Jump to content


DFX Market Analyst
  • Content Count

  • Joined

  • Last visited

  • Days Won


Blog Entries posted by JohnDFX

  1. 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. 
  2. JohnDFX
    Is Trump Intentionally Stirring Market Volatility?
    The dust is still settling from the most recent string of reciprocal retaliations between the US and China in their ongoing trade wars. As a brief synopsis, the White House frustrated by the lack of progress in negotiations as they were due to break for a month announced August 1st it would slap a 10 percent tariff on the remaining $300 billion in Chinese goods that it was not already taxing. China responded the following Monday by letting the USDCNH cross the 7.0000 Rubicon. The US in turn labeled its counterpart a currency manipulator so that it could pursue other legal means to which Beijing suspended all agriculture imports from the US. That is where we find situation heading into the new trading week. It is possible that we are in another period of stasis where uncertainty starts to give over to complacency once again. Yet, there is motivation for President Trump to keep up the pressure. With the exchange rate adjustment made on the Yuan, China has essentially made a means to automatically offset much of the impact from US tariffs. This is more of a move towards a market-based currency policy than what we have seen before (there aren’t naturally hard barriers in exchange rates), and a weaker currency would be expected should an detrimental economic wind blow in.
    Nevertheless, the US President will use this shift to bolster his claims of manipulation, and the markets will grow wary of the implications for foreign investor capital repatriation that raises added concern China will not be happy to deal with given its financial and economic pains of late; but this was ultimately the most practical move. Moving forward, raising the tariff rate on Chinese import will be largely offset by exchange response, which means the principal strategy for exerting pressure on the country has essentially been neutralized. The administration could try to muster alternative plans with greater effectiveness but there is little the US could resort to short of mustering international support – and their regular threats to trade partners doesn’t make that likely – or that would otherwise pull other countries into support of China. With an appetite to ‘go it alone’ and keep on the offensive, the US government looks like it wants to simply improve the channel of influence with its tariffs. For that to happen, the Dollar would need to depreciate. 
    This is why Trump has been relentless of his critique of the Federal Reserve, voicing discontent with the group nearly every day last week. He sees a simple formula of rate cuts leading to a weaker currency – which is not assured – but he seems to carry little about the group’s credibility or the concern such a move would inspire among investors (a sudden aggressive easing despite stocks at records and the jobless rate at decades low would suggest a crisis is ahead). With the central bank unwilling to cave to the pressure and no other practical approach within his means to devalue the currency without triggering heavy consequence, he may be attempting to rock the market such that investors demand Fed’s action. The slump last week, in May and through the fourth quarter (signaled in early September) all came soon after the US escalated trade wars. Could this ploy work? Yes, but it would carry serious complications. 
    ‘Tis The Season of Holiday Trade, But Is This Time Different? 
    We are entering into the prime period of the ‘summer doldrums’. Summer is a fairly generic phase when it comes to the markets and depending on the unique circumstances each year; but statistically, the lowest average daily volume for the S&P 500 – my favorite, imperfect risk asset – occurs through the month of August. This timing aligns broadly to holiday periods in the US and Europe which in turn leverages the remaining global investors’ expectations as to activity through the period. As a notable asterisk, historically, the VIX begins a steep rise through the same months before peaking in September and October. While prominent technical levels, a dearth of traditional fundamental updates and statistical norms are all means to coax expectations; I find a profitable bias and ultimately complacency are most reliable sources of market intent – much like the assumption of historical status like its ultimate safe haven position which triggers a flight to Treasuries when fear is on the rise once again. 
    That said, market participants shouldn’t form the basis of their position on complacency which is essentially a decision to ignore risk in order to earn tepid returns. There is a saying in markets, ‘will this time be different’ which is used far more often as a contrarian’s criticism of those with that are dubious of a market that has deviated too far from what they gauge as value. It is the same sentiment shared by those that mock the caution of those moving to the sidelines or taking on hedge when risks retreat – particularly should those same unrelenting bulls be saved by a stiff bounce. Yet, asking whether markets are going to eventually shed an unearned optimism which would expose assets that have been artificially driven to excessive highs is the reasonable approach, not blindly buying every dip or (worse) simply adding to an increasingly stretched position with no plan to unwind during favorable times. 
