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JohnDFX

DFX Market Analyst
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Blog Entries posted by JohnDFX

  1. JohnDFX
    Trump Using Mexico as a Trade War Warning to China?
    In a surprise move, the United States is now fighting a full trade war on two fronts as of this past week. With the path to a US-China compromise still lacking any clear hand holds, US President Donald Trump announced a wholly unexpected  economic move against neighbor Mexico this past Thursday evening. According to his tweet, the United States would charge a 5 percent import tax on ALL Mexican goods coming into the country as of June 10th. He further made clear that this was move not in retaliation for trade issues – in fact conditions had seemed to improve significantly on that front with the US dropping the steel and aluminum taxes on both of its direct neighbors in a bid to push through the USMCA agreement. Instead, Trump said that this move was in response to his administration’s frustrations with illegal immigration from Mexico into the US. This political move drew serious consternation from a number of officials and institutions. Aside from the obvious Mexican bewilderment and condemnation; it was reported that Trump’s senior advisers (Mnuchin and Lighthizer) had argued against the move, Congressional members on trade and finance questioned the motivations and the economic impact and business groups in the US moved to bring legal action in a bid to prevent the inevitable hike in their supply chain costs (GM for example produces an estimated 30 percent of the cars it sells in the US in Mexico and could absorb a $6.3 billion hit). 
    We are starting to see some of the disparate systemic themes that have individually pulled at the markets – trade wars, political risk, growth concerns – begin to converge. There is little doubt that the growing chants of impeachment from some portions of the Democrat party are pushing the President to a more aggressive stance with domestic and foreign policies. Looking to secure a ‘win’, he is attempting an alternative route to curb illegal immigration to circumvent the roadblock in Congress. This solution, however, carries serious threat to growth and diplomatic relations; and the possibility of an alternative source of support via an a delicate infrastructure spending program negotiation which would rely heavily on Democrats seems a non-starter. 
    As this new fissure grows, it is important not to forget the extraordinary and expanding risk from the US-China row. It has been a few weeks since the US hiked the tariff rate on $200 billion in Chinese imports from 10 to 25 percent and China’s matching retaliation on $60 billion in US imports (which went into effect June 1). The mood has only further soured since this salvo. The banning of Huawei – China’s largest telecommunications company with a global presence – has lead to considerations of a response through Apple, using rare earth materials and reports of a recent draft on US companies that could be partially or completely blacklisted. Theoretically, the US is counting down to an expansion of the goods it is taxing to encompass all of China’s imports, but that timeline doesn’t look solid. The US and Chinese Presidents are due to meet at the end of the month, but a lot can happen between now and then. What’s truly worrying is that both sides are increasingly favoring escalation in a bid to break their counterpart’s will – a game of economic chicken. 
    Ignoring the Fallibility of the Dollar’s Reserve Status  
    There is general acceptance that the Dollar is the world’s most liquid currency backed by the largest economy and market. That is easily confirmed through data, but with these statistics comes a level of undeserved assumption. Because the country is a superpower and the use of its currency around the world accounts for nearly two-thirds of all global transactions, it is assumed by many on faith that these standings are permanent. I would venture a guess that the British felt the same way 100 years ago, the Spanish 300 years ago or the Romans two thousand years ago. Looking far enough into the future, the US Dollar will not be the principal means of transaction, whether that leads to a direct and singular counterpart (Yuan?), an aggregate (the long-fabled effective SDR) or the era of the blockchain. Regardless of the next epoch of money, there was an inevitable move towards evolution as the rise of global trade and spread of wealth around the world raised issues with transacting through third parties. 
    The bottleneck risks from a common currency were further exposed in the last two financial crises. The excess leverage produced by the Dot-com bust was particular acute in the United States which witnessed a convergence of economic strength, favorable policy and supportive regulation to land on an investment phenomena. When the excess peaked and started to cave in on itself, the fallout was transmitted to the rest of the world. The following financial crisis in 2008 was even more obvious in its amplification of a US-originated problem (subprime housing) tipping the global dominoes until an unprecedented response from the world’s policymakers was the only feasible means of restoring stability. Many governments and institutions in the aftermath of this worldwide crisis stated some level of need to mitigate future contagion risks by reducing their unchecked exposure where possible – including the dependency on the US Dollar. Yet, the haste to make this shift was throttled initially by extreme monetary policy creating fragility in domestic financial paths while the economic expansion also encouraged feet dragging. That landscape has shifted however in recent years with a slowdown in global growth that looks natural in the waning light of the cycle while barren monetary policy stores looks increasingly incapable of holding back any storm tides. It is in this troubling convergence that populism has taken hold. Policies that favor domestic growth at the expense of shared expansion lowers the aggregate potential for the global economy but it sells well to the electorate. The Trump White House has certainly seized on that fervor with the President pushing for trade policies that look to correct perceived imbalances. 
    If the US kept its fight isolated to China, there would be little outcry from other developed and developing economies that have felt the Asian giant’s policies unfair. That said, the US has embarked on a global fight with the metals tariffs from last year, the emergence of the Mexican tax, lingering threats made against Europe and the lurking consideration of a global auto import tariff. When the world’s largest consumer raises barriers, it can be difficult to retaliate in a meaningful economic way. However, when there are many countries that share the burden and willing to cooperate in order to ease the pain – and deliver some punishment – there is greater capacity to retaliate as a group. A plan to pullback on economic ties to the United States translates into a diminished use of the US Dollar which in turn reduces the need to hold the country’s currency and risk-free debt as a financial balance. That accelerates the seismic tide changes in currency dominance and economic position. Add to that the pressure through forced sanctions (such as the demands to trade partners to stop doing business with Iran) and the need for an alternative route increases further. Even at this pace, it will be a very long time before the Dollar is fully supplanted, but the measurable influence will show through far more quickly. 

    A Jostle of Growth Data, Monetary Policy and Brexit Ahead 
    My number one rule for the successful employment of fundamental analysis is to determine which theme or themes will carry the greatest potential influence. It seems intuitive, but many traders will end up assuming far greater weight to every known event – especially those that are prescheduled – than is reasonable. And, when you assume greater influence for every eddy in the market’s stream, you inevitably drown out those factors that are truly market moving. In gauging the fundamental landscape ahead, there are both themes and specific events that hold the potential of significant volatility or trend development if they render the proper outcome. Aside from the dominant force of trade wars, monetary policy will be a substantial influence over the coming days. The most pointed events in this vein will be the RBA and ECB rate decisions. According to overnight swaps there is an approximate 95 percent probability of a rate cut. That degree of discount means an actual cut is likely already priced in, so the Aussie’s response will depend on either the language in the aftermath of the cut or a surprise hold. As for the ECB, they have already made their dovish move a few months back with a hold on any intent for rate hikes and the deployment of the LTROs to compensate for the end of QE. This is a mess of exit from extreme easing and it leaves serious questions about the health of the global economy and financial system. In addition to these two policy calls, we have a host of central bankers speaking including the chiefs of the Fed (Powell), BOJ (Kuroda) and BOE (Carney). 
    Another collective theme that will find significant prompting ahead will be the general concerns for the state of economic growth. We have received most of the 1Q GDP figures at this point, but Australia is due its own figure. Instead, we will look for more timely metrics that act as good proxy to the big picture. There are a range of monthly PMI stats for May due – though the US and European figures are ‘final’ measures. The US ISM metrics are given considerable credit as are Japan’s quarter capital spending report, the US quarter net household wealth and NFPs data. It is not the concentration for any single economy that matters here but rather the breadth of the statistics that can form a clearer picture of global growth. With the growing interest in market measures like the US yield spread, this stands to be an important theme ahead. 
    In terms of region-specific event risks that are worthy of our close watch, I will dedicate significant mental energy to following the progression of the Brexit situation for the Pound and the EC-Italy fight for the Euro. on the former, the British and European conversations on terms for divorce are actually still on ice. That is due to the long reprieve afforded the Article 50 extension but also the state of politics in the UK. Prime Minister Theresa May is due to step down on Friday and the leadership battle is clearly underway. The PM’s shortcomings and the EU Parliamentary election results are likely to encourage support for a candidate that is more friendly to using the no-deal outcome to make progress on the separation. That of course means greater uncertainty and preemptive capital flight as the markets await the fog to lift. In Europe, the cohesion among EU members will come under scrutiny with a number of events scheduled around the state of play in Italy. PM Conte was shown strong supporting in the EU Parliamentary elections, and he is looking to pull together the various countries’ nationalist seats. Given their stated policies, a loosening of cohesion to the foundations of what holds the Euro together will be a consequence. Alternatively, the European Community is not simply waiting for the disruption. The group is due to take up its review of Italy’s breaking financial rules, which Deputy PM Salvini recently warned could land Italy a 3 billion euro penalty recently. 
  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
    UK Parliament Votes to Delay Brexit Deal, Now What? 
    Heading into the weekend, overnight implied volatility behind the Cable and other Pound crosses had charged to their highest level in over two years. That reflected well the fundamental weight represented by the first Saturday sitting in the Commons in 37 years. Parliament convened to debate the government’s withdrawal agreement bill which Prime Minister Boris Johnson managed to hash out with European negotiators during the EU leaders summit. The compromise came at the last possible moment as the law passed by MPs before their proroguing required Johnson had a deal in hand by October 18th or he would be required to send a letter to European officials requesting an extension for negotiations to avoid a no deal outcome. It was telling that the progress towards avoiding a hard Brexit scenario to this point had seen GBPUSD charge its biggest 7-day rally in decades yet anticipated volatility had soared in tandem. That speaks to the level of speculation going on and the very convoluted situation with which we are dealing. 
     
    Ultimately, Saturday’s vote would confound the momentum that had built towards a tangible deal and in turn trip up the speculative charge that had gained such remarkable purchase these past few weeks. The MPs voted 322 to 306 on the so-called Letwin amendment which would withhold approval of the deal until legislation was in place. That would in turn trigger the ‘Benn Act’ which required to the PM to send a letter requesting an extension from the October 31st deadline out to January 31st. The government did this begrudgingly along with a second letter in which Jonson made clear he believed a delay would be a mistake. The impact that this has on the market is inevitability convoluted as the array of scenarios for the ongoing negotiations is itself complicated with options. Though the deal was not pushed through, the effort to delay is principally based on an effort to push back a no-deal outcome in a bid to permanently prevent it from ever coming to pass. Nevertheless, the intensity of the recent charge is compounding speculative appetite that will likely be frustrated by this turn of events. A swift retreat that could then turn to contemplative balance. It is possible that the EU could reject the request to push back the decision date which would send a shock of panic through both the Sterling and capital markets, but that is a low probability. 
    Granting the UK an extension that only lasts a few weeks rather than three months would leave very little time to accomplish anything other than an approval of the offered withdrawal agreement or risk reviving the no-deal scenario. Some European leaders want to know what will be the point of offering an extension – coming to agreement on the given deal, general election or perhaps referendum. The pressure will remain in all of these scenarios, but the intensity will be greater depending on the immediacy of the scenario. Meanwhile, the government officials (the Foreign Minister) have stated their belief that they have the necessary numbers to push the current deal through Parliament. It has been suggested they will call for a ‘meaningful vote’ and possible seek to work through the details of the current deal in order to find the majority that Johnson needs to move forward. To Pound traders and foreign investors, this will look like general uncertainty which is naturally reflected as volatility. Committing to a particular course for a market steeped in such instability will be exceptionally risky. That kind of scenario will draw more speculators than steadfast investors, only compounding the situation. Beware trading GBPUSD this week. 
    A Serious Escalation of the Global Trade War…Underappreciated
    Despite efforts by the European Union’s trade delegation to negotiate a compromise, the United States Trade Representative’s (USTR) moved forward with slapping hefty tariffs on certain EU imports. The White House will not be easily swayed with this push as it considers the effort to be sanctioned – at least partially – by the global community. The World Trade Organization (WTO) found that the US could pursue corrective measures against the EU to the tune of $7.5 billion for what it considers harm done through unfair subsidizations for the Europe’s principal airplane manufacturer, Airbus – never mind the group found the US guilty of similar practices in favor of Boeing, it just has yet to rule on the amounts that can be pursued. While the lack of ground the US is willing to negotiation is a general problem that the whole world is experiencing, the particular trouble for the EU is in the products that are being taxed. In addition to the expected 10 percent tariff on imported airplanes, the US has also imposed a 25 percent hit to certain agricultural products and there was also reports they were pursuing industrial goods as well (though that isn’t yet clear in the details). These unrelated industries to the initial dispute register as economic aggression that urges retaliation. 
