pain will inevitably come to a head. If we had an end date to work with, there would be a more decisive risk aversion, but it is the uncertainty of pacing that leaves the markets to drift with anxiety. Most critical updates in this ‘war’ have come out of the blue in the form of a tweet from US President Donald Trump.
    Add to this fully capable theme conflicting – though less capricious – matters, and there is just enough sense of opportunity in short-term efforts to keep bulls clinging to hope. Monetary policy, new and failing economic relationships, corporate earnings and more can fill in between shocks of new tariff threats. Though, if we came to a scenario of a universal dovish shift in central banks (or any other theme for that matter), would it be enough to offset the blight to global growth from trade wars? Not likely.
    Any Whiff of Fed Worry and a Dollar with Everything to Lose
    I weighed out my theory last week that Fed policy can only disappoint moving forward. That is not to say it can maintain a sense of status quo – it certainly can. However, the genuine opportunities for this central bank to ‘surprise in favor of the bulls’ is so improbable as to be impractical. It has already established a pace remarkably aggressive relative to counterparts. If conditions continue to support growth and optimism, it would lead other central banks onto a path to close the gap with the Fed. If economic and financial health floundered, the Fed would in turn have to ease its pace.
    This past week, the CPI data gave quantitative support for the status quo – though not any material Dollar lift. The Fed’s monetary policy update to Congress on the other hand laced its confidence on the economic outlook with modest concern over the fallout from trade wars while a separate report suggested the tax cuts would have less positive effect on the economy than previously anticipated. You can bet Fed Chairman Jerome Powell will have to address questions on both fronts when he testifies before the Senate Wednesday in the semi-annual Humphrey-Hawkins testimony. There are many Congressmen and –women from both parties who have called out the President’s aggressive position on trade as self-defeating.
    Powell will want to avoid triggering market fears (avoiding volatility is a third, unspoken mandate of the central bank), but the lawmakers will push the topic whether to illustrate the damage they fear or to earn political points. If he admits growth is at risk from the advance of trade wars, it would signal to the market that the pacing already baked in is less stable than what is presumed, and the passive premium behind the dollar may start to bleed off.
    China Data Run and Data Questions 
    China is in a very difficult position. It is attempting to transition itself from methods of growth that are impossible to maintain over the long term without inadvertently causing disastrous instability. To successfully make this ‘evolution’ to an economy primarily supported by domestic consumption, stable capital markets and a wealthier population (rather than leveraged financing and questionable export policies), the government requires a remarkable amount of stability.
    The healthy risk appetite and moderate growth registered for the global economy over the past five years was the perfect environment upon which to pursue this effort. That is especially true because the Chinese data that already draws a fair amount of skepticism from the rest of the world would look like an unlikely idyllic steering for the economy – a pace that could be dubiously attributed to the general environment. Now, however, that gentle landing has been disrupted by the aggression from the United States. The drive to escalate trade wars threatens not just the important trade between to two countries, it risks pushing disbelief over China’s statistics to the breaking point. Though they would not likely show serious pressure in any area of the economy or financial system that they control, markets have grown adept at reading between the official lines when it comes to China.
    Spurring fears of a ‘hard landing’ for the world’s second largest economy could spur capital flight as foreign investors look to repatriate and nationals attempt to slip through controls to diversify their exposure. It should be said that if there is a crisis in China, it will spread to the rest of the world; but some may be happy if China were permanently put off the path to securing its position as the antipodean super power to the US. It is this big picture landscape that we must keep in mind as the important data of the coming week – China 2Q GDP, fixed investment, surveyed jobless rate, retail sales and foreign direct investment – crosses the wires with unsurprisingly little impact on the controlled USDCNH exchange rate.
    Any questions, just ask.
    John Kicklighter
  4. JohnDFX
    Jackson Hole Symposium Has Too Much to Cover 
    There are two particularly important, multi-day summits scheduled for this coming week. Given the individual market-moving capacity of US President Donald Trump, the G7 Summit from August 24th through the 26th will be particularly important to watch. He has announced remarkable change in policy at or around such large events before – particularly when provoked by flabbergasted global counterparts. There are five general topics on the agenda which are all important but the market-centric among us – and who wouldn’t considering them more dialed in given the state of the economic outlook – will be most interested in the third of the listings which is the conversation on globalization. It is worth noting that as of January 1st, 2020, the United States will take over the presidency of the group. Yet, as far as the impact this can reasonably have on the markets for the week in front of us, there is very limited potential given that the event begins on a Saturday. If anything, anticipation for surprise policy tweets will discourage positioning for fear of another painful weekend gap. 
    The other major gathering on tap from Friday through Sunday is the Kansas City Federal Reserve-hosted Jackson Hole Symposium. This is a gathering of major policy authorities (government and central bank), business leaders and investors whereby they discuss the most important matters for the financial system and economy of the day.  Given the current fragile nature of both dynamics at present, there is enormous pressure on this event and its participants to urge a sense of calm. They will find this exceedingly difficult to achieve. The official topic of the event is the ‘Challenges for Monetary Policy’ which is certainly a concern, but not one designed to immediately provide relief. The politicizing of monetary policy threatening short-term focus and policies that result in currency war- like conditions will likely come up explicitly if not in the undertone. If the Fed and others use this event to warn that the effectiveness of there tools are diminishing as they are already stretched to the max and face diminishing returns in economic and financial influence, that will only solidify reality for so many that have grown to believe that there are only three things certain in life: death, taxes and asset inflation. They will attempt to hedge their language, but market participants are extremely vigilant of cracks in our troubling backdrop. Furthermore, the world will be looking for as much reassurance of a safety net against an increasingly probable economic downturn as can be mustered. This will likely prove a very disappointing event for many. 
    The Inverted Yield Curve vs Sovereign Debt Sliding Into Negative Yield 
    The story of the inverted yield curve continues to gain traction across the market – from bond to FX trader, new investor to old hand. In part, this is testament to the self-reinforcing influence of the financial media and financial social platforms. That is why there is a cottage industry in analyzing the collective views garnered from browsers and tweets, whether for genuine view or contrarian signal. Yet, how much should we really read into such a signal. There is very strong statistical evidence to suggest that certain yield comparisons in certain countries heralds economic and/or market troubles. The 10-year to 3-month Treasury yield curve is an economist favorite and has been inverted for a number of months now while the trader-favorite 10-year to 2-year spread only slipped below the zero mark this past week. Just to be clear, this is essentially a situation where the market demands more return from (virtually) triple-A rated government at the front of the world’s largest economy to lend to them over 3 months and 2 years versus 10 years. Something is systemically wrong if this is the case. Usually, this portends recession as we’ve seen for most similar instances in history. There is caveat in the reality that the sample size is small and conditions do change between the generations that pass between many of these instances. The Fed and other central banks being so active in purchasing their local government’s debt is a very big systemic change. However, there is also very serious data to suggest that we are looking at a stalled economy despite all the unique circumstances and distortions we are dealing with at present. 
    Another consideration with the signals these curves offer is the time gap between the market-based cue and the official flip on the economic switch. Yet, just because there is an average 12 month lag time between the two, does not mean we can comfortably assume that we can continue to press our luck until mid-2020. The official signal of a recession by the NBER and others is two consecutive quarters of economic contraction. What’s more, the speculative nature of the financial markets rarely has investors hold out on their judgement of risk until that lumbering signal has flashed red. I find that the curve is not so personally concerning as the overall level of global yields themselves. The US 30-year Treasury yield plunged to a record low this past week. Globally, an unprecedented amount of government and high-rated debt is facing negative yield. That may seem fine on the face of it from a consumer’s perspective – who wouldn’t want to be paid to borrow money – but it is a reflection of serious problems in the system. Negative yields are an indication that there is no appetite for lending despite the affordability, it creates sever problem for profitability of financial institutions and it means there is very little policy room for authorities to ease conditions to jump start growth whether stalled or collapsing. As you see the headlines continue to flash negative yield around the world, remember that this is a serious problem for the environment in which you are investing. 
    Trump Eased Trade War Pressure but Neither Markets Nor China Placated 
    There was a noticeable waver in the Trump administration’s trade war pressure this past week, which many political pundit zeroed in on from both ends of the spectrum. Perhaps spurred by the market’s sudden bout of indigestion following the reciprocal escalations between the US (announcing the remaining $300 billion in Chinese imports would face a 10 percent tariff) and China (allowing the 7.0000 level on the USDCNH exchange rate give way), the White House backtracked to offer some modest relief in the pressure. It was announced that some small portion of goods would be left off the list all together owing to their importance to health and security while a wider range of consumer goods (clothing and consumer electronics) would avoid the new tax until December 15 to avoid hitting the American holiday shopping season. The half-life of the market’s enthusiasm was even more brief than their shortened bout of fear following the initial one-two punch to global trade. China’s was similarly dubious in its response. The White House lamented that China did not move to ease its own policies aimed in retaliation, but that should not exactly surprise given that the US had enacted a disproportionate escalation and China’s own measures cannot be linearly throttled – to push the exchange rate back below 7.0000 would only reinforce the belief that the PBOC is fully manipulating its 
    Moving forward, we will have to rely on unscheduled headlines to update our standings in US-Chinese trade relations. Perhaps the Jackson Hole Symposium or G7 summit will offer up some key insights, but there is little reason to believe these administrations are plotting it out thoroughly to offer investors genuine relief. Furthermore, it is crucial that we don’t lose sight of the other trade conflicts building up around the world. Japan and South Korea as well as the Eurozone and UK skirmishes are serious problems to the fabric of global growth. Yet, my top concern remains on the risk that the two largest regional economies in the world could see threats evolve into actions. The US and EU have warned each other with complaints and suggestion of policy preparation, but there hasn’t been serious movement yet. That may have changed however when France decided to push forward with a 3 percent digital tax on the largest tech companies in the world – which happen to largely be US-based. Some of these biggest players (Google, Amazon, Facebook) are due to testify to Congress early next week and they will no doubt cry foul. Yet, if they push the volatile government too far; their efforts to reduce their tax bill could trigger a much larger drain on global growth and trade…which will cause a much larger hit to their income. 
     