    GBPUSD Is Within Reach of a Three-Decade Low 
    Though many technical measures may suggest the British Pound is stretched in its tumble – particularly in its past three months – and various fundamental aspects to the currency would argue a foothold of relative value, the currency is dropping like a rock. This past week, the Sterling continued its crash against an otherwise unsteady Dollar to trade within 1 percent of the more than three-decade low the pair hit during its October 2016, post-Brexit flash crash low. EURGBP has been of similar constitution. Despite the growing tab of issues for Europe between an ECB dovish drive, Italian government stability risk and the United States constant pressure on its trade status; this pair has climbed for 14 consecutive weeks through this past Friday – though it is still 5 percent from its recent record high set back in late 2008. GBPJPY is perhaps the most forgiving as it is approximately 9 percent from its own decades’ low, which I guess we would have to give credit to the Bank of Japan’s early work to devalue its currency.
    This past week, the UK economy was weighed by troubling economic data which included he first quarterly contraction in GDP since 2012. The real source of fear however remains with the troubled course of the UK-EU divorce. We are still months out from the official deadline (October 31st) for both sides to work out their differences and come to an acceptable split. Yet, with former Prime Minister Theresa May’s departure, the reassurances that the government would do everything in its power to avoid a ‘no deal’ outcome have gone. In fact, new PM Johnson seems to have as the centerpiece of his negotiation strategy a clear warning that this option is wide open. In fact, his reassurances have been so effective, that now the market is treating that once-unthinkable scenario as the baseline outcome. There is little doubt that severing the economic links with the diplomatic ties would carry serious economic and financial ramifications – the IMF, BOE and even the UK government have provided stark assessments. Yet, at what point would the Sterling be fairly valued for a hard break should it come to pass? That is open to interpretation – and the market will be making its best effort to find that balance so long as Boris Johnson voices his appetite for ‘no-deal’.
  3. JohnDFX
    Another Massive Escalation of the US-China Trade Wars
    The White House continues to double down on its aggressive posturing against China in a bid to force the county to yield to its demands at the negotiation table. This approach follows a few patterns in economics, sociology and debate whereby the commitment to escalation persists despite growing risks and diminishing return when or if a compromise is struck – such as the ‘escalation of commitment’ behavior. Late this past week, President Trump himself announced that an additional $300 billion in Chinese imports – essentially the balance of all trade with the country – would be saddled with a 10 percent import tax starting September 1st. He and his representatives – such as economic adviser Larry Kudlow – stated the burden could be avoided if China were to budge on the economic impasses, but the former would also remark that they could be increased further if the situation was seen as not progressing. China does not historically yield to such overt, public tactics; rather it more often responds by retaliating in kind. That is a problem as there is not a like-for-like option for China to respond at this point. It ran out of US imports to slap new or escalated tariffs on with the last volley. 
    This disproportionate status was a glaring imbalance, but China likely resorted to mere threats as it feared pushing the US to more dramatic retaliations. In diplomatic terms, to not respond now would invite a more emboldened US as it sees no negative consequences for inflicting pain. The next steps from here is where greatest risks reside. If China finds a back channel agreement to halt the pressure, it could suggest an interim turning point. China however would not want the capitulation public for political reasons, but the US would for political reasons. If China retaliates, it will likely take the stalemate off the rails. Without US imports to tax, the country would have to resort to selling private US assets which would not sway the government, restricting rare earth materials which wouldn’t register to the White House until much economic damage is done or they result to a ‘nuclear’ (economic) option. Allowing the Yuan to depreciate sending the USDCNH above the 7.00 mark will offset strictly tariff-based costs, but it will give Trump a platform to claim manipulation – though a currency would naturally depreciate if it is on the short-side of economic pain. Selling US Treasuries would be the most severe option with plenty of pain for China to share as its holdings are enormous, but desperate times can push people to desperate measures. 
    Side Effects of Trade Wars: More Demand for Stimulus, Other Countries Start Fights 
    The immediate consequences of an escalating trade war between the world’s largest economies is easy to visualize: economic pain for both that spills over to the global economy as trade inevitably will be impacted for those ‘other’ countries. However, there are other outcomes that can result that have just as disruptive properties on growth or the financial system. One side effect of driving such a destructive fight is that it lowers the boundaries for taking further risks in other avenues, effectively normalizing detrimental decision making. One natural segue is for a country that feels aggrieved to utilize similar tactics with other counterparts for which it feels are taking its partnership for granted. That most threatening spillover for the global community would be for the US and European Union to take active measures against each other. That shouldn’t seem so far fetched now considering the number of reports that suggest the US President has moved forward with China against the suggestion of advisers. Both sides of the Atlantic have laid out lists of tariffs that they are readying against each other and there are obvious flashpoints like the Airbus-Boeing row. Spillover is not just a circumstance for those countries already engaged.