    Remarkably, despite what this situation would insinuate, the coverage around its unfolding has been particularly light. In part that is likely owing to more immediate concerns such as Brexit, the US-China stand off and regular warnings of economic lethargy. Just as crucial to the limited impact is the lack of retaliation from European officials. That is unlikely to last. In a best case scenario – short of an unexpected compromise – would be Europe waiting until the WTO rules on the notional amount it can pursue against the US for the Boeing finding. That could keep this additional threat to the already fading growth forecast at a simmer rather than rolling boil. Yet, there is considerable debate among European officials on how to act. Germany’s Finance Minister has urged his counterparts to hold off on retaliations to allow for negotiations to work and likely to avoid a high probability path of steady escalations that seems routine with the US. On the other hand, the EU’s Trade Minister warned before the official tariff start date that they would have “no alternative” but to take countermeasures if Washington wouldn’t deal.
     
    If Europe moves to counter the US, risk trends and economy watchers will pick up on it readily. We may find some grey area should retaliation be held to what is considered like-for-like for industries unrelated to airplane manufacturing. If that is the case, the US may not be quick to cry foul and escalate, particularly when they are distracted by so many other issues nowadays. Alternatively, if they are spoiling for a fight and looking for a reason to spread their self-labeled righteous efforts to rebalance trade practices around the world, the Trump Administration could make another sharp response in a shock-and-awe approach. Ultimately, we will not be able to avoid that recession that seems to be lurking at the fringes if the two largest economies in the world decide to gouge the trade between them. 
    EURUSD Launches a Rally, But From Where? 
    There is a lot going on in the FX and global capital markets, so it is understandable that some significant movement in some of the less-trafficked corners of our charts goes overlooked. Yet, that doesn’t suit the EURUSD. The world’s most liquid exchange rate (and arguably asset) has accelerate a bullish reversal that began with the month. Technicians would recognize the move for being the strongest two-week advance in approximately 13 months. From there, the technical boundaries that we’ve overcome – like the 3-month descending trend channel – carry some weight of their own. But what makes this effort particularly remarkable in my estimation is the starting point. Through the end of September, the pair was trading at its lowest level in two-and-a-half years. Adding to the interest in the move is the context of a market that has proven remarkably stagnant. Sure, we were plumbing new lows, but the decline was coming in starts and fits with a very gradual descent which reflected well on the broad restraint this benchmark has exhibited for the past 17 months. Are we finally seeing volatility restored to a pair that has successfully avoided large swings for that long? 
    To interpret the probability of a transitional period, we need to understand what has steered the market through its restrained routine thus far. Why has EURUSD been so controlled? While some believe this is an anchor born of two reserve currencies, I suspect that we are witnessing the confluence of multiple competing forces. Safe haven capacity, relative growth and now trade war implications are just a few of the more exceptional forces jostling these currencies. It is very likely that these matters take up a bigger role in their relative performance into the future. Yet, at present, the bullish reversal from EURUSD has a few interesting properties to perhaps highlight what is the most interesting matter at present. This past week, the Euro didn’t show a broad rally across its major counterparts and EURCHF in particularly made no effort to reinforce. Alternatively, the Dollar made a fairly broad retreat. Realization of trade war blow back, recognition of the struggling economic data or political uncertainty may all be contributing to the slide; but I think a more familiar catalyst is responsible: monetary policy. Through the end of the past week, the probability of a third consecutive rate cut from the Federal Reserve rose to 89 percent according to Fed Funds futures. That is a significant escalation from a week ago and up from little more than 20 percent a month ago. If this is indeed the root of this ground swell, thing should get more and more interesting as we approach the Fed’s October 30th meeting.
  4. 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. 
  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
    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
  7. 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.

  8. 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
     
  9. 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
  10. JohnDFX
    Positioning Extremes Grow More Extreme 
    There are a few undisputable and universal forces when it comes to the financial markets. One of those all-powerful winds is the concept of risk trends which is referred to by many names such as ‘risk on, risk off’ or referenced unknowingly when we blindly attribute market wide movement to animal spirits through technical cues, smart versus dumb money, panic to greed. Another of these truisms is the allocation of capital. While total wealth does grow and contract, it is apportioned to some market whether that is emerging market equities to US Treasuries to home mattresses. In a global market, there is also distribution to different regions according to what country or collective economy presents the best opportunities. And, from this parsing of investment preference; we can learn a lot about the market; but one of the most elemental solutions is the global market’s general bearing for sentiment (the risk trends referenced before). There are no easy, definitive measures for allocations across such a wide universe of markets, but there are various measures for specific areas and key ports for which to apply measure such that we come to a good understanding of the markets’ health. 
    One of the most basic measures of preference on a regional basis is exchange rates. We have seen the USDCNH surge the past few months showing capital leave China and enter the US. That is likely a bi-product of trade wars and can signal deeper problems for China if they risk signaling to the world that there is capital flight that can disrupt their efforts to promote stability between economy and market. Given that there is certain control that Chinese authorities have over their systems, we could get more complicated in the evaluations by comparing the USDCNH to the USDHKD, look to derivatives or wait for the lagging economic data like the TICs from the US. Another good equivalence is the performance of ETFs. These derivatives are quickly becoming favorite products for global investors due to their supposed risk reduction through diversification (we heard the same thing with AAA rated subprime housing MBS 11 years ago) and the wide range of coverage they offer. There are measures of capital flowing into and out of specific, liquid ETFs (ie SPY, TLT, FXI) as well as general groups (all equity versus all bond). 
    Another measure of positioning is the use of leverage. We may not know what people are doing with their cash in many instances, but the use of borrowed funds is often better tracked as the ‘investors’ (or lenders) want to know their exposure. As it happens, in the US, there is record use of leverage by investors, consumers, corporations and the government. Further measures of positioning are the sample readings like that on the DailyFX Sentiment page which shows retail traders (who have a very short time frame and primarily fight existing trends) and the CFTC’s COT report of speculative futures. From the latter, this past week has shown a dramatic swing in Dollar interest from the biggest short in 5 years to the heaviest long in nearly 2 (all in a few months), Treasury net short has hit a dramatic record low, and gold flipping to net short for the first time since 2002 among other surprises. There is a lot to learn once you know what to look for and how to put it into context. 
     
    A Lesson from the 2013 Taper Tantrum Applied to a Global Scale 
    Back on June 19, 2013, then-Fed Governor Ben Bernanke announced that the US central bank would begin to ‘taper’ its theoretically open-ended bond buying stimulus program (known as QE3). By the time he stated their intention, the market had already suspected this was going to take place owing to the language of the group and the performance of data coming out of the economy. However, the announcement had a significant impact nonetheless. What resulted was termed the ‘taper tantrum’. In response to this news, US Treasury yields shot higher as the markets largest sovereign debt buyer at the time announced their intention to reduce purchases moving forward. And that had a material economic effect as the cost of US Dollar-based loans – particularly for foreign buyers who had exchange rate risks – started to shoot higher. 
    It therefore comes as little surprise that emerging market corporations that borrowed funds in Dollars shuddered at the news, and the EEM Emerging Market ETF showed the discontent. However, after some months of fear, conditions stabilized and borrowers and investors acclimated to the notion of higher costs. Even if they were exiting the active rate-depression game, they would still be low for a long period of time. What’s more other central banks like the ECB, BoJ and others were still at or near record lows with some pursuing equally massive stimulus programs. As such, complacency returned for some years after. Yet, where are we today? 
    We still have that telltale complacency – as mentioned above – but the foundation of confidence has continued to erode as global central banks have reached the end of the road. Either they are willfully plotting their own exit from their extraordinary accommodative states (like the ECB, BoE, BoC) or they are floundering as the market realizes they have essentially reached the extent of their influence (BoJ, SNB, RBNZ). Financial markets from equities to real estate have performed remarkably well in the interim, but economic activity and inflation plateaued long ago. That has produced an elevated risk exposure without the economics to fund the exposure. So, with exceptional risk, moderate economic potential, external pressures increasing (trade wars) and central banks either easing back or losing tractions; it is worth evaluating that 2013 ‘taper tantrum’ and consider what the possible implications would be if we raised the stakes from one country to the world. 
     
    Jackson Hole Symposium and US-China Trade Top Event Risk
    The coming week carries one of the most deflated expectations for seasonal activity for the financial markets. The Labor Day holiday for the US (September 3 this year) traditional signals a change in ‘Summer Lull’ activity to a more active and liquid Fall trading. These activity levels are as much self-fulfilling prophecy as actual liquidity phenomena, but it occurs nevertheless. However, a footnote here before we analyze further. There are some dramatic examples in our recent past where volatility as exploded in August despite the conventions. The 2015 market-wide tumble triggered by Chinese exposure fears began in August and the same month in 2011 led to global losses for shares and other risk assets as the Eurozone debt crisis unfolded. We should never rely on market parables when we are employing our capital – especially when so many global risks are so plain, such as a possible Chinese crisis arising from the US-China trade war or Italy threatening Euro-area stability to register as echoes of history. 
    This said, the standard global economic docket is particularly thin over the next five days of active trade. It would be fitting to assume the markets are just going to drift down a lazy river if we did not appreciate the broader context. While the biggest risks to our immediate future are likely unknown fundamental waves, there are two themes that are scheduled and we can follow as they unfold. The first is the US-China trade war. The US Trade Representative’s office is expected to hold a public but off-camera hearing on Chinese tariffs throughout the week. It is worth reminding that the Treasury has left public feedback open until early September until they decide on whether or not to proceed with the $200 billion in new tariffs President Trump threated some weeks ago. More promising, US and Chinese officials are due to restart trade talks on Thursday and Friday. It was reported that this meeting will start to build a map that can take the countries back to more favorable terms such that the countries’ two Presidents can agree at the highest level when they meet in November. 
    The other high-level event to watch over the coming week is the Jackson Hole Symposium. The annual meeting of central bankers, business leaders and key financial lawmakers hosted by the Fed can cover crucial developments in global markets and the economy. The official theme of this conference is ‘Changing Market Structure and Implications for Monetary Policy’, but expect the conversation to touch many of the key themes mentioned above: global retreat from extreme easing, the failing effectiveness of stimulus, global pressures via trade wars and the extremely inflated levels of global capital markets.
  11. JohnDFX
    Growth Takes Center Stage with Peoples’ Congress and OECD Forecasts 
    Most investors and traders attempt to project into the future in order to take advantage of large market moves before they are priced in and the trend potential is spent. That is perhaps the most basic precept of speculation, yet it also brings with it a range of collective cognitive biases. One such mass psychological distortion is a prioritization of the means over the ends. When looking back to the 2008 financial crisis, there is often specific reference to the US subprime housing market implosion while 2000 is referred to as the Dot-com bubble owing to the remarkable outperformance followed by decline of technology shares. Both situations were charged by excessive leverage and resulted in both financial and economic pain, but they are best remembered by their ‘touch off’ event. Why is that? As pattern recognition machines, humans want to avoid a repeat of a painful event from the past, but we don’t always bore down to the root of the problem – especially when the situation is complicated or inconvenient (such as chasing mature and fundamentally dubious trends). At present, we have a range of high-profile fundamental themes that could ease experience another flare up that coincides with the eventual turn of the markets (trade wars, monetary policy flub, fiscal policy flub, political crisis, diplomatic relationships breaking down, etc). 
    Yet, in a neutral market environment, all of these issues could be absorbed readily with little more than a brief injection of volatility. To see the market reverse course systemically, the fuel is more important than the ignition. As with most other periods of extravagant speculative reach – which have subsequently turned to collapse – we are dealing with an overabundance of leverage across the global economy. It doesn’t matter if we reference location (US, Europe, Asia) or participant segment (consumer, investor, businesses, governments), there is an exposure issue. As extensive as the risk may be, it doesn’t necessarily reach an obvious or quantitative level of critical mass whereby it collapses upon itself. As the saying goes: ‘the markets can remain irrational longer than you can stay solvent’. That said, recognition across the market that the ‘fundamentals’ are extremely divergent from the prevailing levels in the market will eventually trigger a cascading of hold out sentiment capsizing under the recognition. Arguably the most incontrovertible evidence that value does not align to speculative ambition are broad measures of economic health like GDP. We have absorbed most of the 4Q GDP readings from the US, Europe and Asia over the past month, and the general consensus is one earning clear caution. Of course, the period may prove a lull or a true turning point, but only time will bear that out. 