  5. JohnDFX
    It is Not Wise to Start Financial Fires in a Market so Parched for Value
    The financial markets find themselves in between two storm fronts. On the one hand, there is the seasonal liquidity drain that is associated with Summer trade. More historical norm than actual exchange closures, the ‘Summer Doldrums’ present a consistent curb on volume, open interest, volatility and productive trend year after year. However, the restraint is not guaranteed. Though not as common as those Fall (for the Northern Hemisphere) triggered crises and deep bear trends, there are certainly bouts of panic that originate in these quiet months. And that is why we should pay closer attention to the other storm front that has consistently stood at the border of our collective consciousness. We have watched as growth forecasts have cooled, the limitations of monetary policy to offer temporary support have entered mainstream discourse and protectionism has emerged to threaten one of the most consistent sources of stability in globalization.
    These are not new risks, but they have been regularly brushed to the side in favor of short speculative opportunities to be pursue distractedly. Yet, draining liquidity in these questionable conditions has acted to call greater attention to the risks at hand. And, now with the tension applied by the United States on peers and counterparts alike, we are seeing the growth of clear conflict threatening to force the issue of more candid evaluations of value. Trade wars had – and still has – the capacity to trigger a full scale deleveraging of excess risk, but the temporary stay in the spread of kind-for-kind retaliations among developed world giants soothed imminent fears. This front is likely to erupt once again in the not-to-distant future under more pressing circumstances.
    In the meantime, a sister action in the form of US sanctions placed on less-friendly countries may take up the reins on global sentient. The Trump administration reversed its participation in the nuclear deal with Iran (27th largest economy) and restored sanctions on the country much to the condemnation of the other participants of the deal. The US has also moved to apply new penalties on Russia (12th largest economy) in response to its supposed use of nerve agent on a former spy. The USDRUB soared to a two year high this past week. And, showing the most severe short-term impact of all was the quickly escalating sanctions that the US is placing on Turkey (17th largest economy) for ostensibly the country’s refusal to release a US pastor swept up during the failed coup. The country’s currency has dropped over 55% versus the Dollar (through Monday’s open), and this time the financial exposure for major economies (particularly European) was quickly seized upon. Let’s see if this fire can be contained. 

    Is the US Placing Pressure on Major Counterparts Like the  EU Through Proxy? 
    The Trump Administration has likely started to recognize that there are rumblings of coordination from those countries that are already under the influence of the United States’ sanctions or feel they soon will be. That is likely a key reason the President struck a conciliatory tone with EU President Juncker when a few weeks ago he agreed not to pursue further tariffs – particularly on autos – so long as the two economic superpowers were negotiating. That said, it is clear that the strategy being employed on the US side depends on applying enough pressure that counterparts are willing to sacrifice more in order to win a compromise to find relief. That brings in the proxy pressures that the US has seemingly favored over the past weeks in the stead of outright trade wars.
    As mentioned above, the US has announced sanctions against Iran, Russia and Turkey in short order. These moves would certainly draw less criticism from Americans dubious of the government’s foreign policy moves as each is considered more adversary than ally. Yet, there may be more to these pursuits than simply following a moral compass with global relations. Other countries have supported efforts to promote relationships with these countries over the past years which has entailed exceptional investment alongside diplomatic capital. On two fronts in particular, this particular application of pressure has had enormous side effects for the Europe.
    With Iran, the EU is still trying to hold together the agreement made between the OPEC member and the other participants of the original nuclear agreement, taking a lead to promote stability. When President Trump stated in a tweet that those that county to do business with Iran could have their business with the US halted, some business leaders took it seriously and looked to curb trade. Yet, the EU responded saying any European companies that complied with the United States’ demands on Iran – and thus jeopardized the effort to hold the agreement together – would face penalties from European authorities. With Turkey, there is no slow build up. The rapid tumble in the country’s currency (Lira) has risked the stability of assets foreign interests have pursued. European banks are particularly exposed and that led the ECB to voice concern over their connection should instability grow. While this rapidly escalating proxy pressure on Europe by the United States’ actions maybe unintentional, the nature of how it is playing out suggests otherwise. 

    Dollar Rally a Result of Policy and Justification to Devalue?
    On July 20, President Trump lashed out (via Tweet as his want) at the Euro and Chinese Yuan claiming the currencies were being manipulated to render an unfair competitive advantage to their respective economies. Such claims are dubious at best. With the Yuan, history shows the country has a penchant for exerting influence over the activity level and direction of its ‘Renminbi’ to help promote economic, financial and social stability at home. However, their ability to keep all these efforts leveled out on the horizon is increasingly troubled. What’s more, a steady charge higher for USDCNH is exactly what would be expected if the United States’ tariffs on China were having their intend effects.
    As to the criticism of the Euro, there is little evidence to support that view. Four years ago, the anger would have been justified when the ECB said it would applied monetary policy in order to prevent the EURUSD exchange rate from passing 1.4000 – there must have been an agreement behind closed doors to allow this given how blatant the effort. This claim now, however, finds little support in action or event threat. Again, this is likely evidence of a strategy with questionable execution. Making a claim that multiple major currencies are being unfairly devalued – one others may agree to out of historical assumption and the other more dubious – can be used as pretext for enacting a policy aimed at counteracting the stated inequity.
    If there is indeed interest for US officials to abandon the ‘strong Dollar’ policy as has been hinted at multiple times over the past months and actually introduce policy to sink the currency, that appetite will be significantly bolstered this past week with the surge for the USD versus both the ‘majors’ and emerging market currencies. Arguably the result of the Trump Administration’s own policies, it may nonetheless serve as the foundation for a new course of global financial conflict. 
  6. 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
     
  7. 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). 
  8. 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.
  9. 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. 
  10. JohnDFX
    Trade Wars Update: It No Longer Matters? 
    Seemingly a routine occurrence for the global financial markets, we saw the state of global trade deteriorate yet again through the past week. As expected, the United States went forward with tariffs on an additional $200 billion in Chinese goods. The terms are for a 10 percent rate on a range of imports that will increase to 25 percent by the end of the year. The standard, immediate response from China was quickly implemented, but only on $60 billion in US goods. It is not clear the strategy from China as they vowed a ****-for-tat response to what they have deemed unprovoked trade wars, but the country does not have much more room to tax imports from its major counterpart – and certainly not $200 billion worth of goods. This alone moves us into a new phase of a standoff of escalating cost for the US, China and the world. 
    Will China ease off the pressure? Are they simply plotting an alternative course? Could this be an attempt to prevent President Trump from pursuing his threat to trigger the $267 billion in further duties in the event of a reprisal to the $200 billion? It isn’t clear. With the situation clearly under greater tension, the news over the weekend that plans for further talks had broken down ensures greater financial threat from this already-enormous burden. What is even more remarkable than the state of trade from these two economic leaders is the apparent state of obliviousness from the speculative markets. While certain assets show greater disregard to the threat than others (the S&P 500 is at a record high while the EEM Emerging Market ETF is only modestly off its multi-year low), they have all displayed a measure of neglect these past weeks as the tab has grown exponentially. 
    To suggest that this situation simply doesn’t matter would be recklessly negligent. It isn’t impossible that speculators accustomed to complacency and FOMO, but it would nevertheless increase the scope of risk to stability through the future. Ignoring the dangerous wobble in a tire as you steadily accelerate down the freeway is not a reasonable state even if we can sustain it for the time being. If we continue to build up exposure until a severe economic or financial crisis arises, it will only amplify the eventual collapse. 
    What is Eating the Dollar and How Long Does it Dine?
    The Dollar marked an important technical tumble this past week. Already under pressure over the past months, the DXY’s drop below 94.35 and EURUSD charge above 1.1700 represents the break of ‘necklines’ on head-and-shoulders patterns (the latter inverted). This is pressure not isolated to the trade-weighted aggregate or its heavily represented most liquid pairing. We can see the currency’s unique struggle intensifying distinctly across the spectrum over these past few weeks. But with this evidence of broad struggle, we should attempt to identify its source if we intend to establish the intent of follow through – whether persistent or near its conclusion. Reverting to an old textbook relationship, some are connecting the currency’s traditional safe haven role to the recent rebound in risk assets – including record highs for certain benchmark US indices. 
    That would be a tidy explanation, but is suspicious for its timing considering this haven function hasn’t played a significant role for months. Further reason to question this relationship is the explicit status for the Greenback as the highest yielding major currency. That advantage will likely increase this week as the Fed is expected to hike rates another 25 basis points to a range of 2.00-2.25 percent. It could be the case that the currency’s premium could be deflating under expectation that the central bank is planning to downgrade its pace of tightening at this meeting through the Summary of Economic Projections (SEP) and Chairman Powell’s press conference. Yet, we don’t see that anticipation in assets that more directly relate to such forecasts - overnight swaps and Fed Funds futures. 
    Political risk will prove an increasingly prominent risk through media headlines in particular over the coming weeks, but there is little direct threat to economy or financial markets just yet. This slow reversal of a six-month old bull trend may also have developed in response to the longer-term concerns. Over enough time, the accumulated cost of engaging in a multi-front trade war while increasing the budget deficit during a healthy economic phase will erode the appeal of the United States’ currency’s principal status. It is possible that this long-term pressure is starting to set in; but if that is the motivation, it can readily be sidetracked by more intense short-term concerns (like next week’s FOMC decision). 
    Political Risk Increasing as US Election Cycle Heats Ups 
    Political risk is an abstract fundamental influence on the financial system. Certainly each trade has their political beliefs on policies ranging from economy to social causes; but more often than not, these views only cloud our assessment of the markets. It is generally-accepted market wisdom to remove emotions from our trading; and there are few things in life that more readily trigger emotion than politics. Practically-speaking, however, there is little in the way of policy that can readily translate into significant market movement in the short-term. That said, one of the few outlets with a direct link to financial health and stability is the state of international relations. And, on that front, the danger has grown visibly and exponentially. Perhaps one of the most obvious instances of this pressure on net global growth and capital rotations through trade comes from the United States. 
    The Trump Administration has driven forward with hefty tariffs and economic sanctions on some of the largest economies in the world. Whether we personally view the policies as good or bad / right or wrong, the economic impact is straightforward. As time marches on, attention on politics will intensify with the mid-term elections approaching. While much of the high drama related to the balance of the Legislative branch, threats of Presidential impeachment and the Supreme Court pick has little to do with the kind of direct market implications that we should keep in the forefront; it can nevertheless bolster the appreciation of economic and financial connection by virtue of its mere presence in the headlines. What’s more, this is not a uniquely US concern. There is political pressure rising across the world. 
    Reports of a possible election call in the United Kingdom have followed the failure of progress in the Brexit negotiations at the EU leaders summit in Salzburg. Mainland Europe is not immune to systemic risk via political pressures. Italy is still a massive concern to stability between its enormous debt and populist government. Poland and Hungary pose a threat to core EU beliefs – and have drawn criticism for such – owing to their nationalist governments’ policies. In Asia, financial pressure is starting to show subtle cracks in social contentedness while US sanctions have spilled over from Russia restrictions. Japanese Prime Minister Abe managed to keep his position this past week, but the economic and international diplomatic position or the country has not improved materially. The question investors should ask themselves is whether these relationships improve for compromise or rapidly intensify should economic or financial crisis start to emerge. 
  11. 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.  
  12. JohnDFX
    Monday’s Open: Trade Wars Status Quo That Really Isn’t 
    The G-20 Summit has passed and by the accounts of the key players, the results were encouraging. I guess no new fronts have been added to the global economic conflict after the two-day meeting, so that is a silver lining we can hold onto if we wanted to be optimistic to the point of true enthusiasm.  According to President Trump’s account of his meeting with his Chinese counterpart Xi Jinping, their discussion was a success as it reportedly signaled the restart of negotiations between the two countries. To be sated by this news would mean ignoring the fact that they had supposedly never officially broke off talks and being on speaking terms is about as low as the bar can be set. The genuine improvement in circumstance after this summit was the fact that the White House’s threat to put another $300 billion in Chinese imports under the 25 percent tariff. The US President also announced that he was lifting the ban on US firms selling products to banned Chinese telecom Huawei – though the company remains blacklisted and cannot export its wares to the United States. 
    The real question heading into the new trading week is how this news is leveraged: by bulls or bears, to charge conviction or short circuit intended trends. If we do see the market buy into the optimistic perspective of the US-Chinese negotiations, it will prove very difficult to develop any meaningful trend. This outcome is tuned more towards a relief rally. That being the case, there was never a significant discount established in the broader markets. These past weeks have seen speculative assets rise with the S&P 500 and Dow in particular anchored to record highs. That would suggest that the markets may in fact have been pricing in a more significant improvement of circumstances which could completely drown out any low-grade rally that could arise. Further, in this conflicted backdrop, it would be very difficult to sustain a troubled risk-on rally with liquidity under pressure owing to the US Independence holiday on Thursday July 4th. A middling risk rally would very unlikely override shallow markets.
     