    Like nationalism, the tactics of protectionism can be adopted for other countries that feel they are experience circumstances similar to those that spurred the US to action. One example is Japan and South Korea who have gone through a few iterations of retaliation between them as they claim the other is taking advantage of the relationship. Another consequence of trade policy that directly throttles economic activity is outcry for relief through other circumstances. Monetary policy became the go-to aid for any threats to growth over the past decade, so it is natural demands for relief are directed towards groups like the Fed, ECB, BOJ and others. That exact pressure has been raised by the US President to the FOMC for months. The central bank has rejected the pressure for the purpose of its independence, but the group cannot very well ignore tangible risks to economic health that result from international policies. The response is not limited to the countries that are engaged either. While the Fed has cut rates and is expected to do so again next month, the ECB is investigating a return to QE and the PBOC vows to resort to easing in the second half; the markets expect groups like the RBA and RBNZ will have to offer relief of their own as soon as this week when they meet on policy. 
    A Reminder: The True Tipping Point is Realizing Central Banks Are Powerless 
    Speaking of the need for monetary policy, one of the greatest financial risks facing the global economy – aside from the excess of leverage at all levels of the financial system (government, businesses, consumer, investor) – is the realization that central banks do not have the tools to stabilize future crises. Rationally, most market participants would recognize this is the case if they were to project the course of future periods of market instability. Yet, after a record decade of bullish markets (in US indices), there is an understandable complacency and even a large pool of investors that have never even experienced a true bear market. When a troubled reality wins out, however, the tools that central banks can use are going to be severely limited. Even in the best of circumstances, rate cuts are not nearly as important for stabilizing the financial system as basic credibility – essentially the market responding to the belief that the deep-pocketed central banks’ efforts will alter the course. 
    The Fed, among the major central banks, has the most room to maneuver through traditional policy – and that is not much scope with the high end of the range at 2.25 percent (225 basis points). The other major central banks are working with substantially lower yields. Stimulus programs are more directly associated to firefighting in modern times, and key central banks (the ECB and BOJ most prominent) have extremely little margin to add more liquidity to the system with any hope of earning financial return. A thought experiment: if fear started to spread across the global markets and central banks were not a reliable source of emergency stability, where would you expect to find support? If your answer is a coordinated government response in this environment, our precarious state should be obvious. Let’s hope it doesn’t get to that point.
  4. JohnDFX
    ECB Didn’t Live Up to Lofty Speculation, Will the Fed? 
    There is a span of high-level rate decisions this coming week, but only one of these updates carries serious potential to not only move its domestic assets but further potential to generate reaction from the entire financial system: the FOMC. This past week, the European Central Bank offered us a look into how far the dovish reach of the largest central banks is currently stretching. Against heavy speculation that the group was going to clearly lay out the runway to further rate cuts and escalation of unorthodox policy, they instead offered a more reserved view of their plans. Fending off an approximate 40 percent probability of another 10 basis point rate cut, the ECB held rates and offered up language that said they expect to keep rates at their current level “or lower” through the first half of 2020. On a full swing back into stimulus – versus the half measure of the TLTRO – President Draghi said they were looking into options. There is complication in the ECB pushing ahead with further accommodation as new leadership is coming in a couple months. This seems to concern them more than the risks that their increasingly extreme measures risk degrading the efficacy of monetary policy all together, particularly risky in the event that we face another global slowdown or financial crisis. 
    The swell in European investor fears about the prospects for the future may be soothed by an outside wind if it proves timely and fully supportive. According to the market, the Federal Reserve is certain to hike rates at its meeting on Wednesday. Fed Funds futures are forecasting a 100 percent change of a 25 basis point (bp) cut and is reaching further to an approximate 25 percent probability of a 50 bp move. That is unlikely. Under scrutiny from the President and the markets, the Fed is attempting to signal its consistency as it works to reinsure its credibility. In the June Summary of Economic Projections (SEP), the median forecast on yields was for no change to the benchmark this year. A 25 bp cut at this meeting would not deviate too far from their assessment as the dot plot showed at least 8 members expected at least one 25bp cut (1 anticipated two), so it was a close sway in majority. That said, 50 bp against a backdrop of data that has performed well and equity markets are records would send the wrong signal: either one of hostage to fear of volatility or a sense of panic that they are not sharing about the future. How much is the markets banking on the Fed to converge with its much lower yielding counterparts? That answer will likely spell how much volatility we should expect. 