    Yet, the impatient, speculative nature of the market may dictate determination before the data has a chance to verify months after it occurs. More timely data and surveys are therefore consumed veraciously as market participants perform their qualitative or quantitative assessments. References to historical, market-based patterns (such as the yield curve) grow in popularity. All this said, there is still greater weight attributed to ‘official’ figures. In the week ahead, we have a few important updates that will represent ‘official’ benchmarks. For the trade war-racked Chinese economy, the effort to throttle a debt-fueled explosive expansion threatens to trigger an unwanted rapid economic slump. How genuine a risk is this from a country where data is just as regularly second guessed? Their own growth target provided in the official Peoples’ Congress is one of the most insightful measures we find from the world’s second largest economy. In the meantime, the developed world will see a more comprehensive update to its growth forecast from the OECD who will release its updated projections mid-week. The more sensitive the reaction to these data points, the more worried about basic growth the market is. 
    Monetary Policy and a Possible Repeat of History for the ECB
    The world’s largest central banks have taken a noticeably dovish shift over the past year. Many were unnerved by the disruption in global markets through the first half of 2018, but the second extreme bout of volatility in the fourth quarter and subsequent downturn in the economy in that same period has pulled most holdouts into the same camp. In recovery that unfolded after the Great Financial Crisis, monetary policy authorities played a critical role in fostering the revival of investor sentiment and economic stability. Yet, their efforts over the past five, where the more extreme expressions of monetary policy hit their stride, resulted in far less productive economic return (inflation and growth). Not official objective, but nevertheless a sought-after result, additional waves of stimulus have also seen progressively less appreciation for local capital markets (targeting a ‘trickle down wealth effect’) and even a disconnect from forcing a trade-supporting depreciation in currencies. While in previous years this was not a mainstream topic of conversation as the impact was nuanced and there were supporting factors concealing the erosion of efficacy, it is now a glaring disconnect that the market is instantly wary of should reliance of economic health shift back onto the banks’ shoulders. 
    This may be a trial that we are not able to avoid as the global economy sputters and the world’s governments’ show little interest or capacity to collaborate on a scalable solution. Thus far, most of the movement towards a more accommodative monetary policy position – from the already ‘crisis’-level setting for most – has been verbal. However, action may soon be on the way. Swaps are pricing in modest probabilities of rate cuts from the Fed and RBNZ with the RBA sporting a high probability while the Bank of Japan continues to inject stimulus with reckless abandon. The most overt signal to the global financial system that central banks have lost control would come from the European Central Bank should it decide to act. The group has just capped its progressive easing effort as of December and it finds itself already at the extreme with negative rates along with a massive balance sheet. Unlike the Fed, the ECB hasn’t given itself enough time to reestablish a buffer to employ further support should push come to shove. That said, the group has started to signal growing caution and seems to be testing the market’s reaction with thinly veiled suggestions of another policy adjustment. 
    Despite this, going back to the QE program is not an option while further rate cuts deeper into negative territory would only prove the current settings are ineffective. Another tool has come back into the conversation from the Eurozone debt crisis days: LTROs. While not the same stigma as quantitative easing, it is nevertheless a tool looking to do the same thing – coax along stubborn economic recovery. The last time this central bank connected policy to economic trouble (at the time, it said the interest was deflation sustained by a too-strong currency), the side effect was an incredible 3,500 pip slide in EURUSD. If even a portion of that depreciation were realized today, the competitive trade environment would almost certainly trigger a currency war. And, in this environment, that would almost assuredly result in a stalled global economy and financial crisis. 
    There is More to Trading Than Spotting Explosive Breakouts and Trends 
    This is something I have written on before, but it is so important that it bears repetition. There is more to trading than spotting fantastic breakouts or riding enormous trends. These are the kind of market developments that can result into large profits if properly navigated, and the former tends to render those large returns more quickly. Large returns in a short timeframe is what every market participant is looking for, but these events are statistically infrequent and require considerable discipline to exploit. So, those seeking these conditions are projecting improbable regularity and they more-often-than-not do not have the experience to properly pilot. That is not a successful strategy. 
    In contrast, range or congestion-based markets are historically the most common environment. Further, the shortened time frame of market moves, the greater compliance to technicals and a more forgiving connection to fundamentals (events and themes) makes for a backdrop that is far more aligned to the average traders’ tendencies. So, why do so few traders look to take advantage of these conditions? There are a multitude of reasons but among the most common are an unrealistic appetite for extreme returns in a very short time frame as well as a misconception of what successful investors are (everyone wants to be the hedge fund manager that makes an incredible account doubling return on one trade). 
    This digs not into the conditions of the market or even strategy in particular but rather it speaks to trader psychology. If we can change our objective to more timely trades with reasonable objectives that lead to respectable returns over time, we will naturally align ourselves to more readily take advantage of the market. Now, this is not to say that we are always navigating a range-based market – only that such settings are the most common. The most prepared market participant is the one that has a different strategy or adaptations of a single strategy that are more appropriately attuned to range, breakout and trend environments. Of course we also need the tools to assess which setting is currently on display. 
  12. 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. 
     
  13. 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. 
  14. JohnDFX
    Risk Trends – Monitor Liquidity Closely 
    Sentiment is turning increasingly septic across the financial markets. This past week certainly wasn’t the first week that signs of trouble were starting to show. However, a clear capitulation by one of the favorite benchmarks of hold-out bulls – US indices – has undermined one of the few reliable backstops left. The S&P 500 and Dow have been in retreat through much of October after hitting their respective record highs. Up until this past week, the slip still fit the mold of a measured retreat for which the ‘buyers of the dip’ have flourished. Yet, the past five-day stretch added a troubling gut punch to the opportunists’ gut. The major American indices, paced by the S&P 500, crashed through their respective multi-year bull market trendlines. While Wednesday’s 3.0 percent tumble was particularly acute, it was Friday’s more restrained drop that was perhaps more remarkable technically and a record setter. The gap lower on the open was the biggest in almost exactly 10 years (2 days off during the height of the Great Financial Crisis) and the largest on record. Furthermore, it the move that would treat a former critical level of support as new resistance. With this symbolic risk leader removing its support, we may find one of the most critical contributors to keeping the peace allowing progress as we slide into deeper retreat. 
    As we keep track of this small sliver of the financial system, comparison to deeper and more productive retreat for global equities (VEU), emerging markets (EEM), junk bonds (HYG) and so many other important assets will act as a sort of speculative gravity. One of my favorite measures of genuine sentiment is to gauge correlation for these various risk assets as they commit to a clear and consistent trend. Yet, where that may indicate that sentiment is in control with a viable direction, the measures of intensity are different. Two crucial elements of a market that is tipping from controlled descent into relentless deleveraging are market positioning and liquidity. For market positioning, exposure can be assessed through open interest via derivatives like futures and ETFs. The net speculative futures position monitored by the CFTC (COT) is a significant medium-term evaluation – in contrast to the short-term readings from the DailyFX-IG sentiment data. That said, there are longer duration measures that we can utilize for trends. Total open interest in futures (for speculation and hedging signals), capital moving into and out of ETFs and leverage readings for different economic participants (investor, consumer, corporate and government) can all register the state of the financial system. As these readings start to reverse course and funds begin to prioritize safety over return, we begin to solidify a self-sustaining course. However, tipping the market into a true panic with all its important implications, we must monitor the liquidity behind the market. 
    An abundance of selling overwhelming bullish interests is one thing. Attempting to unload exposure but finding no market forcing a rapid drop in price to satisfy the offload is something completely different. There are many ways to measure the strain on the system, but not all are made the same. I find many of the government (Cleveland Fed) and bank (BofAML, Goldman) measures are lagging. Spreads between market and sovereign (TED spread) or risk premium (high yield fixed income over blue chip) is more timely. Given how exposed investors are up the risk curve, the natural rolling out of the tide from higher risk and thinner markets can trigger a cascading problem in the opposite direction towards the core of the market. It is worth noting that late this past week, Japan’s central bank, Finance Ministry and financial authority (FSA) held an unscheduled meeting to discuss the tumble in equity markets (15 percent down in October). We should keep a close eye on whether more such concerns are confirmed on other points across the globe. 
    Themes Versus Event Risk for Euro and Pound 
    There are already significant fundamental winds blowing for the European currencies, but the storm will start to foster confusing cross winds in in the coming week. In particular, traders will have to untangle the influence between scheduled event risk and more systemic themes. We have seen this many times before in different asset types and different regions. How many times have we seen a high profile event draw the market’s attention in its approach only to find its ultimately impact waylaid by an unresolved and overriding theme? For this week, least severely conflicted currencies (hardly an inspiring designation) is the Euro. On the docket, we have a range of economic releases including inflation to region-wide sentient surveys. As important as those figures are, there is far more fundamental charge from the likes of the Euro-area 3Q GDP figures and Italy’s specific data. Italy will report its own GDP update, its monthly budget and other various indicators. We care about this specific country for its systemic, thematic influence. The standoff between the European Union and one of its most indebted members has hit a critical stage. 
    Italy has made clear it has no intention of backing off of commitments to increase public spending to help spur growth through pensions, support for the poor and more. Yet the Union and other member countries’ leaders have demanded change to meet the previous government’s commitments and not run afoul of the Union’s restrictions. We were here before with Greece approximately 9 years ago. If this moves forward, the situation could prove far more severe as Italy is a core member rather than a small, fringe component to the healthy system. From the Pound, the fundamental conflict will be far more substantial. The ongoing drumbeat for the Sterling is the unresolved Brexit. This has been the general state of the market backdrop for over a year and a half. However, we are fast approaching a critical deadline which looms like a cliff. They have to start decelerating now to ensure they do not pitch over the ledge. Where it seemed last weekend a breakthrough was reached when it was suggested Prime Minister May was ready to compromise on the boarder, we saw late in the subsequent week that talks within her government had stalled over strong infighting yet again. We have few definitive dates to monitor for progress through the immediate future, so we have to rely on erratic headlines instead. 
    In the meantime, the Bank of England (BOE) rate decision on Thursday carries more weight than normal. While speculation of another hike by the MPC (Monetary Policy Committee) before the end of the year has dropped off sharply, focus on policy standings has ramped up considerably thanks to the Bank of Canada’s rate hike. What’s more, this is one of the nuanced meetings for the BOE as we are also expected the Quarterly Inflation Report and Governor Carney’s press conference – which is collectively referred to as Super Thursday. Expect volatility but question trend. 
    The Unique Signal on Risk from the Dollar, USDJPY and Aussie Dollar
    As we attempt to untangle the commitment in risk trends – a worthwhile pursuit given how much potential lays underneath this evaluation – there are a few measures in the FX market that deserve closer attention for their unique readings. First in that is the US Dollar. The most liquid currency in the world, this asset is often considered a binary safe haven. It is true that the currency represents a good harbor to stormy financial markets, but there are shades of grey to sentiment and to this indicator’s signaling. In the event that we see a full-tilt deleveraging of risky exposure, there is no question that the Greenback will climb. This has less to do with the depth of the currency’s own market, and relies far more on the international appetite for US Treasuries and money markets when the walls are falling down around us. When capital is fleeing to such safety, it first must cross the exchange rate barrier. However, short of the extreme measures capital shift, the Dollar’s status comes with significant caveats. This is a currency that has also drawn significant interest as a carry currency over the past few years owing to the Fed’s unmatched path of policy normalization. That hasn’t always afforded the USD lift, but it has factored in nonetheless. 