    Alternatively, a bearish take on the after-action would likely trigger deeper misgivings in the markets and potentially tip a selloff that can override thinned conditions. This scenario could start as a retrenchment as the excess premium afforded to an assumed reversal in one of the most abstract and wide-reaching fundamental threats registered in years (trade wars). It could further grow into an appreciation of the economic pain that is slowly compounding as the efforts put into place thus far build upon the burden in economic activity. That is recognition of true fundamental struggle that contradicts superficial speculative ambitions that have placed greater emphasis on the expectations around the likes of the Fed rather than the tangibility of GDP. While generating enough conviction to carry risk aversion through the liquidity drain this week, it is far more likely to happen in a fit of panic rather than greed; and this is the type of falling fundamental start that can get the ball rolling. 
    Seasonal Forces Versus Fundamental Winds 
    Generally speaking, there are strong fundamental winds blowing in these markets, but the urge to revert to restrained market conditions as is familiar during seasonal lulls like we are expecting during this ‘height of Summer’ week will prove a powerful deterrent. Seasonally, July is more buoyant for expected volatility (via the VIX volatility index) than June; but that is not saying much for state of turnover throughout the average year. Also, Thursday’s Fourth of July holiday is really only a US celebration; but the expectation for sidelined speculative activity fuels an assumption among the global rank that is often realized by sheer force of will – or want. Looking to the same historical norms, low volatility has also contributed to stronger performance for risk appetite, which fts the assumed inverse correlation between the likes of the VIX and the S&P 500. Given the record high of the latter and general premium-despite-fundamental-trouble for the many other speculatively-linked assets in the open market, it would be difficult to leverage genuine gains through the forthcoming period. 
    Overriding liquidity conditions is difficult to do whether attempted through fundamental or technical means. It is, nonetheless, significantly more probable to mount an offensive when there is a common event or theme for which a wide swath of the market can line up behind. Trade wars referenced above is one such deep well upon which the speculative rank can draw. Another is monetary policy. This past month, the remarkable recovery mounted by the vast majority of risk assets seems to have a very clear connection to monetary policy. In particular, the Federal Reserve’s policy decision and forecast on the 19th was seen as a boon to doves. It should be said the group did not cut rates nor did it indicate any intention of easing through 2019, but the market took what it wanted from the event. That is another point of speculative reach.
    In the week ahead, there are a number of events and data points that could hit at this fundamental disparity, but Friday’s June employment report (NFPs) is the most distinct. If the general strength of the data holds firm, it could sharply drop expectations for a July cut – presently priced at 100 percent according to Fed Funds futures. Then again, if the data drops sharply, the implications for growth moving forward could lead the market to think more critically on the shortcomings of any future central bank efforts, as impotent as they already are. 
    Setting the Course for the Official 2Q GDP Readings
    While monetary policy is a theme that will follow one of the top highlights for event risk in the coming week and trade wars will following the G-20 summit headlines, the most comprehensive matter to hit upon through the breadth of the period will be growth. Interest in the health of the global economy has simmered for months between the cumulative pain afforded to the trade issues, the uneven state of financial assets, questions over the policy authorities’ (central bank and government) willingness to offer backstop, the serious erosion of confidence surveys and specific high-profile market developments like the inversion of the 10-year / 3-month Treasury yield curve. That all builds into greater deference to be paid to the forthcoming official round of 2Q GDP readings that will start to cross the wires in a few weeks’ time. That run kicks officially on Monday July 15th with the release of China’s 2Q GDP figure. In the meantime, there are a host of economic readings on tap for this week alone. 
    As far as comprehensive views go, a Bank for International Settlements (BIS) annual economic update will most likely give a more dire assessment of what the world is looking at heading into the second half of 2019. This group is known as being frank about risks and somewhat pessimistic, with no compunction when it comes to warning over the instabilities developing in the financial markets. They will almost certainly decry the state of global trade and the precarious nature of risk taking. In data terms, the Friday NFPs are a good barometer for the health of the world’s largest economy, however, I put greater emphasis on the ISM’s service sector activity reading for June. That particular segment of the economy accounts for approximately three-quarters of output from the behemoth.
    That said, if the service and manufacturing reports from the group point to the same general direction, the implications are far greater. For a global perspective, there are Markit-observed PMIs are due for Asia, Europe and North America. We are expecting ‘final’ readings for Japan, the Eurozone and US; but the figures for China, Italy and UK are just as important to the overview. As with many fundamental dimensions nowadays, there is a significant bias in terms of impact for different bearings. A firmer showing would act as mild justification for the already optimistic slant from the markets. A worsening conditions will draw further and further on the discrepancy in speculative view and excess market pricing. 
  13. 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.
  14. 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. 
     
  15. JohnDFX
    Another Massive Escalation of the US-China Trade Wars
    The White House continues to double down on its aggressive posturing against China in a bid to force the county to yield to its demands at the negotiation table. This approach follows a few patterns in economics, sociology and debate whereby the commitment to escalation persists despite growing risks and diminishing return when or if a compromise is struck – such as the ‘escalation of commitment’ behavior. Late this past week, President Trump himself announced that an additional $300 billion in Chinese imports – essentially the balance of all trade with the country – would be saddled with a 10 percent import tax starting September 1st. He and his representatives – such as economic adviser Larry Kudlow – stated the burden could be avoided if China were to budge on the economic impasses, but the former would also remark that they could be increased further if the situation was seen as not progressing. China does not historically yield to such overt, public tactics; rather it more often responds by retaliating in kind. That is a problem as there is not a like-for-like option for China to respond at this point. It ran out of US imports to slap new or escalated tariffs on with the last volley. 
    This disproportionate status was a glaring imbalance, but China likely resorted to mere threats as it feared pushing the US to more dramatic retaliations. In diplomatic terms, to not respond now would invite a more emboldened US as it sees no negative consequences for inflicting pain. The next steps from here is where greatest risks reside. If China finds a back channel agreement to halt the pressure, it could suggest an interim turning point. China however would not want the capitulation public for political reasons, but the US would for political reasons. If China retaliates, it will likely take the stalemate off the rails. Without US imports to tax, the country would have to resort to selling private US assets which would not sway the government, restricting rare earth materials which wouldn’t register to the White House until much economic damage is done or they result to a ‘nuclear’ (economic) option. Allowing the Yuan to depreciate sending the USDCNH above the 7.00 mark will offset strictly tariff-based costs, but it will give Trump a platform to claim manipulation – though a currency would naturally depreciate if it is on the short-side of economic pain. Selling US Treasuries would be the most severe option with plenty of pain for China to share as its holdings are enormous, but desperate times can push people to desperate measures. 
    Side Effects of Trade Wars: More Demand for Stimulus, Other Countries Start Fights 
    The immediate consequences of an escalating trade war between the world’s largest economies is easy to visualize: economic pain for both that spills over to the global economy as trade inevitably will be impacted for those ‘other’ countries. However, there are other outcomes that can result that have just as disruptive properties on growth or the financial system. One side effect of driving such a destructive fight is that it lowers the boundaries for taking further risks in other avenues, effectively normalizing detrimental decision making. One natural segue is for a country that feels aggrieved to utilize similar tactics with other counterparts for which it feels are taking its partnership for granted. That most threatening spillover for the global community would be for the US and European Union to take active measures against each other. That shouldn’t seem so far fetched now considering the number of reports that suggest the US President has moved forward with China against the suggestion of advisers. Both sides of the Atlantic have laid out lists of tariffs that they are readying against each other and there are obvious flashpoints like the Airbus-Boeing row. Spillover is not just a circumstance for those countries already engaged.
     