    Donald Trump Throws a Curve Ball on Trade Wars
    Fear over trade wars had receded recently as confusion seemed to replace the tangible pain of tactical threats. Between the US and China, headlines were more about the next round of talks that were being conducted at a high level in China while trouble over the status of Huawei and the retaliation that could bring was fading out of the news cycle. We almost cleared the week with a ‘no news is good news’ perspective when President Trump decided to weigh in on something the market had long suspected was a strategy but presumed would never be made certain by officials. In offhand remarks that suggest he does not appreciate the fear that can be easily sparked in speculative markets, Trump said China may not agree to any trade deal until after the Presidential elections in November 2020. That may very well be China’s strategy: wait it out until a more amenable administration potentially takes over. That said, the Chinese economy has already taken a significant blow from the standoff thus far. It is unlikely they would want to keep it up that long on the chance of turnover. This may also reflect a Trump administration tactic: refuse to compromise out to the election and use it as a campaign point that no other government would be able to close the deal. Either way, this is a concerning musing. 
    And, in the meantime, don’t forget that there is pressure building up on other fronts. For the United States, the question of open trade war with Europe seems to be graining tangibility with the theorizing of explicit moves from both sides for a variety of perceived infringements including the Airbus-Boeing spat. The most costly threat though remains the potential that the US is considering a blanket 25 percent tariff on all autos and auto parts which could encompass many countries but carry the most pain for Germany, Japan and South Korea. Speaking of those latter two, there is an Asia-specific trade war burgeoning between Japan and South Korea with the former threatening the supply materials necessary for the latter to produce computer chips. And, though it isn’t often considered a ‘trade war’ front, the UK-EU divorce carries with it clear trade disruption implications that will compound a global figure in collective trade. 
    Another Verse in Milestone Towards Currency Wars 
    Most business leaders and financiers publicly project a confidence that the world faces little or no risk that a currency war could erupt between the largest economies in the world. Privately, they are very likely worrying over the pressure building up behind active measures to devalue currencies and setting off a chain reaction of financial instability. It isn’t a stretch to suggest certain major currencies are artificially deflated, but most instances are not this way intentionally (for the purpose of economic advantage over global counterparts) or have been implemented recently. The ECB deflated the Euro with direct threats of monetary policy back in 2014 when EURUSD was pressuring 1.4000. Japanese officials slipped up before that when they suggested they are pursuing their open-ended QE program in an effort to drive their currency lower to afford a trade advantage. They later back-tracked and now simply say their ceaseless JGB purchases are a bid to restart inflation, which has floundered for three decades. The Swiss Franc is faced with constant intervention threat by the SNB, but their efforts are tied to the Euro and ECB’s overwhelming stimulus drive.
    In most instances around the world, policy officials are attempting to account for missing their stated policy goals (such as inflation) or offset external pressures that are themselves the results of a collective unorthodox policy epoch. However, in this desperation, there is increasingly an assumption of malicious intent from trade partners. President Trump is certainly suspicious of global counterparts. He reiterated his concerns this past week in something of a different light. Seemingly facing pressure by advisers for his frequent lamenting of the strong Dollar being interpreted as a ‘weak Dollar’ policy, the President said the Greenback is still the currency of choice – which he supports – while the Euro wasn’t doing well and the Yuan was ‘very weak’. That still looks like intent. What is troubling were the reports that trade adviser – and noted extreme China hawk – Peter Navarro had presented a range of ideas to possibly devalue the Dollar to the administration. They rejected the ideas, but the fact that this is taking place at all certainly raises the threat level of a currency war extremely high.
  5. JohnDFX
    China GDP Refocuses Speculative Attention from Monetary Policy to Growth
    Last week, it was fairly clear that a particular fundamental theme had stepped up to take command of our attention. Monetary policy has garnered greater traction recently owing largely to speculation that the Federal Reserve will have to reverse its course of normalizing extreme accommodation and subsequently cap the responsibility for global investors to bear the exceptional risks in our financial markets on their own shoulders. This speaks to a familiar equation that we’ve seen take center stage through the unique growth phase of the past decade: where genuine economic potential lags, central banks can compensate by offloading risk to make anemic returns more attractive. The US central bank was the chief threat to that calculation of complacency after 200 basis points of tightening and a slow runoff of its balance sheet. 