    If we are in risk aversion that sees the Dollar drop, it is less likely to be the type that is systemic and associated to ‘panic’; while a USD surge would indicate something very different. This ambiguous picture of the Dollar can be extended to a specific currency pair as well: USDJPY. Both the Dollar and Japanese Yen respond to market sentiment as safe havens. The Yen is more appropriately ‘safe haven adjacent’ however as it is a funding currency that facilitates carry trade appetite. As confidence gives way to fear, a deleveraging of carry nevertheless sees the Yen appreciate and signals a change in course. Yet, what if the intensity picks up? The Dollar’s carry status would facilitate a drop in the exchange rate, but an extreme tempo would likely designate a more appropriate harbor from extreme fear. If it is difficult to evaluate confidence from the USD alone or via the correlation between assets, use the USDJPY as a barometer. We have done a lot of ‘preparing for the worst’. What if sentiment stabilizes and there is a rebound in risk appetite? First, it is important for me to qualify that I would not consider a bounce in risk appetite to signal a lasting trend. There are still deep, unresolved inequities between risk assets prices and their values. 
    I would look instead for short-term opportunities. One such opportunity may come with the Australian Dollar and/or New Zealand Dollar. Both are carry currencies that have lost all appeal for their carry. They further have exposure to China which is troubling and host their own domestic issues (such as housing tension). Yet, if risk trends stabilize, there is deeper discount here than more confused outlets such as the Dollar or the Yen crosses. Further, these currencies have not dropped in recent weeks’ sentiment slump, which denotes a bias that can reduce risk and leverage potential under favorable conditions. There is still key event risk to monitor ahead such as Australia’s 3Q GDP and CPI, but we shouldn’t underestimate the opportunity should the course be set. 
  15. JohnDFX
    Weeks Left of Liquidity, A Laundry List of Unresolved Fundamental Threats
    We have officially closed out November Friday and we are now heading into the final month of the trading year. Historically, December is one of the most reserved months of the calendar year with strong positive returns for benchmark risk assets like the S&P 500 along with a sharp drop in volume and significant drop in traditional volatility measures (like the VIX index). There is a natural, structural reason for this moderation. The abundance of market holidays, tax strategies and open windows for various funds all contribute to this norm. That said, there is another element that plays as significant a role in the seasonal pattern as any practical influence – if not more – and that is habit. Mere anticipation of quiet during this period does as much to ensure a self-fulfilling prophecy as the practical developments of the period. Yet, assumptions of quiet when the market as a whole – and most traders individually – have so much exposure to surprise financial squalls would be particularly poor risk management.  
    Looking ahead, it is first important to assess the practical time lines of full liquidity. The next two weeks (the first half of December) are only sheltered from unforeseen storms by expectations alone. It would be prudent to at least be engaged and dynamic in the markets through this period. The third week of the month will see position squaring take its toll on speculative positioning and liquidity. This is a useful time as we can establish where investors believe the most aggressive risk exposure is held (‘risk on’ or ‘risk off’) as they unwind anything with a shorter-duration holding period. Through the final full week of the year, the markets will be severely drained by market closures and limited time and market depth to meet the tax and portfolio redistribution windows. To general a strong market move – trend or even a severe drive – would take an exceptionally disruptive event for the financial system. I am concerned over the complacency in the market, but not so apprehensive as to believe we will tip the beginning of a lasting financial crisis through the final week of the year – and yes, it would be a bearish run if anything as there is virtually no chance of a sudden wave of greed that will bring investors back to such a fragmented and thin market. 
    That said, there is still plenty of potential/risk that conditions could deteriorate exponentially through the first half of the month owing to the convergence of structural and seasonal circumstances. In general, a near-decade of uninterrupted speculative advance has started to lose traction as market participants have recognized their dependence on extreme but limited monetary policy, the growth of securitized leverage and sheer self-enforcing momentum. In 2018, we have seen conviction built on that unreliable mix start to falter with severe bouts of momentum in February and October with sizable aftershocks in March and November. This speaks to the underlying conditions in the market that could fuel a sweeping fire if properly ignited by any of a number of systemic threats that we are tracking across the global markets. Trade wars, Fed policy, convergence of global monetary policy, lowered growth forecasts, breaks in trade relationship (Brexit, Italy, US,etc) and other issues are systemic threats that have gained some measure of purchase these past months. If there were a sudden panic spurred by recession fears for example, then the drain on liquidity naturally associated with this time of year could in turn amplify fear into a full-blown panic with systemic deleveraging into 2019. 
    Now Everything Fed-Related Carries More Consequence 
    There has been a notable shift in Fed policy intent, and the markets will be engrossed with interrupting exactly what this course correction will mean for the capital markets. Though there has been subtle evidence of a waning conviction in pace for some weeks, FOMC Chair Jerome Powell made it explicit (well, as explicit as their careful control of forward guidance would allow) in his prepared speech on the bond markets in which he remarked that the group was perhaps closer to its neutral rate than previously expected. Now, some would say that is merely practical observation that after three rate hikes in 2018, they have closed in on their projected ‘neutral rate’ range of 2.50 to 3.50 percent. We could still keep pace and extend the most hawkish forecasts and hit the top end of that scale. That is true, but we have to remember what the central bank’s primary monetary policy tool has been over the past half-decade. 
    It hasn’t been changes to the benchmark rate or adjustments to the balance sheet but rather forward guidance. They have gone to exceptional lengths to signal their policy intent without making promises for the course so that they could back away from extreme easing without triggering a speculative panic based on exposure leveraged by years of excess backed by the vaunted ‘central bank put’. If so much effort is being put into this tool, then changes should be taken seriously rather than downplayed for convenience of a comfortable trading assumption. If there was intent behind the subtle change in rhetoric, it is an effort to acclimate the markets in advance of an event whereby the forecast will be delivered in black-and-white without the ability to establish nuance before the market’s respond with speculative shock (an event like the December 19 rate decision whereby the Summary of Economic Projections will make explicit the rate forecasts). 
    If indeed this is the objective to temper the market before the frank forecast is offered, then each speaking engagement and key data update between now and then will carry greater consequence. In the week ahead, we have Powell testifying before the Joint Economic Committee, which is a perfect opportunity to slightly extend the effort to make its intentions known. Recognition of this undertaking is the first step. Establishing what it means for the Dollar with rate premium and risk trends that have found confidence in the central bank’s reassurances will be critical. 
    G20 Aftermath Produces an Official Communique and US-China Trade War Pause 
    Pop the corks. The G20 has agreed to an official communique while the US and Chinese Presidents made a breakthrough on the escalation of their escalating trade war. Yet, before we over-indulge in risk exposure build up, we should perhaps look further ahead to the hangover that confidence in which this development is likely to lead us. Typically, an official press briefing that all the leaders agree to (dubbed the ‘communique’) is routine. However, with the rise of populism in the global rank and subsequent deterioration of relationships, simply signing off a commitment to shared goals of growth and stability has become an exceptional milestone. The leading consensus heading into this gathering in Argentina was that no official briefing would be released as the United States would not approve anything that would set its America-first agenda into a negative light. Further, China would not sign off on a statement that cast its own policies as unfair trade. 
    Perhaps recognizing the deteriorating sentiment amongst businesses, investors and consumers globally; the other parties would not demand these inclusions as protest for making so little traction with their constant protests. The indirect references to US and Chinese policies were left out. That is not genuine progress but simply self-preservation. As for the more remarkable ‘breakthrough’ in US and Chinese relations, the countries’ leaders found enough common ground to compromise a pause in the rapid escalation of their trade war. For discussing key economic issues between the two countries, the US agreed to delay the increase in its tariff rate on $200 billion in Chinese imports from 10 to 25 percent due previously to take effect on January 1st. The threat made by President in the weeks preceding this gathering of adding another $267 billion in Chinese goods to the tax list didn’t seem to warrant specific reference – perhaps as a backdoor strategy or because it would assumed to be included. 
    This is a pause in the escalation of activities rather than a genuine path back to a state of normalcy where collective growth is the foundation for the global economy. This is the bare minimum for registering an ‘improvement’ in relations, and it will be this thin veneer of progress that will truly test the market’s appetite to source anything of ancillary value to build up speculative exposure. I doubt this will inspire a true effort to significantly build up exposure in these unsteady times. In years past, such a development may have spurred the next leg of a yield chase; but recognition of the risk/reward imbalance is far too prominent nowadays. The question is how long this pause in an explicit outlet of fear lasts? Long enough to carry us through the end of the year? We’ll find out soon enough. 
  16. JohnDFX
    In the Aftermath of the Fed
    The baton has been dropped. The Federal Reserve was by far the most aggressive major central bank through this past financial epoch (the last decade) to embrace ‘normalization’ of its monetary policy following its extraordinary infusion of support through rate cuts and quantitative easing (QE). Over the past three years, the central bank has raised its benchmark rate range 225 basis points and slowly began to reverse the tide of its enormous balance sheet. As of the conclusion of this past week’s two-day FOMC policy meeting, we have seen the dual efforts to level out extreme accommodation all but abandoned. A more dovish shifted was heavily expected given the statement in January’s meeting, the rhetoric of individual members as well as the state of the global markets and economic forecasts. Yet, what was realized proved more aggressive than the consensus had accounted for. No change to the benchmark rates was fully assumed, but the median forecast among the members accounted for a faster drop than the market likely thought practical. From the 50 bps of tightening projected in the last update in December, the median dropped to no further increases in 2019 and only one hike over the subsequent two years.
    The Dollar responded abruptly Wednesday evening with a sharp tumble, but there was notably a lack of follow through where it counted – the DXY Dollar Index wouldn’t go the next step to slip below its 200-day moving average and break a ten-month rising trend channel (a hold that confounded those trading an presumed EURUSD breakout). Why did the Greenback hold – for now – when the move was clearly a dovish shift? Likely because the market is already affording for an even more dovish forecast as Fed Fund futures have set the probability of a 25bps cut from the Fed before the end of the year as high as 45 percent. What’s more, if you intend to trade the Dollar; it is important to recognize that even with a more dovish path ahead, the Dollar and US assets will maintain a hearty advantage over its major counterparts. That would particularly be the case should other groups extend their dovish views to more actively explore deeper trenches of monetary policy.
    Looking beyond the Dollar’s take, however, there are far more important considerations for the global financial system and sentiment. The Fed was the pioneer of sorts for massive stimulus programs designed to recharge growth and revive battered markets. It was also the first to start pulling back the extreme safety net when its effectiveness was facing deserved scrutiny by even the most ardent disciple of the complacency-backed risk-on run. In other words, its course change carries significantly more weight than any of its peers. The question ‘why is the Fed easing back and so quickly’ is being posed consistently whereas in the past market participants would have just indulged in the speculative benefits. The overwhelming amount of headline fodder – from trade wars to frequency of volatility in the capital markets – makes for a ready list of considerations. Yet, the group’s own economic forecasts brought the reality home far more forcefully.
    Though we have seen numerous economic participants downgrade the growth outlook (economists, investors through markets, the IMF, etc), to see the median GDP forecast in the SEP (Summary of Economic Projections) lowered from 2.3 percent to 2.1 percent for 2019 made the circumstances explicit. We’ve considered multiple times over previous months what happens if the market’s start to question the capability of the world’s largest central banks to keep the peace and fight off any re-emergences of financial instability. Now it seems this concern is being contemplated by the market-at-large. That doesn’t bode well for our future.
    A Sudden Fixed Income Interest When ‘Recession’ Warnings Take Hold
    Except for fixed income traders and economists, the yield curve is rarely mentioned in polite trader conversation or in the mainstream financial media. Its implications are too wonky for most as it can be difficult to draw impact to the average traders’ portfolio and given the considerable time lag between its movements and capital market response. Yet, when it comes to its most popular signal – that of a possible recession signal – the structure of duration risk suddenly becomes as commonplace a talking point as NFPs.
    On Friday, the headlines were plastered with the news that the US Treasury yield curve had inverted along with a quick take interpretation that such an occasion has accompanied recessions in the past. There have actually been a few parts of the US government debt curve that have inverted at various points over the past months, but this occasion was trumpeted much more loudly as it happened in the comparison to the 10-year and 3-month spread (what has been identified as a recession warning even by some of  the Fed branches themselves). First, what is a ‘curve’? It is the comparison of how much investors demand in return (yield) to lend to the government (for Treasuries specifically) for a certain amount of time. Normally, the longer you tie up your money to any investment, the greater the risk that something unfavorable could happen and thereby you expect a greater rate of return. When the markets demand more for a short-term investment than a longer-term one in the same asset, there is something amiss. When the markets demand more return from a three-month loan to the US government than a 10-year loan, it seems something is very wrong. Historically, the inversion of these two maturities has predated a number of us the recessions in the United States – most recently the slumps in 2008, 2001 and 1990. 