    Like nationalism, the tactics of protectionism can be adopted for other countries that feel they are experience circumstances similar to those that spurred the US to action. One example is Japan and South Korea who have gone through a few iterations of retaliation between them as they claim the other is taking advantage of the relationship. Another consequence of trade policy that directly throttles economic activity is outcry for relief through other circumstances. Monetary policy became the go-to aid for any threats to growth over the past decade, so it is natural demands for relief are directed towards groups like the Fed, ECB, BOJ and others. That exact pressure has been raised by the US President to the FOMC for months. The central bank has rejected the pressure for the purpose of its independence, but the group cannot very well ignore tangible risks to economic health that result from international policies. The response is not limited to the countries that are engaged either. While the Fed has cut rates and is expected to do so again next month, the ECB is investigating a return to QE and the PBOC vows to resort to easing in the second half; the markets expect groups like the RBA and RBNZ will have to offer relief of their own as soon as this week when they meet on policy. 
    A Reminder: The True Tipping Point is Realizing Central Banks Are Powerless 
    Speaking of the need for monetary policy, one of the greatest financial risks facing the global economy – aside from the excess of leverage at all levels of the financial system (government, businesses, consumer, investor) – is the realization that central banks do not have the tools to stabilize future crises. Rationally, most market participants would recognize this is the case if they were to project the course of future periods of market instability. Yet, after a record decade of bullish markets (in US indices), there is an understandable complacency and even a large pool of investors that have never even experienced a true bear market. When a troubled reality wins out, however, the tools that central banks can use are going to be severely limited. Even in the best of circumstances, rate cuts are not nearly as important for stabilizing the financial system as basic credibility – essentially the market responding to the belief that the deep-pocketed central banks’ efforts will alter the course. 
    The Fed, among the major central banks, has the most room to maneuver through traditional policy – and that is not much scope with the high end of the range at 2.25 percent (225 basis points). The other major central banks are working with substantially lower yields. Stimulus programs are more directly associated to firefighting in modern times, and key central banks (the ECB and BOJ most prominent) have extremely little margin to add more liquidity to the system with any hope of earning financial return. A thought experiment: if fear started to spread across the global markets and central banks were not a reliable source of emergency stability, where would you expect to find support? If your answer is a coordinated government response in this environment, our precarious state should be obvious. Let’s hope it doesn’t get to that point.
  16. JohnDFX
    Is Trump Intentionally Stirring Market Volatility?
    The dust is still settling from the most recent string of reciprocal retaliations between the US and China in their ongoing trade wars. As a brief synopsis, the White House frustrated by the lack of progress in negotiations as they were due to break for a month announced August 1st it would slap a 10 percent tariff on the remaining $300 billion in Chinese goods that it was not already taxing. China responded the following Monday by letting the USDCNH cross the 7.0000 Rubicon. The US in turn labeled its counterpart a currency manipulator so that it could pursue other legal means to which Beijing suspended all agriculture imports from the US. That is where we find situation heading into the new trading week. It is possible that we are in another period of stasis where uncertainty starts to give over to complacency once again. Yet, there is motivation for President Trump to keep up the pressure. With the exchange rate adjustment made on the Yuan, China has essentially made a means to automatically offset much of the impact from US tariffs. This is more of a move towards a market-based currency policy than what we have seen before (there aren’t naturally hard barriers in exchange rates), and a weaker currency would be expected should an detrimental economic wind blow in.
     
    Nevertheless, the US President will use this shift to bolster his claims of manipulation, and the markets will grow wary of the implications for foreign investor capital repatriation that raises added concern China will not be happy to deal with given its financial and economic pains of late; but this was ultimately the most practical move. Moving forward, raising the tariff rate on Chinese import will be largely offset by exchange response, which means the principal strategy for exerting pressure on the country has essentially been neutralized. The administration could try to muster alternative plans with greater effectiveness but there is little the US could resort to short of mustering international support – and their regular threats to trade partners doesn’t make that likely – or that would otherwise pull other countries into support of China. With an appetite to ‘go it alone’ and keep on the offensive, the US government looks like it wants to simply improve the channel of influence with its tariffs. For that to happen, the Dollar would need to depreciate. 
    This is why Trump has been relentless of his critique of the Federal Reserve, voicing discontent with the group nearly every day last week. He sees a simple formula of rate cuts leading to a weaker currency – which is not assured – but he seems to carry little about the group’s credibility or the concern such a move would inspire among investors (a sudden aggressive easing despite stocks at records and the jobless rate at decades low would suggest a crisis is ahead). With the central bank unwilling to cave to the pressure and no other practical approach within his means to devalue the currency without triggering heavy consequence, he may be attempting to rock the market such that investors demand Fed’s action. The slump last week, in May and through the fourth quarter (signaled in early September) all came soon after the US escalated trade wars. Could this ploy work? Yes, but it would carry serious complications. 
    ‘Tis The Season of Holiday Trade, But Is This Time Different? 
    We are entering into the prime period of the ‘summer doldrums’. Summer is a fairly generic phase when it comes to the markets and depending on the unique circumstances each year; but statistically, the lowest average daily volume for the S&P 500 – my favorite, imperfect risk asset – occurs through the month of August. This timing aligns broadly to holiday periods in the US and Europe which in turn leverages the remaining global investors’ expectations as to activity through the period. As a notable asterisk, historically, the VIX begins a steep rise through the same months before peaking in September and October. While prominent technical levels, a dearth of traditional fundamental updates and statistical norms are all means to coax expectations; I find a profitable bias and ultimately complacency are most reliable sources of market intent – much like the assumption of historical status like its ultimate safe haven position which triggers a flight to Treasuries when fear is on the rise once again. 
    That said, market participants shouldn’t form the basis of their position on complacency which is essentially a decision to ignore risk in order to earn tepid returns. There is a saying in markets, ‘will this time be different’ which is used far more often as a contrarian’s criticism of those with that are dubious of a market that has deviated too far from what they gauge as value. It is the same sentiment shared by those that mock the caution of those moving to the sidelines or taking on hedge when risks retreat – particularly should those same unrelenting bulls be saved by a stiff bounce. Yet, asking whether markets are going to eventually shed an unearned optimism which would expose assets that have been artificially driven to excessive highs is the reasonable approach, not blindly buying every dip or (worse) simply adding to an increasingly stretched position with no plan to unwind during favorable times. 
    GBPUSD Is Within Reach of a Three-Decade Low 
    Though many technical measures may suggest the British Pound is stretched in its tumble – particularly in its past three months – and various fundamental aspects to the currency would argue a foothold of relative value, the currency is dropping like a rock. This past week, the Sterling continued its crash against an otherwise unsteady Dollar to trade within 1 percent of the more than three-decade low the pair hit during its October 2016, post-Brexit flash crash low. EURGBP has been of similar constitution. Despite the growing tab of issues for Europe between an ECB dovish drive, Italian government stability risk and the United States constant pressure on its trade status; this pair has climbed for 14 consecutive weeks through this past Friday – though it is still 5 percent from its recent record high set back in late 2008. GBPJPY is perhaps the most forgiving as it is approximately 9 percent from its own decades’ low, which I guess we would have to give credit to the Bank of Japan’s early work to devalue its currency.
     