    Moving forward, the Fed’s support or opposition to supplemented risk taking will still carry enormous weight, but the perspective is now one of ‘wait and see’ until the next rate decision on July 31st – where the markets are certain of a 25 bp cut and price a 20 percent probability of a 50 bp move. 
    In the meantime attention will likely shift to something with more immediate influence. For scheduled event risk through the week ahead, the top listing is arguably the Chinese 2Q GDP update. As an economic milestone for the world’s second largest individual economy, the gravity here is obvious. However, the implications run deeper than that. This is the official government-based growth reading that will set off the season of GDP readings, with the US figures due on Friday, July 26th. Furthermore, given China’s efforts to transition their economic dependency away from exports and onto domestic means as well as its central position in the ongoing trade wars, we are monitoring an integral player in the web of global health that is facing exceptional instability. 
    There is perhaps some reassurance to be found in this figure given that the government has substantial control over the economy and the reporting of the statistics. It is very unlikely that we register a severe shortfall. That said, the markets compensate for these measured movements with greater deference towards even small changes. What’s more, Asia’s economic health was already cast in shadow at the end of this past week. Singapore – the world’s 34th largest economy – reported a dramatic 3.4 percent quarter-over-quarter slump in the previous quarter. This series does have some history of volatility, but the bare growth of 0.1 percent annual expansion is unmistakably poor with the worst pace since the second quarter of 2009.  
    Pressure Increases Even Further for Trade War ‘Accidents’ and Especially for Contagion 
    The good will between the United States and China in their trade relations following the G-20 sideline meeting seems to have all but evaporated. Without meaningful progress to seed reasonable hope of reversing the large tariffs the countries have placed on each other, we are left to evaluate the growing tension on the periphery of their fraying relationship. This past week, senior officials in the Trump administration reportedly agreed that China had violated its sanctions on Iran by importing a million barrels of its oil, but there was no immediate agreement on how to respond. On the other side of the table, China has said it will sanction those US companies that were involved in the arms sale to Taiwan. While a full reversal on the trade war doesn’t seem to be in the cards through the foreseeable future, there seems little will at present to escalate the situation along its natural course of the US going ‘all in’ on all Chinese imports while China responds with even more unorthodox measures such as restrictions on rare earth materials. 
    Meanwhile, the pressure is ratcheting up outside the now-conventional channels of economic retaliation with the very real risk that all such efforts will be construed as some form of retaliation and escalation. Reports this past week that Trump had tasked aides to look into means to devalue the Dollar is immediately believable and a serious threat of destabilizing an already-troubled situation.
    The President has repeatedly accused China and the EU of using monetary policy and other means to artificially weaken their respective currencies to afford ill-gotten advantage to their economies. While there are arguments that can be made to both cases, pursuing retribution at this juncture would be a severe threat. A related issue that will no doubt draw the attention of Trump and his advisors was the appointment of IMF Director Christine Lagarde to be the new leader of the ECB when Draghi steps down at the end of October. The IMF recently issued its review of the EU with advice that the region should continue to sport its enormous stimulus given conditions. That can easily be interpreted by a person or people looking for antagonism as a move to further advantage. 
    Another development that should be watched closely is France’s decision to move forward with a 3 percent digital tax on earnings made in France by large tech companies. Many of those companies that will face the levy are American, a fact that will not go unnoticed by the White House. With the UK considering a 2 percent tax of its own and the EU still moving forward with debates on a broad duty, there is a rising risk that the US pushes forward with the tens of billions in tariffs it has warned Europe over and perhaps even the adoption of a blanket tariff on auto imports. If this is the course we follow, take those atmospherical recession warnings more seriously.
    US Earnings Season Starts with Recession Fears, Trade Fallout and Business Cycle Under Scrutiny 
    The second quarter US earnings season is due to start in earnest in the week ahead. We have already taken in a few noteworthy corporate updates these past weeks. Levi Strauss, who reported this past week, is the target for retaliatory tariffs from Europe while Micron and Fedex who offered updates two weeks ago find performance directly reflective of trade tension. While there are a few companies reporting that have overt exposure to strained Chinese relations, the high profile updates ahead will tap into other matters. Netflix’s report on Wednesday will look to leverage some of the influence that it enjoyed in previous years when tech shares paced US equities which in turn led the global view on risk appetite. However, lately, the FAANG members and collective seem to have lost the ear of the market. On the tech side, IBM’s update on the same day and Microsoft figures on Thursday will offer a more endemic growth picture. 