    First is the lead period the curve reversal has to economic contraction. The signal can precede a downturn in growth by months and even years. Preparation is good, but moving too early can ‘leave money on the table’ for the cautious or accumulate some serious losses for those trying to trade some imminent panic. Further, there are certain distortions that we have altered the course in normal capital market tributaries that could be doing the same for Treasuries and therefore this reading. More recently, the revived threat of the US government shutdown through December and the unresolved debt ceiling debate put pressure on the asset class. At the same time, though, few believe the US would do little more than allow for a short-term financial shock in order to make a political point. Far more complicating for the market and the signal is the activity of the US and global central banks. The Federal Reserve has purchased trillions in medium-dated government debt as part of its QE program. They only started to slowly to reduce holdings and push longer dated yields back up a few years after they began raising short term rates in earnest. Their recent policy reversal only adds to the complication.
    Now, all of this does not mean that I believe the US and global economies will avoid stalling out or even contracting in the near future. Between the dependence on capital markets and stimulus, the heavy toll of trade wars and nationalistic policies, and the pain for key players in the global web; there is a high probability that we will see an economic retrenchment in the next few years. That said, that wouldn’t make this particular signal a trigger (causation) or even correlated through the main forces that would bring on a recession. Nevertheless, yelling ‘fire’ in an a panicky crowd on foggy day can still yield volatile results.  
    Brexit, Just Winging It
    Another week and another upheaval in Brexit expectations. Through much of the past year’s anxiety over the withdrawal of the United Kingdom form the European Union, there was at least some comfort to be found in the finality of the Brexit date (March 29th, 2019). While it could end in favorable circumstances for financial markets (a deal that allows considerable access for the UK) or acute uncertainty (a no-deal), at least it would be over. Well, that assurance is as clouded as the expected outcome from the negotiations themselves. Shortly after I wrote the Brexit update last week whereby there was a clear timeline for another meaningful vote on the Prime Minister’s proposals – after Parliament voted for an extension of negotiations – the Speaker to the House of Commons thwarted the effort when he said the scheme would not be reconsidered unless it was materially different. It is likely that see another significant change in this drama any times (and even multiple times) this week.
    At Prime Minister May’s request, the European Commission agreed to an extension of the discussions beyond the original Article 50 end date for this coming Friday. Yet, where the PM intreated a postponement out to the end of June, the EU agreed only to May 22nd – the day before European Parliamentary elections. Beyond that date, the UK would theoretically remain under the regulations and laws of the EU but would have no say in their direction which wouldn’t appeal to either side. So, now we are faced with another ‘fluid’ two months of critical deadlines. 
    This week, it has been suggested the government will try to put up once again for a meaningful vote – though it is still not clear whether the proposal will be meaningfully different (the EU has offered no further concessions) or there has been a successful challenge against the Commons speaker. When this could be put up to vote is unclear, but it has been suggested between Monday and Wednesday. If the proposal is approved, the timeline to May 22nd will remain and we will start to see a genuine path form. If it is not, then the following week Parliament will have to indicate that “they have a way forward”. If they do not, an extension or no deal will likely be considered for April 12th – out to the previously mentioned May 22nd date. If we pass April 12th without a clear plan, the probabilities of a ‘no deal’ or ‘no Brexit’ will rise significantly. Those two scenarios are extreme and on the opposite end of the spectrum. From a Pound trader or global investor considering UK exposure, you can imagine what a situation where the probability of diametrically-opposed, market-moving outcomes are considered balanced would do to the markets. It will curb market liquidity and leverage uncertainty. That would translate into divestment, difficulty establishing trends and serious volatility. If that isn’t your cup of tea, it is best to seek opportunities elsewhere for the next few months until this is sorted. 
  17. JohnDFX
    Ending a Trade War is a Windfall for Growth? 
    US and Chinese trade officials met this past week to lay the groundwork for another attempt to push for a breakthrough in the superpowers’ ongoing trade war. These are lower level meetings aimed at finding concessions and terms for which Trump and Xi would eventually sign off on. With over $350 billion in goods from both countries saddled with import taxes, the economic toll the engagement is exacting is starting to show through in data. In the US, trade figures have shown a rise in the deficit and sharp drop in exports to China, costs have risen for a range of goods normally curbed by cheaper foreign production, and confidence metrics have reversed course. The NFIB small business sentiment survey for example has fallen back to the level it stood at during the Presidential election. China’s economic updates have also marked multi-year lows in GDP, industrial production and more. While they are generally all firmly in positive territory, there is likely a ‘premium’ China attributes to its data.
    A growing number of institutions and economists are warning that the world’s second largest economy may be on the path for a stall and/or the collapse of its excessive low-quality debt market. The Trump Administration seems to have gotten whiff of at least one of those analyses as they have made repeated remarks about the strained position of their counterpart’s health when justifying their steadfastness. Officials jawbone (or talk a market or asset to a higher or lower level) for a number of reasons. Some central banks have attempted to talk down their currencies (BOJ, RBA, RBNZ), the Fed turned it into a tool (forward guidance) and economic leaders are constant cheerleaders for their own economies and markets. Yet, it is highly unorthodox, to say the least, for leadership in one of the largest economies in the world to stoke fear in a global peer. And yet, that is what President Trump, Chief Economic Adviser Kudlow and Treasury Secretary Steve Mnuchin have done over these previous months.
    If neither of these countries were to blink, it would inevitably tip a financial or economic crisis for at least one of them. And, if one slips into the abyss, it will pull the other in with it. Perhaps this recognition is starting to sink in, or the ‘game of chicken’ is simply too dangerous now with the US equity markets sliding with the President starting to take some of the blame. It has been reported that Trump has told his team that he wants a deal to be struck to help stabilize the markets. It wouldn’t strain belief at all to imagine this was a serious demand from the President. There were some boilerplate remarks of optimism this past week which were largely overlooked, but the Chinese Vice Premier’s planned visit on January 30-31 may indicate they may be close to resolving their issues. It is worth evaluating a future where a resolution is struck. Yet, putting the scenario to the test, would pulling out of a destructive economic policy in turn translate into a windfall of growth and investment opportunities? No. It would remove a manufactured threat that has already inflicted permanent damage and would allow the focus to shift to a host of other unresolved issues. Preventing further damage is the best the two sides can hope for in this situation. 
    The Lasting Effects of a Record Breaking US Government Shutdown
    We have broken a record over the weekend. As of Saturday, the partial shutdown of the United States government surpassed 21 days to count for the longest closure on record (surpassing the 1995-1996 stretch during the Clinton era). This is not a record to be proud of as it will translate into weaker economic growth, a drop in sentiment and the complicated progression of lower sovereign credit quality. The general economic implications are perhaps the easiest to envision. Government supported industries (such as airlines) will see their costs and revenues suffer while the 800,000 federal employees that are furloughed will not be paid. It is estimated that every week, the US economy will lose between 0.05 and 0.1 percentage points of growth owing to the situation.
    Even three weeks of that is significant given the state of economic conditions when this factor is excluded. Perhaps a (small) silver lining was the strong bi-partisan vote by Congress to provide backpay for those same federal employees – though that doesn’t offset the ultimate pain. Sentiment is another victim of this situation. We have seen consumer, business and investor sentiment sink the past months for a few reasons, but this shutdown is no doubt a contributing factor. If the country can’t come to an agreement on a basic stop-gap funding, what is the probability that they will be able to fulfill the infrastructure investment plan touted ever few months for years? My greatest concern for this situation is the damage it does to the United States credit quality. All of the three majors have issued some sort of warning on pursuing this path, but the most recent official statement came from Fitch this past week. There are those that don’t believe a downgrade is possible for the US sovereign rating, to whom I say it already happened when Standard & Poor’s cut the country one step to AA+ back in 2011.
    There are far more that believe it wouldn’t matter if another cut was made – and they would use the 2011 example as their evidence. When S&P cut the US rating, there was a distinct and severe move in credit and risk assets. Eventually, the market’s did stabilize and push the concern to the background because exceptions were made for the event. Even though many covenants only allow for top credit rated assets as ‘risk-free’, most agreed to make accommodations so as not to completely upset a financial system that relies heavily on the haven status of T-notes. Add a second, third or more cuts, and it looks less and less like a one-off. It registers as an absolute need to diversify. It may be hard to appreciate how systemically important this is, but the tipping point could fundamentally change the financial system and US standing in the world.  
    Breakthrough or Not, A Brexit Vote that Can Charge the Pound 
    We are just over 75 days away from the official date that the United Kingdom is due to separate from the European Union. If all that was necessary was to come to terms with an agreement between the two parties on their relationship post-split, this would perhaps not be so frightening. Instead, there is considerable preparation that needs to be done before that date even comes around. Most would agree, that the time table for an accord and steady transition was some months ago. Now, with each passing week that infighting persists, the consideration and appreciation of painful scenarios increases. We have the opportunity to finally find agreement from the UK’s side this week. On Tuesday, Parliament is set to vote on the Prime Minister’s Brexit proposal. You may recall that a vote was called on a previous plan, but May called it off at the last minute when it became clear that it would be handily defeated.
    It is nowhere near as clear time around that the MPs will deal the PM another rejection, but that is the leading consensus. If the proposal is accepted and the UK can return to the table with the EU, it would certainly be construed as lifting a significant weight off the Sterling’s shoulders. There are still a host of unknowns including cross boarder investment, financing and banking liquidity; but at least there will be a viable path the markets can follow. If however, she is rejected, the markets will grow increasingly agitated, fearful that an accident will happen. Following recent votes, Parliament passed law that if the proposal was rejected, the government would have to produce a ‘Plan B’ within three sessions (Monday as Friday is closed) rather than the standard 15. They had also previously ruled that if the country were heading for a ‘no-deal’ Brexit, that Parliament would have more say over the ultimate path.
    As it stands, there seems less risk of a crash out; but the hurdle for an agreement between the government and parliament remains very high. Uncertainty is a bearish pressure on the Sterling. An agreement would remove a considerable amount of that fear and perhaps help stoke a recovery. Looking at the CME’s Pound Volatility Index, fear remains troublingly high relative to other currencies and even other assets. Outcome or no, be prepared for Pound volatility. 
  18. JohnDFX
    Make or Break for Brexit? 
    There have already been so many twists and turns in the UK’s efforts to negotiate its separation from the European Union that that investors are getting dizzy. It is troublingly difficult to gain a reliable bead on a probable outcome for this stalemate, but the lack of time and dwindling hope of an outcome that will satisfy the majority of those involved raises the threat of a ‘bad’ outcome and even worse market response. This is not one of those events where ignoring the risks can prompt complacent gains. Once again, we are coming up to a key milestone in this saga where conditions can continue with a narrow course forward where the best case scenario still reflects considerable uncertainty and no small measure of market fallout. Or, it can be pitched into disarray. If you are monitoring the march forward of this fraught Brexit divorce – and you should whether you have direct Pound or UK investment exposure or not – highlight on your calendar Parliament’s vote on Prime Minister Theresa May’s proposal Tuesday. 
    The draft was made in concert with EU negotiators which produced a result that theoretically both sides could sign off on. That would seem a viable course forward if not for the level of discord in UK politics. Rhetoric surrounding the Prime Minister deal is distinctly harsh from both the conservatives who found vindication in the referendum outcome as a sign of a clean break as well as Labour and other groups who are attempting to keep economically supportive elements of EU access or do not support the withdrawal altogether. It is likely that Parliament votes the plan down which will open up a range of scenarios – very few of which are will avoid deeper trouble.  After a rejection, the government has three weeks to work another deal, but the EU will be far less interested in an agreement that asks for more and the rapidly diminishing time frame will leave little opportunity to warm counterparts to their side. 