    This past week, the UK economy was weighed by troubling economic data which included he first quarterly contraction in GDP since 2012. The real source of fear however remains with the troubled course of the UK-EU divorce. We are still months out from the official deadline (October 31st) for both sides to work out their differences and come to an acceptable split. Yet, with former Prime Minister Theresa May’s departure, the reassurances that the government would do everything in its power to avoid a ‘no deal’ outcome have gone. In fact, new PM Johnson seems to have as the centerpiece of his negotiation strategy a clear warning that this option is wide open. In fact, his reassurances have been so effective, that now the market is treating that once-unthinkable scenario as the baseline outcome. There is little doubt that severing the economic links with the diplomatic ties would carry serious economic and financial ramifications – the IMF, BOE and even the UK government have provided stark assessments. Yet, at what point would the Sterling be fairly valued for a hard break should it come to pass? That is open to interpretation – and the market will be making its best effort to find that balance so long as Boris Johnson voices his appetite for ‘no-deal’.
  17. JohnDFX
    Reckless Acceleration of the Trade War
    With the global (including the US and China) economy already straining under the weight of the ongoing trade wars, the two largest individual economies too steps this past week to leverage the pressure even higher. As expected, China felt it necessary to respond to the upgraded efforts  announced by President Trump on a staggering $300 billion more in Chinese goods – the ‘rest’ of the country’s imports that weren’t already facing a tax. It seems the White House considered the phased application of the 10% duty between September 1 and December 15 was a show of good will, but Beijing did not. The response from Beijing of its own staggering of $75 billion in tariffs between those same dates as well as the return of a 25 percent tariff on US auto imports previously paused in April was somewhat surprising as the country is not in a particular strong position to match like-for-like taxes on the other country’s goods, a reality reflected in their allowance of the USDCNH to overtake 7.0000. This automated offset to direct charges from the United States responded as intended with a charge to a fresh record high through Friday’s close, and subsequent strong follow through into Monday’s Asia open to surpass 1.5 percent in a mere three days. It seems Washington’s strategy is following the shock-and-awe model as the President announced a further step mere hours after China’s response to the previous step. He upped the rate on all those tariffs already in place (25 to 30% on $250 billion) and those that are due to be imposed (10 to 15% on $300 billion). Yet, that ‘floating’ exchange rate will remain a point of frustration for the administration as it allows China more cushion to ‘wait out the President’. 
    It is very likely that Trump is intent on forcing China – who it is suggested intends to hold out until the election – to avoid rolling the US economy into a stall out that makes his reelection chances very difficult. While it perhaps seems a war devolving away from strategy, there are absolutely objectives on both sides, they just happen to be very rudimentary. While officials may very well have a cutoff point at which they intend to throw the breaks on the war, I believe we are already passed the point of no return. The leaders of these respective economies likely recognize this inevitability as well – Trump stated recently that a ‘short’ recession would be worth it if it changed China’s habits. At the point that these governments see a near-term recession as a foregone conclusion, they will revert to strategy aimed at safe guarding their long-term status in the global economy. While it may seem the US has the leg up on the trade war scale, China’s leadership has more breathing room against re-election pressure. This is a fight from which the participants cannot easily extricate themselves.  
    The Ominous Approach of a Stalled Global Economy 
    As the fighting in global trade escalates, the outlook for economic activity steadily erodes. There are certainly a number of data points and forecasts that project ominously for key local economies – and the aggregate global health by proxy – but it isn’t the number of flashing red lights that speaks to the inevitability of growth stalling out. It has a lot to do to the awareness of trouble an subsequent anticipation that is formed from these increasingly-perceptible readings. President Trump has repeated the claim frequently as of late that the news outlets are pushing fears of a recession in a bid to push self-fulfilling prophecy in a bid to oust his administration at the next election. While most news agencies work on an ad model that benefits from some measure of panic (‘if it bleeds, it leads’), engineering a regime change is far-fetched. That said, the purveyors of news inevitably play a role in the evolution of sentient among consumer, business leaders and investors. 
    In reporting the subsequent inversion of the 2-10 Treasury yield curve this past Thursday or the troubled mix of data from the global August PMIs (timely proxy for GDP), they are raising awareness of the unfavorable environment in which there is tangible risk in making large purchases, ramping capital expenditures or adding to existing ‘risk’ positions. Falling into step with such troubling forecasts has more to do with human nature than any ploy and perhaps any sense of inevitability. Even though we are deep in an economic and investment growth cycle, it is always possible to stretch it out even further. Yet, pushing those in control of expenses to reach further increasingly marginal returns or gratification (from purchases) at the growing risk of losses to jobs, revenue or capital, requires greater and greater suspension of belief in traditional ‘value’. Unfortunately, the hope for tax cuts, infrastructure spending and monetary policy gearing does not offset the realities of an economy that has run out of traditional fuel and quickly burning through its reserves. 
    Jackson Hole Symposium: The Vows of Unlimited Economic Support Ring Hollow 
    With global investors showing obvious concern at the state of affairs around the world where governments are pursuing policy aimed at fostering growth at the expense of others and bursts of volatility continue to flash danger on many account statements (the S&P 500’s three worst single-day declines this year were all in August), it is natural for traders to seek out a savior. In textbook terms, a rise in risk would encourage a proportional response from market participants in reducing their exposure. Yet, that is clearly not the regime we have been operating in these past years – and frankly that has rarely ever been the case as speculation is an inevitability (and why I do not ascribe to the efficient market hypothesis). Often, the stalwarts of the financial system suggest their views of optimism or pessimism are based purely on the backdrop of economic growth, but their assessments are necessarily more complicated than just a single GDP projection pulled out of thin air. The scenarios of trade wars (both benefit and detriment), diverted capital flow owing to background policy change and monetary policy are more informative of our course moving forward than the linear projections of dated indicators like the quarterly growth figures from governments. So, when we are pressed to evaluate the heaviest influences for surprising risk and sustaining positive growth, there is no greater power than the world’s largest central banks. 
    For a decade, they have flooded the system with cheap funds with a stated goal of encouraging growth, but through a less-often admitted means of what amounts to ‘trickle down wealth’. There was actually a point during the Bernanke era that the Fed Chairman stated clearly that they were attempting to spur underlying economic growth by supporting financial venues. Well, over the past years, this mechanism to support expansion has clearly diminished in power. A Dollar, Euro or Yen of stimulus has translated into increasingly infinitesimal growth. Most investors recognized this diminished capacity but were willing to overlook the traditional conduit of performance so long as these same central banks could reduce their personal risk through their efforts. It is the unmistakable failing on that implicit effort that poses more significant threat to market’s moving forward. That is why there was so much attention being afforded to what the leaders of the financial and monetary authorities would say at the weekend Jackson Hole Symposium. It is also why it was virtually impossible to truly live up to the demands of market participants. Their assurances to do ramp up a weak response to another downturn with extremely limited capabilities certainly does not.
  18. JohnDFX
    Is Trump Responding to the Dow – and Would He Prioritize Index Over Dollar? 
    This past week generated another heavy round of criticism from the US President. In both ad hoc press conferences and tweets, Donald Trump scrutinized a number of economic and financial hurdles that he believes is threatening the health of the US economy. The most familiar critique continued to target the Federal Reserve and specifically its Chairman, Jerome Powell. Trump took to the wires to levy blame against the monetary policy authority essentially every day. His specific accusations were of a familiar flavor, but they boil down to an essential accusation that the independent setter of interest rates was keeping the Fed Funds baseline higher than it should be which is choking off growth. His specific targeting, however, shows some internal conflict over his interests and the paradox for which his own demands would not be met even by a fully compliant central bank. The most frequent issue the President has taken with Fed policy has been the level of the US Dollar – which notably closed this past week at a more-than two-year high, or EURUSD two-year low. An accusation that other authorities are manipulating their own currency (the ECB with the Euro and PBOC with the Yuan) isn’t his chief concern, but rather that the Fed isn’t responding in kind. 
    From his remarks, it seems he is less concerned over the economic pain a stronger currency may bring, but rather that the transmission of the trade war efforts employed by the Administration are watered down by the exchange rate adjustment. Therein lies one conundrum as an effective policy push by Washington would lead to a weaker global counterpart and thereby weaker currency. Therefore, some extra-ordinary effort needs to be employed to keep the currency steady or to force it to depreciate alongside the transmission of the pressure – hence the badgering Powell. Conversely, when the stock market begins to sag, the focus from the White House shifts to the level of the Dow or S&P 500, though the stated interest remains the same in a reflection of strong growth. It should be said, the economy is not necessarily the market. As the market slips and recession signals multiply, there is an effort to identify the source. Relatively little attention is paid to the age of the maturity of the economic and financial cycle alongside the disparity of expansion and unrealistic investor expectations as there is a collective obsession for singular catalysts (a function of crowd psychology). 
    There has been a growing din of criticism around the negative impact of the trade war tariffs in economist assessments, business sentiment surveys, earnings reports and more. The President has stated clearly though that he will not let up on the pressure mounted against China. With the blame building, Trump has instead started to redirect towards American businesses. This past week, he blamed auto manufacturer GM for not moving the operations it has in China back to the US. That same day, he also stated that companies that warned earnings could be negatively impacted by the trade wars were “weak” or “badly managed”. This does not exactly warm investor enthusiasm over the health of the markets. So, will the President continue to push for a lower Dollar and shame US businesses into amplifying the effort to transmit the tariffs or let up on the economic conflict to keep the markets buoyant? You can’t have both and eventually bouncing between the two objectives will seem conditions fracture. 
    The Bank of Canada and Reserve Bank of Australia Kick off a Season of Critical Monetary Policy Decisions 
    September is a month for which nearly every one of the major central banks are due to weigh on their local monetary policy; and this year, we happen to find this ‘external’ influence on economy and market performance at a particularly critical junction. Markets are buoyant – some like the US indices are much higher than others, but they are broadly trading well beyond value – and the underlying strength of the global economy has clearly eroded. This has put increased pressure on the world’s monetary policy authorities to compensate for where the markets lack in traditional form. Unfortunately, rates are already extremely low and there is already an enormous amount of stimulus (over $20 trillion from just 6 central banks alone) sloshing around the system. What more could these groups reasonably do? What would we as market participants assume policy efforts that have already earned limited economic performance and has more recently struggled to offer capital market lift can do through further iterations of the same? I am skeptical that there is the same delusion that has translated into convenient complacency that we’ve seen in previous years standing in wait to provide further lift through the foreseeable future.
    The limited capacity of the Fed, ECB and others is no longer an academic conversation but rather Main Street fare. We are due some critical rate decisions later in the month – the ECB on the 12th expected to introduce an open-ended QE, the Fed on the 18th is targeted with a demand for another cut, then a combo of BOJ, BOE and SNB is on the 19th – but we have a few decisions we should watch this week as well. The Bank of Canada (BOC) is currently the most hawkish major central bank, not for its current level but rather its reticence to commit to a dovish course. If this group capitulates, it can be a big Canadian Dollar charge, but it could also nudge views of global monetary policy. As for the Reserve Bank of Australia (RBA), the group is already into easing mode and generally contemplating unorthodox policy. This is significant on a global basis because the Australian Dollar’s position amongst the majors is in large part a function of its yield – it is a carry trade. As that trait falters, the systemic view of returns and value are further distorted. 
    Seasonality Takes an Extreme Swing in September Through the S&P 500 and VIX 
    With Friday’s close, we have brought to an end the week, month and season all at once. This period traditionally marks a serious transition of market conditions that usually moves from quiet listlessness and beneficial complacency into a period of significant activity and substantially higher risk of capital market losses. Historically, the month of August is the most reserved period of the calendar year according to the performance of the S&P 500 over the last four decades (see the attached image). While the index averages out a moderate level of gains for the month, what is truly remarkable is the volume behind the market. When adjusted by active trading days, August registers less trading than February or December (which have fewer total days). When we look to the reasoning behind such restraint, there is a certain level of self-fulfilling prophecy to the receding tide. Investors expect that quiet will dictate the decisions of other investors so they themselves accordingly with smaller adjustments to position that leave the systemic and long-term balance to another time. What is interesting is that the month of August is actually quite active when referencing the VIX volatility index. That mix of restraint in progress but rising volatility was actually in clear display this past month as the S&P 500 spent much of the period bouncing rapidly back and forth in a restrictive span. That sets the stage for September. 
    With the US Labor Day holiday, we transition from the full ‘Summer lull’ to the active Fall trading season. Volume picks up, but volatility hits new highs through the month – peaking between September and October. Notably, this activity starts to register more progress in price action. Referencing back to the seasonal measures, the S&P 500 has averaged only one month of losses back to 1980 and that is during the month of September. This likely has as much to do with the markets living up to its fears as any repeatable development timed specifically during this part of the year, but it occurs with statistical relevance nonetheless. What’s more, the market has plenty to worry over at this juncture between the fears of recession, the persistence of trade wars, wavering confidence in the leveraged dependency on central banks and more. Often times, investors are simply waiting for a collective reason to de-risk from exposure they already consider excessive, and this gives a familiar anchor into the mass psyche. 
     