    Perhaps the most prominent theme to extract from this week of US earnings will be an important ‘cost’ of monetary policy accommodation from the Fed. The central bank is warning the engines for rate cuts, and most investors can only see benefit from the reversal with the moral hazard tide rolling back in. Yet, there are systemic risks associated to the fact that the group is so unnerved about the near future that it is contemplating easing despite still meaningful growth, not to mention the danger that could follow should the markets decide to lose confidence in central banks’ ability to fight off crises owing to their depleted resources. 
    In revenue terms, a drop in benchmark rates is often a burden to banks. While each cut in the overnight rate does not confer proportional burden to financial institutions’ margins while each hike adds to it, that is more often the case over cycles and particularly when we are attempting to lift rates off of long-term deflated levels. We are unlikely to see the fall out in this past three-month period’s returns from JPMorgan, Citigroup, Goldman Sachs, Bank of America and Morgan Stanley; but their forward guidance for future profits can certainly offer up reference. Look beyond the single tickers’ response to their own financials and instead monitor the systemic repercussions. 
  6. JohnDFX
    Enough Threats of a Currency War and You Find Yourself In One
    It has been a common theme in the negotiations between the United States and the countries they have targeted for trade inequities that aggressive language has preceded tangible action. While both sides (the US versus the ‘World’) have been clearly willing to dole out the warnings, it has been the White House that has advanced both action and intimidation far more willingly. At this stage, we have seen the trade war level out somewhat. US President Trump and Chinese President Xi agreed to some measure of armistice at the G-20 meeting, heading off a standing threat by the US to expand is onerous 25 percent tariff against Chinese imports to encompass the remaining $300 billion or so in goods that were not already being taxed. Yet, that is about as far as the agreement has stretched – with the caveat that US firms would be allowed to sell their manufactured goods to Chinese telecom. As far as the scorecard goes, this hardly qualifies as de-escalation; but negotiations are ‘ongoing’.
    In the meantime, US policymakers seem to be anxious to avoid any impression that they are letting off the pressure on the rest of the world to ‘right their wrongs’ against the country. The US Trade Representative’s office this past week proposed tariffs on an additional $4 billion worth of EU goods to add to the $21 billion list offered up back in April. This is ostensibly a response to the ongoing spat between the US and Europe on what they each deem is unfair subsidizing of each other’s’ largest airplane manufacturer (Boeing and Airbus respectively). Thus far, the two principal Western economies have not engaged in an all-out trade war – like the US and China have – but all the ingredients of escalation are in place. I maintain that if these two economies engage in this growth-destructive behavior, it will inevitably stall the developed world (and like global) – GDP.
    As it happens, President Trump has taken the standoff to a different venue altogether: exchange rates. He revived his criticisms this past week that other key economies are targeting devalued currencies as a means to artificially amplify their own growth. Of course, a government that is conducting an aggressive trade war that looks to leverage taxes to change trade partners ways would hope for a steady – or cheaper – currency to ensure those levies have their maximum impact and the local reciprocal pain is minimized. While Trump’s threats have thus far have been kept to criticism over the Federal Reserve’s policies while his own administration say he is not seeking a ‘weak dollar policy’, if the central bank doesn’t acquiesce to his critiques, he may very well pursue other avenues to make a more comprehensive impact. That said, if the US were to forge twin trade and currency wars, a financial crisis is likely and a systemic downgrade in the use of the US Dollar as top reserve currency would be inevitable. 
    Fed Monetary Policy Finds Itself In a Position to Steer the Broad Markets 
    We have gotten to a point where there is so much reliance on monetary policy for the well being of the entire financial system that the markets are gauging their day-to-day sentiment against significant shifts in monetary policy expectations. While external support for the markets is a function of all the majors central banks’ collective efforts, the world’s largest authority holds greater pull owing to its symbolic status as captain to the world’s largest economy and as the paradigm of what a ‘hawkish’ policy is this unusual economic cycle. The interest is so sharp that the markets are reading into key pieces of event risk not for their economic consequences, but rather for the support or opposition it represents to a faster reversal in Fed Reserve policy. Point-in-case was this past week’s US employment report.