    Parliament voted this past week – after finding the Prime Minister in contempt for refusing to release official legal advice on Brexit – to give itself greater say over the proceedings should her plan be rejected. This is likely to empower the MPs to demand more favorable – but perhaps ultimately unworkable – terms. It may also raise the pressure for a second referendum. Previously May has rejected the option outright, but recently she has floated the idea. It comes off more as a threat for conservatives to get in line, but she has said there is a choice of “my deal, no deal or no Brexit at all”. Two of those three options are considered assured crisis to all the relevant parties involved; and unfortunately, that third lesser evil is different for all of them. Beware Pound volatility and the risk of fast moving local capital markets which can be exacerbated by the waning liquidity in these final weeks of the year.
    This December is Already Bucking Seasonality Expectations
    As we have discussed more and more as of late, there are seasonal norms in capital markets. These unlikely cycles arise through a few different practical market occurrences. Mid-day direction changes in individual trading sessions, summer doldrums, quarterly earnings runs and more draw on reliable conditional developments that can shape conditions – though specifics like direction are still up to the unique circumstances that play out in the given period. In the final weeks of the calendar year, we have one of the most reliable norms in trading. For those that want the scene described in a short phrase, ‘Santa Claus Rally’ usually suffices as they can fill in the circumstances with their imagination. A reduction in liquidity for western holidays and/or a general sentiment is seen as the foundation for a market’s performance. The liquidity aspect is at least correct and conditions earned through collective habit can often fill in the rest. However, when we follow this theme to the assumed bullish-backed trend, there are certain environmental criteria that need to support the outcome. 
    Normally, the pending risks column needs to either be small or populated with issues that can readily be deferred until more convenient market conditions return. That is not the case now with growth forecasts slowing, warnings of financial risks growing more numerous (from the likes of central banks and IMF), trade war consequences kicking in and political risks splashing the headlines. These are not issues that can readily be shelved and they are receiving media attention on a regular basis. With this backdrop, there are frequent sparks that can provoke panic which makes the backdrop all the more threatening. If an otherwise contained crisis arises somewhere in the world, the thin market conditions can amplify the ill-effects of panic to spread well beyond its normal reach. And, while it may not be capable of a lengthy collapse of the financial system through such diluted conditions, it can lay the groundwork for a vicious cycle that begins the process only to catalyze fully when markets fill out – much like a nuclear reaction. 
    In portfolio and statistical theory, it is not advisable to position for collapse against these seasonal norms as the probabilities are still skewed in favor of the norms. However, it doesn’t mean that we need to be utterly complacent with the risks that we hold. Reducing size, diversifying away from ‘risk’ markets or buying hedges reduces your beta exposure, but it isn’t like we are missing out on opportunities through a period that will be ‘dead’ in the base case scenario. The volatility we have experienced this past week, the past two months and in two distinct periods over the year (Feb-March and Oct-Nov) are a reminder that we should be more proactive with our reducing our exposure to the capricious unknown.
    Who Faces the Greater (Probable) Systemic Threat: Dollar or Euro?
    Everything in investing is a probability – that is a mantra I repeat to myself to avoid the delusion of certainty in a view or position. To put belief into action, I try to always lay out the probable scenarios for a particular market, asset, event, etc. Even if I consider a certain outcome more likely, considering the alternatives can help to identify earlier when the theory isn’t panning out and to even help stage an actionable strategy for a lower probability path. Most of the time in trading, the focus is to identify best case (the most productive bullish) scenarios, but there is just as much value in projecting worst case outcomes and their probabilities. This can help us avoid markets with a severe probability/potential imbalance or even identify better trading opportunities – I would rather pursue a short in a productive bear trend than suffer a long exposure in a choppy bull market. In evaluating the majors for their practical ‘worst case scenarios’ (those outcomes that are severe but not wholly unlikely – or qualifiers for a true ‘black swan’ designation) I think the Dollar and Euro deserve closer observation. 
    For the Pound, the market is well aware of the possibility of a bad fallout from the Brexit which puts investors on guard and making moves that help to hedge risk. The Japanese Yen is so inextricably tied to risk trends and the Bank of Japan’s policy so open-ended that other issues struggle to compete for anxiety. For the Euro, a return to existential rumination on the currency union with the Italy-EU budget standoff is a still-underappreciated issue. The bulls in the market likely look back to the situation with Greece and assume a routine path for any future confrontations to be resolved in the same way. That is presumptuous to be negligent. The fact that this is occurring after Greece and during the UK’s bid for a withdrawal (admittedly from the EU and not Eurozone) should raise the level of concern significantly. It hasn’t. Perhaps the lingering premium afforded the currency for the eventual turn from extreme accommodation by the ECB will be the first dashed enthusiasm to awaken market participants of more unfavorable outcomes. If a country were to leave the currency union (EMU or Eurozone), it would fundamentally change the appeal of the currency as a global unit by significantly reducing the size of its collateral (GDP and capital) which would in turn significantly increase its perceived volatility. And, those are critical properties of a currency. 
    The situation is unusually similar for the US Dollar. The pursuit of trade wars inherently encourages the world to redirect funds away from the US Dollar to avoid the policy conflicts that it brings (in trading terms, the volatility). Meanwhile, the rising deficit becomes increasingly problematic as the cost to service the massive debt rises and outside demand dries up. This can lead to a general shift away from the Greenback’s use permanently which the market won’t fully appreciate until much deeper into the situation. Similarly here, the market may more readily recognize something is wrong via monetary policy as the Fed adjusts to some form of the systemic risks by slowing its pace of policy normalization. So, which currency faces the longer-term – but still reasonable – risk? The Dollar. The ubiquity of the currency globally (nearly two-thirds of all FX transactions) means that it has far far more to lose should its use diminish. And that is very likely as the threat of further credit quality downgrades occur owing to its appetite for debt and its withdrawal from the global markets. 
  19. JohnDFX
    Trade War Rumors are Generating as Much Reaction as Official Announcements 
    The trade war remains one of the most far-reaching and economically-threatening themes currently assailing the global markets. After more than a year of escalation whereby the market has acclimated to a steady flow of stories detailing the malaise this conflict has sown, it should come as little surprise that the market has grown somewhat deadened to hints that conditions may grow marginally worse. Yet, in contrast, any budding suggestions that a demonstrable improvement in the relationship may be around the corner are being met with far more speculative enthusiasm. This past week, two such reports dotted the headlines and played no small role in helping push US equities beyond levels that technical traders would consider weighty (2,645 for the S&P 500 and 24,325 for the Dow). 
    First, on Thursday, it was reported by WSJ that President Trump was debating with officials whether to lift tariffs on China. That would be a complete 180 on their negotiation tactic thus far, but it wouldn’t be exactly far-fetched given the President’s penchant to change course when his priorities change and to offer help to a struggling market since the Fed has shown little willingness to comply with his demands. Equities responded to the headlines with a smart rally to the midpoint of the October to December tumble. However, before traction could be fully secured; the US Treasury’s spokesperson rejected the news, saying neither the Treasury Secretary nor US Trade Representative had advised such a tack. While the market slipped on the official correction, the hope of an eventual breakthrough was appealing enough that Friday’s trading session opened to an official ‘breakout’ beyond the aforementioned barrier. 
    To follow up Friday, Bloomberg issued a new report that China had offered the United States a plan whereby it would dramatically increase its purchases of US-made good (to the tune of $1 trillion) in a bid to close the countries’ trade gap in six years. This plan was not clearly and quickly rejected – perhaps because China is not as concerned with the favorable impact it can have in cooling financial markets. And, with that additional fundamental push, the indices closed out its fourth consecutive week advance strong. It is inevitable that we face another round of trade war updates in the week and weeks ahead; and whether they signal deeper divide or possible mending, they will likely be market-moving. That is because we are in a limbo where the general health of the global economy is crumbling, and this remains one of the more consistent drains. Further, the market sense of urgency over this state will increase as more reliable sides of economic health continue to degrade. We’ve seen a host of signals these past weeks – US consumer sentiment, Chinese liquidity conditions, etc – but this week’s 4Q Chinese GDP update will serve as a direct status update. 
    The World’s Top Concerns, Monetary Policy and Recession Fears
    The economic docket has a few high-profile listings (China 4Q GDP and ECB rate decision among them) over the coming week, but the traditional fare doesn’t give the proper scale of the broad fundamental themes that we are dealing with moving forward. There are far more systemic issues under consideration by the world’s market participants, and a few items give perspective of the themes better than others. It is important in fundamentals to first and foremost assess what carries the greatest weight with the largest faction in the markets. With our laundry list of unfolding issues, no one would begrudge you uncertainty over that question. This week, we will have the rare opportunity to gain some insight into what most concerns the leaders of the world’s largest economies at a summit in Switzerland. The Davos World Economic Forum will cover topics that are no doubt top of our mind, and perhaps some that are under the market’s radar, but from the discussion, time dedicated and sideline comments, we will be better able to ascertain what issues are considered the most troubling. 
    And, while social troubles are of great importance, leaders are disproportionately fearful of economic troubles. No confidence votes, failed re-elections and general discontent more often follow economic troubles. Politics in the meantime will be another great timekeeper for traders looking for the next jolt of volatility. There is upheaval across the world from the US government shutdown to Brexit running out of maneuvering room to the Yellow Vest protests in France extending to a tenth week. Monetary policy will likely earn little for directly-linked currencies, but the sense of the underlying current can materially affect confidence in active support for growth and financial stability. On tap are two of the developed world’s most dovish major central banks. The Bank of Japan (BOJ) sees little chance of altering its active effort to keep QE pumping into the system, but the recognition of its inability to influence change in inflation or economic condition grows clearer with each week. 
    In contrast, the European Central Bank (ECB) took the significant move to end its stimulus program last month – in a first step to normalize from an extraordinary dovish policy-setting. Yet, those intentions may not be fulfilled in the foreseeable future if concerns of economic struggle deeper. Beyond the warning on growth for China with trade wars, US via the shutdown (now cutting off 0.5 ppt), Germany drawing out recession concerns in data like factory activity, Italy risking it far more readily with the local central bank’s own forecasts, we are seeing the world bow under the maturation of a decade-long cycle and the eruption of numerous cuts in fundamental efficiency. If a slowdown becomes an overt reality, will we find relief from the world’s central banks (already at the extreme of their policy setting) or governments (struggling to function and certainly not cooperating well with each other). 
    Where to From Here on the Brexit? 
    As of Monday, the countdown will drop to 67 days until the UK is due to leave the European Union according to the two-year timeline dictated by Article 50. And, despite our dangerous proximity to the official divorce, we seem to be no closer to a plan on how this separation will play out than we did six months ago. That is troubling. This past week, Prime Minister May offered up a proposal in the Commons on how the country may severe ties with the Union. The defeat Parliament delivered May was the worst seen in British history. On the back of that popular discontent, opposition leader Jeremy Corbyn tabled a no-confidence debate that took place shortly after. This time, the majority sided with the PM – though the margin was far smaller than the one she lost by with her plan. Due to votes pushed through in previous weeks, May now needs to issue a Plan B on Monday the 21st. It had also been previously discussed that should the no way forward be found by the PM’s efforts by this date, that Parliament could take greater control over the process to avoid a ‘no deal’ outcome. This will help delay that pressure. Though it is always possible that the EU will take the mandate of the crushing defeat dealt the UK’s leader to offer more concessions, it is more likely that the program she ends up with will still not pass the approval of Parliament. 
    Nonetheless, with debate still to be had, the vote on it will take us out to January 29 (Tuesday). It is worth noting that May’s threats to choose ‘her Brexit, no deal Brexit or no Brexit at all’ have been trumpeted far less frequently as of late. It is not clear whether that is because she is genuinely softening her position and ‘red lines’ or perhaps just because there is a little less urgency with a few more days. The days are steadily ticking down and polls of Brits’ stance on whether to leave or not or what kind of approach to pursue (no deal, May’s deal or more concession) remains markedly mixed. With so much confusion throughout the country on how to proceed, it comes as little surprise that the state of the negotiations are as opaque as they are. Continue to monitor for Pound volatility. 
  20. JohnDFX
    Happy New Year everyone!