  19. 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. 
     
  20. JohnDFX
    What are Central Banks Attempting to Achieve at This Point? 
    Over the past two weeks, we have seen major central banks loosen the reins on monetary policy or otherwise set the stage to move further into unorthodox policies. The most notable moves were made by the European Central Bank (ECB) and Federal Reserve. The latter cut its benchmark by 25 basis points to bring its range down to a high level of 2.00 percent – though it maintained its increasingly dubious position that it expects no further reductions this year. The former took more dramatic action. The 10 bp rate cut lowered its deposit rate to -0.50 percent, but it was the announcement that stimulus purchases (QE) would restart in November after an 11 month hiatus and introduction to tiered rates to help European banks struggling with profitability that represented a shifting frontier for policy. Just as extraordinary was the steady course held by the Bank of Japan (BOJ) who maintained its open-ended stimulus program tied to a 0% 10-year JGB yield target and the Swiss National Bank’s -0.75%  benchmark.
     
    These four central banks alone could represent the landscape of global policy directing growth and inflation in the developed world, and that recognition itself should raise concern over the state of our economy and markets. An obvious question that should be raised in the face of this concerted easing is: what is the purpose? For all of the aforementioned groups, the target is either inflation and/or a growth metric like employment. It is reasonable to further assume there are certain unofficial objectives as well, such as general financial stability or even capital market appreciation as a means to fund a ‘trickle down wealth effect’ (something former Fed Chairman Bernanke was an ancillary objective of the US QE program). Yet, if we gauge the Fed against these various goals, we find core inflation above target, full U3 employment, volatility readings remarkably tame and capital markets at record highs. Why supply more fuel if you are already running at full speed unless you foresee a high probability of some crisis? Admitting this level of concern on the other hand could inadvertently trigger the conditions that realizes those fears. 
    Many feel the hazy objectives shouldn’t matter so long as the potential results are faster growth and/or higher local markets. Yet, that is ignoring the reality of the costs associated to such efforts, and there is more recognition of this cost/benefit reality being voiced among the central banks’ ranks. Adding to the familiar criticism from the BIS, we have had officials from the Fed, ECB, BOJ, BOC, and many others voice concern over our inflated and distorted foundation. Just this past week, Rosengren added to the discussion after he dissented the rate cut saying such efforts lead to inflated asset prices and encourage excessive leverage among household and businesses. An underappreciated consideration in this mix is the more general case that the ineffectiveness of monetary policy as a tool grows increasingly obvious. What happens should a genuine recession of financial seizure – not just a soft patch of unmoored fear of such an occurrence – shows? These banks will be one of the few options to squelch the fire and they will have expended their influence when it wasn’t even necessary. 
    Long-Term Versus Short-Term Objectives
    There is a well-known business school debate that CEOs are incentivized to pursue short-term profits at the expense of long-term business growth – and sometimes continuity. This often leads to the ‘CEO is a villain’ caricature that that prevails outside the world of finance, but these objectives are pressured by a very different market force: investors. Market participants have long sought as much ‘share-holder value’ as possible when considering where to allocate their capital to fulfill a desire to outperform the broader market .That is aggressive even in the best of times, and it is particularly difficult nowadays. Another side effect of the extreme monetary policy being employed across the globe is a remarkably low rate of return on investments tied to benchmark rates (essentially everything). Meanwhile, the S&P 500 upon which performance is benchmarked is setting an impossible pace. How is a company to provide that level of ‘value’ when underlying growth is tepid? They borrow against the future like most other systemic players, such as issuing debt to buy back shares. And so, the system grows ever more unstable. 
    Another point of short-term focus arising on the horizon is found through government/fiscal objective. While there are certain countries that are shifting further towards long-term objectives – like China attempting to shift to service sector strength, consumer spending and open markets – the majority, particularly in the developed world, are heading in the opposite direction. That may be in part due to political cycles. Few places is this pressure more obvious than in the United States. The unfavorable polls for President Trump were easy to right off in previous years, but they are more difficult to overlook as the country starts to get into campaign gear. Just this past month, we have started to see a clear rise in concern over recession risks via investors and consumers in the United States. In a monthly economic Gallup poll, one of the reasons offered for the downturn in the outlook is the references to recession by economists – self-fulfilling prophecy. To stave off a leadership change in 2020, the Administration has very clearly fixed on the health of the economy as a critical target to boost reelection potential. Yet, they have also committed to the onerous trade war. How to offset a mature business cycle, a slower global economy and blowback from trade wars? Through the long-term, it is an improbable goal. For the short-term though, moves can be made to extend for a spell at the cost of greater instability and a deeper slump later on. This is why we are seeing demands for more central bank QE, fiscal policy that defies the typical party line and ruminations of devaluing the Dollar. 
    Recession Signals Rising Again 
    Fear over the health of the global economy continues to erode investor and consumer confidence. Sentiment surveys have stood as one of the most robust countermeasures against data that otherwise calls attention to struggling growth measures. Yet, even the most resilient of the economic participants are starting to show signs of wear. US consumers have maintained an almost unbreakable sense of enthusiasm until these past few months. That matches the sudden surge in search around ‘recession’ via Google – hitting the highest level since the Great Recession this past month. This shows a measure of awareness that will ‘weaponize’ poor data that gives weight to data that was previously overlooked. Testing this theory, last week, the OECD updated its growth forecasts and their perspective sent a chill into the market. With notable downgrades in 2019 and 2020 performance projections for the likes of the US, China, Europe and UK; they downgraded their global targets to 2.9 and 3.0 percent respectively. According to the previous IMF definition for global pacing, a reading under 3.0 percent could be construed a recession. The market didn’t tumble on the unfavorable update, but it certainly took the air out of speculative appetite in the aftermath of more central bank support. 
    In the week ahead, we should keep very close eye on the various cues for economic performance. There are sentiment surveys that are scheduled such as the US, Eurozone, German and UK consumer readings; and there will also be those measures that are often overlooked but made more important given the general perspective in the backdrop. The market readings will further keep markets occupied and perhaps return to main street influence. The US Treasury 10-year/3-month spread has neared zero and the 10-year/2-year spread flipped positive recently. Sometimes, a temporary relief can sharpen the recognition pain when it returns. If these figures worsen again, an already on-alert market will read into the turn. As for traditional data, Monday’s session carries the most direct vehicle in the form of September PMIs from Japan, the Eurozone and US.  
     
  21. JohnDFX
    Politics and Markets 
    There are numerous, open political fissures around the world – including the approaching Brexit deadline; the ongoing flux of Euro-area stability and Chinese social pressure arising from economic concerns. Each of these represents significant headline fodder both within their respective country as well as in the international press. Yet, as many newspaper column inches or top headlines in online news aggregators these issues may represent, they don’t naturally adapt to clear economic or market impact. Evaluations are made over the prevailing trends and assumptions applied as to how these issues will work their way into tangible impediments to either growth or returns. That said, the uncertainty of all three of the aforementioned issues has unmistakably dimmed investors’ and consumers’ growth expectations. To ignore these matters when they are key motivators for a majority of market participants would allow a gaping hole in your analysis. Then again, it is easy to allow the drama of the headlines to overshadow the practical impact it may exert, allowing the natural passions of politics to take your well thought out strategy completely off the rails.
     