    The June nonfarm payrolls (NFPs) beat expectations soundly with a 224,000 net addition (versus 160,000 forecasted) with the jobless rate barely ticking up from its multi-decade low (3.7 percent) and wage growth holding steady at a 3.1 percent annual pace. All-in-all, this was a robust print to contribute to a remarkably strong series. And yet, the markets responded as if it was a bad omen of what was ahead as the major US indices (Dow, S&P 500, Nasdaq) all gapped lower on the open Friday. Why would run of important data that supported the outlook for growth provoke a slump in capital markets? Because, the market is not intending to profit through a long-term picture of strong economic expansion and steadily rising rates of return but rather through the tried and true strategy of front running deep pocketed and relentless central banks. This puts us in an economically-unusual but relatively familiar situation from this past decade whereby the speculative rank covets data that disappoints just enough to warrant monetary policy accommodation without tipping an overwhelming wave of deleveraging. That is a difficult balance to maintain.
    Nevertheless, Fed intent will remain a driving force for this equilibrium which places greater emphasis on top-line US data and central banker speak when gauging global market moving potential. That said, the week ahead holds a few particularly important milestones. On the economic calendar side, the market’s favorite inflation figure – the US CPI – is due for release on Thursday. For the more qualitative influences, there is a range of Fed speak scheduled with Chairman Jerome Powell’s Congressional testimony Wednesday and Thursday. 
    The Curious Case of an Unrelenting Sterling Slide
    The British Pound cannot seem to catch a break. Where many of the key Sterling crosses have come to levels of meaningful support recently, we have seen the boundaries bow under the pressure while some pairs haven’t even broken stride. GBPUSD and GBPCHF are good examples of crosses that show little deference towards boundaries while both GBPCAD and EURGBP have extended incredible pace - 9 week slides for the GBP for both marking the worst performance in 12 years and on record respectively. Against the backdrop of Brexit, this may not seem that unusual a fate. However, it is not so straightforward a scenario when we consider we are not dealing with a relentlessly deteriorating situation – at least not yet. At present, we are in a holding pattern in the UK-EU divorce proceedings as the Britain works out who the next leader of the Conservative Party – and therefore the country – will be.
    Normally, in this situation, we would find markets either trading without much progress either bullish or bearish while in some situations in the past there is a measurable unwinding of a stretched speculative exposure. The difference for the Pound is the practical recognition of probabilities for the difference scenarios. While possible that the leadership change will happen quickly and the two sides hash out a fruitful agreement that satisfies all, it is very unlikely. Instead, the front-runner for the next PM, Boris Johnson, continues to make clear his comfort with a no-deal outcome should European negotiators not relent. And, despite his suggestions that the country will be totally prepared for such an outcome, three years of uncertainty has led to a deeply-rooted skepticism.
    In the event that the controversial figure takes over the Tories and the country finds itself heading towards General Election, it will only extend the uncertainty and make a solution by the designated cutoff date (October 31st) virtually impossible. That deadline marches relentlessly closer. With a clear mandate for negotiation on the UK’s side still weeks away at least, the probability of a more disruptive outcome grows. And, against this backdrop, it is worth reiterating that uncertainty is risk. Be mindful when trading the Sterling.
  7. JohnDFX
    Monday’s Open: Trade Wars Status Quo That Really Isn’t 
    The G-20 Summit has passed and by the accounts of the key players, the results were encouraging. I guess no new fronts have been added to the global economic conflict after the two-day meeting, so that is a silver lining we can hold onto if we wanted to be optimistic to the point of true enthusiasm.  According to President Trump’s account of his meeting with his Chinese counterpart Xi Jinping, their discussion was a success as it reportedly signaled the restart of negotiations between the two countries. To be sated by this news would mean ignoring the fact that they had supposedly never officially broke off talks and being on speaking terms is about as low as the bar can be set. The genuine improvement in circumstance after this summit was the fact that the White House’s threat to put another $300 billion in Chinese imports under the 25 percent tariff. The US President also announced that he was lifting the ban on US firms selling products to banned Chinese telecom Huawei – though the company remains blacklisted and cannot export its wares to the United States. 
    The real question heading into the new trading week is how this news is leveraged: by bulls or bears, to charge conviction or short circuit intended trends. If we do see the market buy into the optimistic perspective of the US-Chinese negotiations, it will prove very difficult to develop any meaningful trend. This outcome is tuned more towards a relief rally. That being the case, there was never a significant discount established in the broader markets. These past weeks have seen speculative assets rise with the S&P 500 and Dow in particular anchored to record highs. That would suggest that the markets may in fact have been pricing in a more significant improvement of circumstances which could completely drown out any low-grade rally that could arise. Further, in this conflicted backdrop, it would be very difficult to sustain a troubled risk-on rally with liquidity under pressure owing to the US Independence holiday on Thursday July 4th. A middling risk rally would very unlikely override shallow markets.