    Coming to Terms with a Bear Market
    We have experienced a remarkable level of volatility recently, which is particularly incredible from the past few weeks considering markets were distorted by holiday trading conditions. When volatility meets thin liquidity, the results can prove explosive. That said, the intensifying fluctuation in the global financial system is not just a phenomenon that could be attributed to shallow markets as we have seen both the price-based results and the explicit sensitivity to fundamental triggers increase through the months preceding the official holiday season. Through the past three months, we have seen a number of specific instruments that have stood as baseline for general asset classes tip into official ‘bear market’ territory – which is defined by a 20 percent correction from a recent peak. Appreciation for the changing tide really didn’t start to peak the sense of panic however until equities started to hit the critical, technical milestones. 
    When key US indices started to trip 20 percent – first the Russell 2000 in mid-December and then the S&P 500 Christmas Eve – the few that may have been oblivious were put on alert and diehard bulls started to feel a true sense of dread creep up their spines. Sentiment has notably shifted from unshakable confidence that the markets will bottom and return to their decade-long bull trend to a sense of desperation that buoyancy will hold out long enough to erase some of the losses late-comers had incurred since October or keep the window open long enough to simply exit. The bounce this past week with the S&P 500 moving back above 2,520 does play to the sense of hope. It is possible that we have found a low for the time being having only just technically hit the bear market milestone for a single day, but that seems improbable. Even with the retreat in this market – not to mention the rest of the world’s speculatively-inflated assets – we are still far from previous cycle peaks. Prominent fundamental themes from slowing growth to failing monetary policy effectiveness to deteriorating international relationships are not going to simply reverse course anytime soon. 
    Further, rising volatility is looking more and more a permanent feature of our landscape. Market’s struggle to calmly inflate already-expensive assets amid tense periods of possible instability. It is possible that we have seen the low, but it would not be wise to assume that is the case. Instead, the better approach for market participants would be acclimatize to a world where we are in a bear market or on the cusp of one. Just as bull markets have periods of correction before they reassert themselves, the bear markets can have interludes of recovery. That does not mean we should commit to the about face just because it is desired. Though some people prefer longer duration, systemic positioning; I still favor taking trades with shorter duration and closer targets until it is clear that momentum has returned to the bears. 
    Fed Fund Futures are Now Pricing in Rate Cuts 
    Through 2018, the Fed’s steady tightening (also fairly described as normalization) efforts accelerated. The fact that the US central bank was tightening at a regular clip while the rest of the developed world’s policy authorities were still contemplating when to make their first move, or at best attempting to take bites when conditions were ideal, became almost mundane. If we were to evaluate the benefit to the Dollar from the contrast in the textbook fashion, we would assume that the Greenback should continue to climb against its major counterparts for as long as it enjoys a yield premium – especially as the spread continues to grow. Yet, we know in speculative markets that investors will move to price in the advantage as soon as it seems feasible – and they did. While they couldn’t full price in the benefit to the USD of a Fed hike regime against such a cold backdrop, it could price in a considerable advantage. 
    After that high water market was set, it would be increasingly difficult to confer greater benefit – perhaps if other central banks were forced to revert to ever more extreme easing techniques while the Fed kept course – but it would be far easier to disappoint. This is what is referred to more generally as discounting the outlook. It also goes a long way to explain 2017 where the Dollar dropped steadily versus the Euro despite the fact that the Fed hiked three times and the ECB had yet to nail down a time for its first move higher. Fast forward to today. We have seen markets slump and economic forecasts drop significantly. As would be expected, the forward guidance from the central bank has cooled materially. The shift is clearly apparent to the broader market as Fed Fund futures and overnight swaps have completely reversed course on the hawkish outlook for 2019 – that at one point was fueling debate on whether they would hike three or four times through the year – with no further tightening expected. 
    In fact, the next move priced into the markets is a cut with the greatest weight afforded to 2020, though 2019 was clearly being assessed as a possibility given contracts through December. NFPs and the rebound in US indices through this Friday have cooled the dovish build up, but the shift has been dramatic. It will be difficult to lift speculative enthusiasm so high again especially after key Fed officials have suggested the need for forward guidance has waned significantly.
     
    What Flash Crashes Say About Market Conditions Rather than the Afflicted Asset 
    One of the more remarkable episodes from this past week’s extremely unorthodox opening play at a new trading year was the flash crash that struck certain currencies (and even a few capital assets). Much of the focus was on the Japanese Yen, but it was not the only currency to exhibit extreme price fluctuation. The Australian Dollar exhibited even more extreme fluctuation in historical and percentage terms (its intraday reversal was the largest I found on record) while the ripples readily expanded out to the British Pound which didn’t even seem to connect to the purported spark to the move. 
    Afterhours to Wednesday’s New York session saw headlines light up on news that Apple (one of the principal firms in equity investors’ portfolios) was lowering its revenue guidance owing to the US-China trade war. Paired with the downgrade in Chinese activity readings earlier in the day and the ongoing US government shutdown, and it was no surprise that fear would hit. With the Tokyo markets offline for a holiday, the thin-liquidity-high-volatility conditions were once again triggered with a subsequent tsunami. This time however, the market response would not play out over days and weeks with a pervasive trend but instead struck all at once with extreme intraday volatility. The catalyst did matter as any lit match would, connections to risk trends are important and certainly automated trading influences (stops, limits, algorithms) no doubt contributed. However, boiling what happened down to these elements is a misleading – but common – psychology effort to regain a sense of comfort. 
    If this unforeseen disaster can be attributed to these elements, then we can feel more comfortable that it is unlikely to happen again and we can keep an eye out for the same environmental triggers. This is not an unusual development in the global markets, even for the most liquid. The Japanese Yen  saw rapid rallies followed by abrupt reversals (Yen cross tumbles followed by rebound) multiple times between 2009 and 2011 brought on by risk aversion, then monetary policy distortion and the intervention efforts of authorities (BOJ and the Ministry of Finance). The point is that conditions facilitated multiple such ‘fat tail’ events through that period, and they could continue to do so for us moving forward. It is the confluence of deteriorating investor sentiment, recognition of excessive exposure, fear that authorities cannot fend off any future financial crises and the abundance of threats to the collective complacency that currently colors our markets. While we may not see another 3.5 percent-plus swing from the Yen specifically in the near future, expect to see more developments that were considered unthinkable over the past 10 years. 
  21. JohnDFX
    Is There an Effort to Keep Markets Uneasy in Trade Wars?
    How many times does something unusual have to occur before it is considered a planned? I have noted a number of times over the past month that some unexpected policy development was announced hours before the markets closed for the weekend. There is an unspoken commitment by central bankers and global leaders to prevent volatility in their respective financial markets. Volatility is the general definition of risk, and there is a clear connection between financial market and economy. In other words, no one wants to trigger speculative rout that could turn into tangible economic pain. And yet, that typical preservation of self-interest doesn’t seem to worry some of those in power looking to stir norms.
    One of the more common culprits of this push against norms is US President Donald Trump and those in his administration. Announcements of new tariffs on Fridays are now commonplace. And this past week would not deviate from that new norm. Two people in the administration with knowledge of the plans said the President intended to push forward with the proposed $200 billion increase in tariffs on Chinese goods despite the effort to revive talks this past week. This is not exactly surprising given the United States negotiation approach of late. They seem to prefer discussing terms after exerting pressure on their counterparts in an effort to leverage a more favorable outcome. It is also the case in this instance that the remarks are not official – as in they do not come from the President himself. Typically, Trump prefers to announce such things himself to signal he retains final say over such matters.
    Leaks are another increasingly common feature of the US political landscape which unexpectedly adds more uncertainty to an otherwise surprise-oriented policy approach – but at least one where we know to focus for answers. Whether intentional or not, the major announcements in policy from the US and other major economies into the twilight hours of the week creates a resting state of increased uncertainty for financial markets. We do not need any more reason to question our already excessive exposure to risky assets between the dependency on excessive monetary stimulus which is starting to correct, exploding levels of debt, increased speculative leverage and obvious efforts by superpowers to promote local growth through policies that curb others’. A frequency of last minute and troubling headlines just before the markets close is yet another reason traders could naturally want to curb their exposure. 
    Evaluating Fundamental Themes for Both Their Probability and Pace of Progress
    Trading fundamentals can be overwhelming for many. While there are many different motivations for market participants the world over to place or remove exposure, there are typically key reasons that draw many – if not the majority – to alter their views in tandem. If there were a first rule for trading using fundamentals, I would say it is to first establish what is most important to the market-at-large. Another functional application of this broad analysis technique (perhaps rule number 2) is to establish the nature of the theme or event itself. Is it complex or straightforward? Is there a distinct time frame for it to render its verdict or is the outcome something that can be debated through time?
    Depending on the circumstances surrounding these fundamental matters, we can determine what kind of contribution they can make towards our trading – or how effectively they can otherwise complicate the opportunities that may otherwise seem complete. We can use examples to illustrate. The Federal Reserve’s next rate decision is scheduled for September 26th. There is clear anticipation for yet another 25 basis point rate hike by the policy authority with swaps pricing in nearly 100 percent probability. That is clear time and outcomes (hike or not). Such simplicity can make for straightforward Dollar or risk trends – though it will also drain the market-moving potential of an outcome that meets deeply discounted scenario. There is still complication in the forecast for another hike around December, pace in 2019, concern over external factors and more; but those clearly are not the primary interest.
    A significant step up in terms of fundamental complication are the ongoing NAFTA negotiations between the US and Canada. While there have been a few dates of confidence thrown out by officials, there is no definitive end date. There is also substantial discrepancy in the outcome for these talks such that a compromise or dissolution of trade relations can render significant market moves. This is an even that is far more difficult to predict for timing and outcome, but it renders far more market movement. And, then there are those events that can continue without resolution for considerable time and the full impact cannot be readily be predicted until long after it is implemented. That is the situation with an event like the US-China trade wars. There are no milestones for furthering the tensions or reducing them and it can prove a systemic threat that directly leads to a global recession and/or financial crisis. Yet, without clear guidelines, the practicality of trading around it is exceedingly difficult. 
    And Now, the Central Banks with Failing Credibility
    This past week, the European Central Bank (ECB) and Bank of England (BoE) delivered their respective monetary policy decisions. These are important policy groups whose decisions carry far beyond their respective economies. The ECB marks one of the most aggressive dovish central banks amongst the majors and carries significant responsibility for sustaining the belief that market enthusiasm is borne out of the extraordinary support these groups are offering to the system. Perhaps recognizing the position they hold and uneven health of its member economies, it is struggling to decide its course. The BoE is one of the most hawkish major players with a course of inflation that is above target and could be used to evaluate the central banks’ commitment to the ‘rule of law’ for targeting price growth as a determinant for monetary policy. Of course, they are dealing with the uncertainty of Brexit which is a situation not uncommon across the world’s largest economies. So this group is acting as an unexpected template for how to deal with external pressures. These are important groups whose moves will be monitored and likely mirrored by other central banks.
    The upcoming two rate decisions this week will not be evaluated for the guidance they can offer others. Rather, they will instead be used as lesson on what to avoid. The Swiss National Bank (SNB) and Bank of Japan (BoJ) have failed to apply policy that renders the deserved effect for promoting growth and price stability – not to mention unstated goals of financial health. They are in fact both groups that have lost significant credibility in the markets, which makes their job all the more unmanageable. The SNB will no doubt keep its rates firmly in negative territory, yet the desired depreciation of the Swiss Franc is unlikely to follow years of unchanged policy. Given the dependency on exports of goods and services – and particularly to the EU – they are primarily concerned with the unfavorable level of the EURCHF exchange rate. This will not change materially until the ECB itself follows a course that allows for more appreciation of the Euro.
    While the BoJ has not done anything so dramatic as the SNB’s implementation and sudden removal of a floor on its key exchange rate, the central bank has clearly embarked on a policy course that has consistently fallen short of its mark. Interest rates in Japan have been kept near zero for decades, and the rise of QE programs was eagerly adopted by the group in an effort to stoke price growth. Despite a steady escalation of this downpour of funds, price pressures have not solidified and the markets have increasingly discounted their ability to even move the Japanese Yen for secondary favor. What we should worry about from these two is what the market response is when such groups are forced to capitulate or the recognition of how exposed the system is should another crisis arise where such groups have no hope of averting collapse. 