    The difficulty in striking this fine balance is even more folly prone when it comes to the state of US politics. There has been an extreme divergence in party politics over the past decade and President Donald Trump has only fostered the divide. This creates a situation in which those in strong support of the White House allow their values outside the market paint a further exaggerated picture of an already complacent and exposed position, seen in the recent consumer sentiment surveys in which those reporting unsolicited enthusiasm for economic health via the President’s policies hit a record high. On the other end of spectrum, there are those that believe a recession is imminent through trade wars, political gridlock, dramatic debt expansion or income disparity. Naturally, the rise of the impeachment inquiry by the House of Representatives for interactions with the Ukraine exaggerates the reach into actual market impact. 
    So how do we make a practical assessment as to what impact such political events can legitimately have so as to avoid emotions-based missteps and/or exploit the ‘wisdom of the crowds’. There are two measures of response that I typically expect in such developments: short-term and long-term impact. For the former, we can evaluate how much interest is concentrated on issue by using tools like Google Trends search or hashtag density for social interest to inform how likely a headline around the topic will leverage a market response. However, I prefer the empirical approach of assessing how much impact a related development will have on the market to set expectations for future updates. For long-term implications for growth and investor positioning, sentiment surveys such as the University of Michigan’s, Conference Board’s or Gallup’s for consumers or New York Fed’s for large investors can help course correct. Yet if you take the time each week or determine which developments are consistently taking control of the market most of the time through the bulk of the movement – what I consider rule number one for fundamental analysis – you’ll find yourself not as readily prone to finding the passions of politics drawing you away from the objective work of applying a successful strategy.  
    Trade Wars Deadlines
    When discussing the course of trade wars, most people would move to evaluate the state of play between the United States and China, and for good reason. These are the two largest independent economies in the world and their relationship has steadily deteriorated to the very costly detriment of the global economy since the first economic ‘shots’  were fired back in March 2018. However, to judge the course of the global economy and investment environment on the talking points between these two superpowers alone would be to miss the truly virulent threat in stalled global trade. There are some caveats to the particular US-China standoff that keeps it from readily inciting panic. Many developed countries consider China a long-term bad actor when it comes to fair trade and have so for many years. Therefore, they are willing to tolerate some degree of pressure. Also, there is an unrealistic assumption of the Chinese government’s control over the health of its economy and financial system born of the command style approach they have used for decades. Then there is dulled reaction time globally that follows a decade of bullish market performance which earns an unreasonable sense of immortality as it keeps buoyant despite supposed fundamental setbacks.
    This confidence evaporates though if and when the altercations shift to encompass other developed world economies. The United States’ renegotiation of the NAFTA agreement seemed to have lifted its pressure on the markets as high-level agreement was made on the replacement USMCA. Yet, are have yet to see Congress approve the deal with Democrats asking for more and the year-end deadline is approaching. With many threats, we face tangible fractures between the two largest developed economies in the world this week as the WTO is due to deliberate the United States ability to apply tariffs for the claim that Europe had illegally subsidized Airbus for an uncompetitive advantage. This is a point of contention, but the risk lingering a seven weeks out is far more likely to provoke extreme retaliations on a global basis. President Trump received a report from the Commerce Department on the threat to national security inflicted by foreign auto imports. The White House had until May 18th to make a decision originally, but he deferred 180 days. That puts the deadline at November 14th. To suggest he wouldn’t go through with a tax on this competition would be to ignore the precedence already set. Also, the political pressure can also lead to more brash decisions. 
    What Should We Expect If a Recession Hits? 
    According to the New York Fed’s recession probability indicator – based on the increasingly popular Treasury yield curve – the world’s largest economy is facing a 38 percent probability of tipping into contraction over the next 12 months. Speculative interest/fear of this occurrence is significantly higher. Many have pointed out that previous instances of this same indicator rising to this level in the past have signaled eventual recessions in all but one instance. Further, there is also the increasingly popular belief that the chances of recession increase significantly as it is discussed and surveys reflect greater anticipation – a self-fulfilling prophecy so to speak. Google search ranking of ‘recession’ surged in the United States this past month to highs not seen since the actual Great Recession a decade ago. Further, other major countries have struggled with their own expansion – such as China running at a decades’ low pace, Japan notching negative quarters, Eurozone members contracting and more. With economic storms such as trade wars, Brexit and deteriorating monetary policy effectiveness weighing, it would seem prudent to at least prepare a contingency risk plan.
    If a recession were to befall the global economy, how would it play out and what would the response to try and correct its course look like? As for the occurrence of a slump in global growth, there will be leaders and laggards to turn into the red. Some with artificial curbs to imported pain or unique sources of growth can hold back the tide for a little longer than others. Considerable attention will be paid to one of the sparks that would ultimately feed the consuming fire, but the recognition of the more prolific fuel – excess leverage throughout the system – won’t be appreciated until it is too late. Consumers, investors and politicians will demand action from the world’s largest central banks. They will attempt to lift the economy, but will come up wanting as they have little in the way of standard policy tools or even effective unorthodox means left to them after a decade of capital market padding. If the market recognizes their limits, it will only deepen the panic. Then the governments of the world will be expected to step in. Programs like the TARP and TALF in the US preceding QE will be unleashed, but these will not be any more effective this central bank stimulus. Coordinated response will be the greatest possible option, but the state of global politics has shown these authorities more interested in competing for limited resources (growth) than collaborating to create more for everyone. That will similarly deepen any crisis. Eventually, unprecedented actions would be taken, but after how much economic pain and investor loss? It is hard to tell. 
  22. JohnDFX
    The Trade War Spreads to More Critical, Global Growth Organs 
    We have been unofficially engaged in a global trade war since March 2018. That is when the United States moved forward with a tariff on imported metals (steel and aluminum) from any destination outside of the country. Since this opening salvo, there have been small actions against countries outside the singular focus of China, but the incredible escalation between Washington and Beijing has drawn most of the global attention. With tariff rates running as high as 30% on over $350 billion in goods between the two economies, it is no surprise that we evaluate the growth-crushing competitive efforts on the basis of these two superpowers alone. As it currently stands, we are still awaiting another wave of products receiving a hefty tariff rate upgrade in approximately two months’ time while talks are set to resume on Thursday between the two parties. That said, reports over the weekend indicated China was not impressed with the Trump administration’s most recent efforts to find middle ground. It is important to keep tabs on the situation between the US and China, but at this point the markets seem to place greater emphasis on the data that reflects the tangible repercussions of their fight. If you want to watch the next stage of painful escalation in this systemic threat, it seems clear that the tension between the US and the European Community is the emergent battlefield. 
    There are already a few active trade levies between these two largest developed world economies, but most of the systemic threats have been reserved to an escalation in mere threats….until now. This past week, the WTO (World Trade Organization) ruled that the United States could raise $7.5 billion in tariffs against the EU for unfair subsidies supporting the region’s principal airplane manufacturer, airbus. The US Trade Representative’s office wasted no time in moving forward with the punitive action. That itself is not a surprise nor even a serious controversy. What was provocative were the details of the United States’ plans. The country announced a 10% tariff on imported airplanes, but it would slap a far more punitive 25%  tax on European agricultural and industrial goods. That is a move that registers more directly as a trade war action, moving well beyond the cover of WTO ‘sanction’ (the group urged negotiations) and encouraging reprisal. To their credit, the EU held back from retaliatory actions this past week, hoping that an understanding could be met. That said, they EC will not wait forever. It was reported that they were ready to react immediately before the ruling, and they have been quick to respond verbally to all of the US threats over the past months. If we go down this route of a trade war even half the scale of what the US and China have committed to, expect forecasts for global recession to change from an outlier of the pessimists to the baseline view of the investing masses. 
    A Near-Daily Update on Recession Fears 
    Until late August, the word ‘recession’ was only uttered by conspiracy theorists or serial pessimists. That reticence was despite a growing wave of economic data, sentient surveys and supranational organizations warning that a stall could be in he not-so-distant future. That isolation has dissipated quickly over just the past few months. The inversion of the US 10-year to 3-month yield curve was the first distinct cue that the market and then media picked up on. With a moniker like ‘economists’ favorite recession signal’, the headlines wrote themselves. Once attention was called to the frailty of the longest running expansion on record (at least in the US), the other holes started to become more overt. In the US, the NY Fed’s own recession indicator listed the probability of contraction for the world’s largest economy over the next 12 months above 30 percent – a signal that has indicated momentum into the genuine article in all but one instance going back decades. Meanwhile, the warnings from global groups have been taken more seriously: such as the OECD, WTO and IMF over these past two weeks – warning of significantly slower growth though not necessarily full contraction. Data has similarly indicated trouble from US and Chinese manufacturing contraction (‘recession’) to some full GDP readings around the world actually printing a negative monthly or even quarterly report – an official recession is two consecutive quarters of contraction according to the NBER. 
    Ultimately, the market determines what is important or market moving. We have seen numerous data points and warnings shrugged off by the markets over the past years because the speculative bias was such that market participants were happy to allow complacency to dictate a capital market drift higher. That does not seem our undercurrent at present however. Since the February 2018 plunge, we have seen a serious struggle among speculative interests to lift the markets back to their previously-set all-time highs, much less beyond them. The US indices were the most bubbly among the traditional risk assets and even they have not progressed far beyond the early 2018 swing high. Most other recognizable benchmarks are significant lower than their respective peaks from that year. In other words, the markets are paying closer attention to warning signs and are more willing to leverage their occurrence into meaningful market movement. With that setting in mind, there are a number of indicators this week that can stir our imaginations for the worst including: China service sector PMI; China foreign reserves; Eurozone investment sentient; Japan household spending; Germany industrial production; US small business sentiment; US consumer confidence; UK July GDP and Germany factory orders among many others. Keep tabs on the economic calendar as well as the headlines (Google search of ‘recession’ is quite informative).
    Gold – When Fundamentals and Technicals Conflict
    Gold is perhaps one of the indicative signals from the market as to the state of the global financial system and economy that you can find from any single source. The precious metal is a well-known safe haven, but its climb this past year has deviated significantly from the performance of fellow measures like the Dollar and sovereign debt not to mention risk assets like US indices. Its position as an alternative to traditional fiat is far more important. With central banks once again turning to expansive policy regimes while economic forecasts barely budge, there is a natural depreciation of all assets that represent this quandary: which includes currencies and government debt. There are few reliable alternatives to these traditional stores of wealth – especially when they are all dropping in tandem (Dollar, Euro, Pound, Yen). One of the very few, historical benchmarks that can meet the test is gold which is global and has played its role as a means for exchange many times through history. Given this unique role, consider the outlook for the economy and markets. Even if you don’t believe a recession is at the door, the threshold for significant expansion is very high at this point. Further, there is not much room for easy speculative gain but enormous room for retrenchment. Where would you seek safety and stability if push came to shove? 
    We – the market at large – were faced with that existential question to some degree this past week. On a technical basis, the precious metal took a remarkable bearish jog, a move that textbooks would place a high probability on fueling an overwhelming bearish trend. This past Monday’s drop cleared two months of range resistance that happened to also stand as the ‘neckline’ on a large head-and-shoulders pattern over the same period. There are few more preferred reversal measures among pattern watchers. If unencumbered by fundamental complications, speculative fear could have readily taken over and guided a more significant move for the bears. Instead, the reversal stalled immediately upon launch. This is the conflict that can arise when two favorite analytical techniques conflict. There is considerable debate over which measure is more indicative and reliable. In reality, they both have their merits and place. The backdrop and depth of catalyst can tip the scales of influence from one method to the other. Yet, if you are a trader willing to considerable a broader picture of the market in order to identify more reliable signals, it is better to find opportunities where the techniques coincide rather than conflict. Yet, in this world of contradiction, it is worth watching gold on a regular basis whether you intend to trade it or simply use it for signaling purposes. 
  23. 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.

  24. JohnDFX
    What Was and Was Not Announced in the US-China Phase 1 Trade Deal 
    Release the doves. The US and China announced last week that they finally were able to come to terms on the their long contentious Phase 1 trade deal. It seems to have conveniently slipped the market’s collective mind that the first stage of the promised reversal to the trade war was announced back on October 11. No tangible change had been put into place between then and now, but that didn’t slow the climb from risk benchmarks like the Dow. There is very good reason to be skeptical about how committed the two governments are to progress given the numerous starts and stops over the past six months (see the attached chart of the DIA). In an ideal scenario, the two sides flesh out the details to the armistice and offer breathing room to work on the Phase 2 leg. 

    That said, US President Donald Trump gave a conflicting view of when the subsequent step of de-esclation would take place as he said it could happen before the election in November and then remarked that there was no reason to rush it. There are notably $250 billion in Chinese imports that are still being taxed at 25 percent, blacklisted entities and a currency manipulator designation among other barriers still in place. However, before we assess the difficulties of next steps, it is important to keep close tabs on the presumed efforts for this current chapter. Absent in the announcement were the size of Chinese purchases of US agricultural goods, enforcement procedures, structural change to IP protections, methods of tracking FX manipulation, procedures for dispute resolution or even a clear statement from Chinese officials (through state media) that they are in fact satisfied with the terms. 
    We shouldn’t view the situation with complete skepticism though as there was very real avoidance of a painful acceleration in their standoff. The US backed off of a planned December 15th increase in the list of taxed imports from China to encompass virtually all of the country’s goods – and China deferred tariffs on US autos. That would have been another severe escalation in the trade war. Further, the White House’s decision to halve the 15 percent tariff rate on the $120 billion in Chinese imports announced back in September is the first meaningful step to actually ease tensions. While this is largely the avoidance of a further step to intensify a painful economic trade war, that may just be enough to stir speculative interest that traders have held on their sleeves. 
    Risk Trends Now that Our Wishes Have Been Met 
    Speaking of speculative interest, we should theoretically have all the necessary ingredients to push ahead with a strong close in global capital markets through the year’s end. On a structural basis, we have seen the capital markets climb with little regard to the troubling questions over traditional value for the better part of a decade – perhaps driven by the very generous policies of the world’s largest central banks – and 2019 has been particularly liberal with the buoyancy. Another layer to add to this favorable backdrop is the seasonal expectations associated to the month of December. Historically, ‘risk’ benchmarks like the S&P 500 climb through the final month of the year as much through habituation as anything tangible like tax harvesting. There is a reason it is called the ‘Santa Claus Rally’. And, rounding it all out, we were given a few very high-level, reassuring events to spur a sense of tangible optimism. The Phase 1 trade war agreement and a clear path for the Brexit negotiations between the UK and EU after the former’s general election are a measurable relief to global risk. 
    With the market’s seeming default optimism, all of this should make for an easy response to extend the bid over November and the first half of December. And yet, this past Friday’s market activity did little to reassure that we were going on cruise control. While measures of implied (expected) volatility dropped in the aftermath of this dual update, the underlying speculative markets would not match with a charge higher. US indices, the best performing of the major assets I follow, marked a technical high with no  meaningful progress. Where we could have mustered some conviction through associated risk measures playing catchup to the SPX, there two we were met with hesitation. That doesn’t mean that market has completely blown its opportunity to rouse conviction; but it draws serious, negative attention. A market that rises despite trouble in backing fundamentals and underlying value suggests a speculative default. That same backdrop failing to progress when concrete support is presented is troubled. 
    The Last Liquid Week of the Trading Year
    Liquidity is exceptionally important when you are trading the markets. A good example of what happens at the opposite ends of the spectrum is the day-to-day activity by one of the top shares in the world (say Apple) and those that are on the ‘pink sheets’. The former can build on its gravity to progress a bullish run further than smaller counterparts from sheer size while also curbing panic selling that may otherwise afflict counterparts as its scale can be interpreted as safety. Alternatively, the smallest shares move in often erratic day-to-day swings and frequently see their value wiped out when risk aversion hits the broader financial system. Fundamental and technical analysis counts of course, but market depth and fluidity is a principal influence. 
    Consider this for what we face over the next two weeks. We are heading into the final thrust of the trading year. Ahead, we face the last full week of the trading year. We’ve seen a clear deference for a risk-on bearing and predisposition towards keeping exposure fairly steady (no profit taking or meaningful hedge build up). Anything other than a slow volume trade of consolidation should be observed closely. A significant climb in capital markets would reflect an ‘all-in’ mentality that would register as quite extreme. Such a climb could be a cue for investors to launch a strong 2020 start, but it could also readily turn into a blow off top when it comes time to reassess value. Alternatively, any meaningful retreat given the prevailing winds, seasonal backing and sliding liquidity could signal risk aversion that is ready to override all the typical hurdles. Be mindful of the market’s next move and the quick assumptions that will be drawn from it. 
  25. JohnDFX
    From the Data, Growth is Top Concern Again 
    If we were to gauge how much market movement is arising from scheduled event risk relative to those unexpected winds from the headlines, I would put greater emphasis on the latter. That can make for difficult trading conditions considering updates like the coronavirus spread do not abide a clear time and distinct categorical outcomes. In this kind of environment, it is more difficult to establish clear and productive trends as there is not a clear thread to be draw enough interest to hit critical mass. Instead, we are left with the risk that otherwise important updates could come at any time – bullish or bearish – which leaves a clear footprint of caution among those participants in the market. Jolts of volatility with unexpected breaks and limited follow through to quench traders’ thirst is instead the norm. It is very possible to adapt one’s own approach towards the markets with this backdrop in mind – even if the result is greater caution, shorter duration and fewer trades. 
    As far as the data is concerned, there are a number of themes and regions to watch over the week before us. However, I will once again keep my principal focus on growth. That is in part because the ebb and flow of coronavirus headlines are leaving a tangible concern around the cumulative impact on growth – much like trade wars in previous months. Yet, from the economic calendar itself there is plenty to give direct insight on the health of key economies. In the first half of the week, we have Japanese 4Q GDP along with a growth forecast update from the Eurogroup and Bundesbank. The more comprehensive reading though is the February composite, manufacturing and service sector PMI releases from Australia, Japan, Germany, the Eurozone and the US, chronologically. That is a comprehensive and global overview of growth. Will it be market moving? Look to see how receptive the market is prepared to be for this more ‘mundane’ theme. 

    ‘Markets Fall on Coronavirus’ and ‘Markets Rise on Coronavirus’ 
    When it comes to fundamentals, there can be a steep learning curve to make the analysis technique functional in the average person’s arsenal. It isn’t surprising that there is only so much time to dedicate to this venture for many (even when it is their money at stake) or when they encounter too many instances of the analysis lining up without the commensurate reaction from the market. This often leads to statements like ‘these markets don’t make sense’ or an appetite to fall back on the more accessible technical side of the markets. However, I find one of the most important factors in interpreting fundamentals is to find what the most important and influential themes are to the greatest portion of the market and calculating a distinct interest into the equation when one shows itself through the noise of an overwhelming range of various factors pulling at our attention.
     
    As far as the systemic fundamental influences go, it seems that the intense but muddled impact of the coronavirus (COVID-19) still flashes its control over the markets. The warnings of tangible economic toll on the economy from this contagion are added to each week. This past week, the Federal Reserve and European Central Bank reiterated the risk through the official testimony of their respective heads while a number of their members issued individual remarks to much the same effect. Supranational groups are also warning caution. Standard & Poor’s offered the most prominent caution when it cut its 2020 GDP forecast for China by 0.7 percentage points to 5.0 percent while global growth could see its pace trimmed by 0.3 percentage points – China does account for nearly a third of global expansion. The importance of this risk is clear, but the influence is starting to be taken for granted to the point that seemingly every rise and fall is either the direct influence or allowance of this novel risk. In fact, if you check the worldwide search interest in Google Trends the past months containing the worlds ‘stock’, ‘market’, ‘falls’ and ‘coronavirus’ the results are almost exactly the same as ‘stock’, ‘market’, ‘rises’ and ‘coronavirus’ (see the attached picture). This is a short-cut many take in assigning a universal influence on a popular theme, which will inevitably breakdown and draw out the ire of investors attempting to follow the logic. Remember to always evaluate what the dominant fundamental theme is and acknowledge that this influence changes hands while also passing through periods where it dilutes across many different matters.
    Intervention in the FX Market Is Not That Uncommon Nor Is It Effective 
    This is a topic I have touched upon previously in the context of the US Dollar and its supposed purity in the eyes of those that observe liquidity as a virtue. There is little doubt as to the currency’s superior depth as the BIS numbers are very clear on the status. However, that position doesn’t mean that outside forces will not attempt to nudge the market in a perceived favorable direction. Most notable in the hierarchy of critics as to the level of the benchmark currency is the US President Donald Trump who has repeatedly accused global peers (China, Japan, the Eurozone) of depressing their own currencies for competitive advantage while simultaneously lambasting Fed Chairman Jerome Powell for the period of monetary policy normalization that he claims has robbed the Dow of ten thousand points and driving up the Greenback. Given the complicated fallout that would follow attempted manipulation of this particular global financial lynchpin, I will continue to monitor it without my typical deep-seated doubt – as this White House is proving reliably unpredictable and the unexpected carries such a serious impact. 
    In the meantime, there are more proactive efforts to alter the course of different currencies out in the wild. This past week, Brazil’s central bank let it be known that they had acted (via 20,000 swap contracts) to prop up the Real. The USD/BRL had advanced to record highs five consecutive sessions, leading the group to take action in an effort to break a slide that threatened to gather further speculative momentum. In the context of the average daily turnover of this very actively traded currency (it is one of the BRICS), the scale of the intervention could not be overwhelming the market through sheer volume. Instead, the idea is to shift market sentiment to align to the effort. Japan attempted the same back in 2011 to 2013 to very disappointing result. While Japan’s Ministry of Finance and Bank of Japan are still attempting to passively guide the Yen lower, there desperation has waned and so have their threats. In contrast, Switzerland has maintained the threats against the Franc as EUR/CHF – the focus rate for Swiss officials – has extended a decline to the lowest levels since third quarter 2015. As the markets continue to rebuff efforts of manipulation, believes of monetary policy ineffectiveness grow, pushing countries further into competitive devaluation and restrictive trade-based policies.

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