  22. JohnDFX
    Another Week, Another Set of Brexit Scenarios
    It seems the weather patterns behind the Brexit seem to changing at a more rapid clip – always ending up back ‘in irons’ (pardon the nautical terminology) as the clock steadily winds down to the March 29 separation. This past week, was particularly momentous with the Prime Minister’s proposal supposedly going to vote in Parliament; but May decided to pull the vote before the allotted session as it was clear it would be voted down handily. And, considering the MPs had voted the week before to give themselves more power in the event the PM’s effort was rejected, she wanted to avoid losing any further control over the already stumbling process. The week wasn’t uneventful however as frustrated conservatives called a no confidence vote in May’s leadership. Ultimately, she survived the challenge and cannot be contested again for a year – though that doesn’t prevent further political pressure nor does it make navigating negotiations on the separation from the EU any easier. 
    It could have been the case that Juncker, Tusk and their European colleagues were waiting to see the outcome of the UK no-confidence vote to prepare further concessions that would warm May’s government; but that did not prove to be the case. After enduring the challenge, May attended to two-day European Community summit where Brexit and a no-deal outcome in particular were to be discussed. She received a clear rebuff on any further compromises from the EU and in fact had some features of the previous offer revoked. We have long ago passed the event horizon for a balanced deal to be struck such that the technical work would be ready by the actual separation date. It is unlikely that this is holdout from both or either side to earn further concession as the brinkmanship only adds to the economic and financial trouble down the line. That means this situation is more likely to continue unresolved until UK leadership makes the call. 
    If May can wrangle the conservatives to accept a temporary backstop, it may be the closest middle ground to be found. Alternatively, we will end up in either one of two extremes: a no-deal break or the call for a second referendum. If we end up with the former, it is more  likely to be pushed all the way to the predetermined end date. A second referendum however would likely be called weeks – perhaps even months – before the March 29 deadline. All the while as uncertainty prevails, external capital will continue to drain from the UK. Already with a default backdrop of uncertainty, global investors will want to avoid an overt threat like the Brexit. Further, domestic capital will increasingly be moved to safe guard rather than applied to more productive, growth-oriented means (such as business spending, property development, wage growth, etc). As has remained the case for some time now, trade Sterling cautiously and with a clear intent – if at all.
    A Critical Fed Decision to Set the Course of 2019 
    Top event risk over the coming week is the FOMC rate decision in my book. This final policy update of the year from the world’s largest central bank is one of the comprehensive events we expect on the quarters. Along with the routine update on rates and the monetary policy statement, this event will include the Summary of Economic Projections (SEP) and Chairman Jerome Powell’s press conference. First and foremost, the central bank is expected to hike rates 25 basis points for the fourth time this year to bring the range up to 2.25 to 2.50 percent. While Fed Fund futures project this outcome at a 77 percent probability – I would set the chances even higher. The Fed has established forward guidance as the primary tool for monetary policy even though it has raised rates at a steady pace and started to reduce its balance over the past year. 
    The utility of guidance is that it can acclimate the market to tangible policy changes before they are implemented to defuse the detrimental financial market volatility it could trigger otherwise. That is extremely important given the transitional phase global monetary policy is in following nearly a decade of emergency-level accommodation. Markets have grown more than accustomed to the support, the have grown somewhat dependent. Normalizing its essential to promote a healthy financial system, healthy risk taking and restore the buffer necessary to fight future downturns. Yet, if this fraught course is piloted poorly, a policy authority can inadvertently trigger the next crisis. Of course, if risk trends are already unsettled, a market that is seeking out threats could fixate on this disturbance readily enough. That said, the Fed may already be picking up on some strain in the economy and markets, looking to trim its pace so as not to run aground. 
    Preparing the market for that deceleration is just as important as setting expectations for its unrivaled hawkish drive over the past few years. Powell seemed to do start the adjustment a few weeks ago when the language in his speech on bonds seemed to denote greater caution and recognition of tension in the market. We have seen markets respond by  pulling rate forecasts via Fed Funds futures and overnight swaps down to only fully pricing in one 25 basis point hike – whereas previously the market had afforded three with debate of a fourth. We are due a definitive view for rate forecasts from the group in the SEP. The update for December showed a majority – by a single person – projecting three moves in 2019. Given how finally balanced that forecast was and the language from some key members, it is very likely to be downgraded. The question is whether a downgrade to just 2 hikes will then be construed as better-than-expected and if the tempo change will trigger concern amongst market participants about financial market health. 
    Was Italy Capitulation, Trade Concessions, A Brexit Vote Save Enough to Revert to ‘December Conditions’ 
    Thus far, we have witnessed a remarkable December. Historically, this tends to be one of the most reserved months of the calendar year for volatility and volume which in turn translates to steady gains for traditionally risk-leaning assets. What we have seen instead is a continuation of the previous two months were high volatility has leveraged incredible swings in popular benchmarks like the S&P 500 and Dow while the VIX holds precariously high. It is inevitable that liquidity will hit holes over the coming weeks owing to market closures, but that doesn’t mean that the markets have to drift calmly into holiday conditions. Shallow market depth and high volatility can converge to produce extreme moves. 
    It is always wise to head into market closures or known liquidity contractions defensively, but that would be especially true of our current conditions. The question now is whether some relief on a number of ominous fundamental themes is enough to soothe the beast until markets fill back out in earnest when 2019 rolls in. Some points of progress optimistic bulls can point to include the agreement by China and the United States to a 90-day freeze fire on further escalation of tariffs, Italy softening its aggressive budget position and UK Prime Minister May surviving a no-confidence challenge. None of these developments are a long-term solution to the threats they represent, but it is breathing room at a time when the markets seem to need it most. Market biases can shift the response to events and themes – from exacerbating seemingly harmless issues into the foundation for true panic or quieting fear over a looming catastrophe. Ultimately, in conditions like these, hedges are worth it.
  23. JohnDFX
    A G20 Meeting of Extreme Consequence
    As far as summits for leaders of the world’s largest economies go – in other words, an already very important affair – the gathering in Argentina this coming Friday and Saturday is crucial. There are a host of global conflicts that will inevitably be addressed at this gathering, but certain aspects will preoccupy the market’s immediate focus. It will be important to recognize what will carry the weight of speculative interest. On the one hand, there are discussion points of great consequence socially and culturally, but those issues will not show their economic consequences much latter and therefore will be largely ignored but for niche corners of the market. An example of this type of discussion point is climate change which has taken on greater importance with countries pleading with the US following its withdrawal from the Paris Accord and the strong of recent, dire scientific reports. In contrast, trade wars, is an ongoing threat to global economic and financial health inevitably drawing an inordinate amount of attention from market participants. 
    Of course, the elephant in the room will be US President Donald Trump who has pushed ahead with the most consequential conflicts on international trade. There will inevitably be numerous pleas made to the leader of the free world to rethink his aggressive approach towards peers. That said, he likely has little interest to hear out there concerns. The mid-term election results will likely redouble his commitment to his current course. To be fair, nearly any outcome would have rendered such a result. Had the GOP swept the polls, it would have been taken as America showing its support. Yet with the outcome that was realized, there is a greater interest in pursuing those courses of action for which he can affect change without the of a divided Congress. And trade is just one such outlet. Alternatively, finding a course out of a discounted crisis could be registered as a political win – though what it would earn for the US markets is another matter. Avoiding a crisis (some would argue one self-manufactured) is not the same as inspiring genuine enthusiasm and speculative run. 
    In particular, this summit should be watched for official and sideline commentary from the US-China discussions. Leaders of the two countries (Trump and Xi) are scheduled to discuss trade at the summit providing an ideal high-level opportunity to afford each an opportunity to claim a political victory. If they change decide to reverse course, it could offer considerable speculative relief and perhaps no small amount of recovery. This could very well be the strategy as Trump has voiced increasingly confident views of the relationship these past weeks that have been walked back by his administration – perhaps to build pressure. If we do see these two countries make nice and start the path towards recovery, yet markets do not translate the news into recovery, I would be concerned about what it reflects for sentiment. Alternatively, no encouraging course correction would be a ‘status quo’ outcome and keep our troubled outlook on its wary course. If the politicians involved want, they can render this event an obfuscated non-mover even without an official communique. Yet, subtly seems less and less standard a virtue of late. 
    Liquidity Restored, Seasonality Conditions and Key Events
    The liquidity tide will roll back in over the coming week. As expected, the drain of US speculative interest this past week due to the Thanksgiving holiday played an effective role in sidelining a concerted effort to mount a system-wide advance or retreat in risk trends. However, the period didn’t end without its troubling signals for the future. The S&P 500 closed a thin Friday trade session with one of the least encouraging candles possible – a gap lower, larger ‘upper wick’, no ‘body’ between open and close and anchored to a noteworthy trendline support. The losses leading up to the US holiday reiterate a troubling frequency of painful losses for the benchmark US indices this year. What’s more, it serves to remind us of the fact that many other corners of the financial system – both in terms of region and asset type – have already trekked much lower. A retreat in US equities would be a general convergence towards significantly weaker global if that were the course that we took. 
    Yet, there is still the natural hold out for seasonal mood disorder – otherwise assumed to be a holiday rally. There is good statistical data to give weight to such expectations but of course there are exceptions to this norm. And, if there were ever a time to worry about a passive climb in speculative positioning, it would be amid a wealth of overlapping and systemic financial risks. From trade wars to the collapse of ineffective monetary policy regimes to growing evidence of excessive leverage (loans, debt, investor exposure), we are dealing with a potentially-toxic environment. As more factions in the global markets recognize the precarious environment for which we are exposed, there is greater threat to fragile stability in key event risk. There is a range of key global events and data due over the coming week.
    In the US, the Fed’s favorite inflation reading (the PCE deflator) will work with the FOMC minutes and Fed speak to set expectations for rate hikes in December and the pace in 2019 which have already suffered in recent weeks. In Europe, the Euro-area sentiment surveys and BoE’s financial stability report will anchor the focus on the region’s quickly fading sense of stability. Chinese and Japanese PMIs will give good proxy for recent GDP in Asia while actual quarterly updates are due from Brazil and India. Now is not a good time to embrace the comfortable warmth of complacency. 
    As the Clock Winds Down for a Brexit Deal, Events Look More Ominous
    There have been a number of notable reversals in fortune for UK Prime Minister Theresa May and the course of the Brexit deal over the past month. And, with each successive ‘breakthrough’ the market has hardened its skepticism over the authenticity of a favorable path for the country’s divorce. We will see just how cynical the speculative rank and general public are at the start of this new active trading week. Over the weekend, May attended the EU27’s summit to discuss the Brexit proposal backed by the Prime Minister. European Council President Donald Tusk announced on twitter that the collective supported the bill, but enthusiasm was held in check with both lawmakers and observers alike. Top EU negotiators reportedly met May on common ground the week before, and the effort was ultimately doomed owing to PM’s own cabinet failing to offer up necessary support to move the effort forward. After the shakeup forced by the resignations of multiple cabinet members, there is little to suggest that she will have any easier a time of navigating the straights. 
    In a few weeks, Parliament will put the deal to a vote; and confidence amongst its members has been shaky at best. Some – even key members to the Prime Minister’s support network – have suggested the current proposal would be not make it through. Should the deal be voted down, the clock will look beyond dangerous to the safe and stable withdrawal for the UK. At that point, May could stick it out and attempt to return with small tweaks latter which may not sway her government or will be too substantial and knock out the EU’s support. That would leave little-to-no time to earn agreement from all parties and scramble to get the passage approval with all governments along with the technical groundwork to set the dissolved relationship up for the March 29th cutoff. Either this course or an explicit refusal to back down on key items can push forward a ‘no deal’ outcome which Parliament has said it will rule against on – though it is not clear what the course will be from that point with so very little time left. 
    There are also a variety of possible courses that end with May be ousted: from her offering up resignation, being pushed out by backbenchers, Labour mustering enough weight to force an election or the PM calling a general election herself in an attempt to gain support. All of these would burn precious time that they negotiations do not have. And, then there is the outlier chance that Theresa May finally entertains the idea of a second referendum which she has adamantly rejected so many times before. That would stop the clock if it were to end with a vote against Brexit or perhaps be used to strategically reset the clock. Whatever course we take, the clock has dwindled and all developments that are genuine progress register as a step to serious pain. 
  24. 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. 
     
  25. 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.
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