    Alternatively, a bearish take on the after-action would likely trigger deeper misgivings in the markets and potentially tip a selloff that can override thinned conditions. This scenario could start as a retrenchment as the excess premium afforded to an assumed reversal in one of the most abstract and wide-reaching fundamental threats registered in years (trade wars). It could further grow into an appreciation of the economic pain that is slowly compounding as the efforts put into place thus far build upon the burden in economic activity. That is recognition of true fundamental struggle that contradicts superficial speculative ambitions that have placed greater emphasis on the expectations around the likes of the Fed rather than the tangibility of GDP. While generating enough conviction to carry risk aversion through the liquidity drain this week, it is far more likely to happen in a fit of panic rather than greed; and this is the type of falling fundamental start that can get the ball rolling. 
    Seasonal Forces Versus Fundamental Winds 
    Generally speaking, there are strong fundamental winds blowing in these markets, but the urge to revert to restrained market conditions as is familiar during seasonal lulls like we are expecting during this ‘height of Summer’ week will prove a powerful deterrent. Seasonally, July is more buoyant for expected volatility (via the VIX volatility index) than June; but that is not saying much for state of turnover throughout the average year. Also, Thursday’s Fourth of July holiday is really only a US celebration; but the expectation for sidelined speculative activity fuels an assumption among the global rank that is often realized by sheer force of will – or want. Looking to the same historical norms, low volatility has also contributed to stronger performance for risk appetite, which fts the assumed inverse correlation between the likes of the VIX and the S&P 500. Given the record high of the latter and general premium-despite-fundamental-trouble for the many other speculatively-linked assets in the open market, it would be difficult to leverage genuine gains through the forthcoming period. 
    Overriding liquidity conditions is difficult to do whether attempted through fundamental or technical means. It is, nonetheless, significantly more probable to mount an offensive when there is a common event or theme for which a wide swath of the market can line up behind. Trade wars referenced above is one such deep well upon which the speculative rank can draw. Another is monetary policy. This past month, the remarkable recovery mounted by the vast majority of risk assets seems to have a very clear connection to monetary policy. In particular, the Federal Reserve’s policy decision and forecast on the 19th was seen as a boon to doves. It should be said the group did not cut rates nor did it indicate any intention of easing through 2019, but the market took what it wanted from the event. That is another point of speculative reach.
    In the week ahead, there are a number of events and data points that could hit at this fundamental disparity, but Friday’s June employment report (NFPs) is the most distinct. If the general strength of the data holds firm, it could sharply drop expectations for a July cut – presently priced at 100 percent according to Fed Funds futures. Then again, if the data drops sharply, the implications for growth moving forward could lead the market to think more critically on the shortcomings of any future central bank efforts, as impotent as they already are. 
    Setting the Course for the Official 2Q GDP Readings
    While monetary policy is a theme that will follow one of the top highlights for event risk in the coming week and trade wars will following the G-20 summit headlines, the most comprehensive matter to hit upon through the breadth of the period will be growth. Interest in the health of the global economy has simmered for months between the cumulative pain afforded to the trade issues, the uneven state of financial assets, questions over the policy authorities’ (central bank and government) willingness to offer backstop, the serious erosion of confidence surveys and specific high-profile market developments like the inversion of the 10-year / 3-month Treasury yield curve. That all builds into greater deference to be paid to the forthcoming official round of 2Q GDP readings that will start to cross the wires in a few weeks’ time. That run kicks officially on Monday July 15th with the release of China’s 2Q GDP figure. In the meantime, there are a host of economic readings on tap for this week alone. 
    As far as comprehensive views go, a Bank for International Settlements (BIS) annual economic update will most likely give a more dire assessment of what the world is looking at heading into the second half of 2019. This group is known as being frank about risks and somewhat pessimistic, with no compunction when it comes to warning over the instabilities developing in the financial markets. They will almost certainly decry the state of global trade and the precarious nature of risk taking. In data terms, the Friday NFPs are a good barometer for the health of the world’s largest economy, however, I put greater emphasis on the ISM’s service sector activity reading for June. That particular segment of the economy accounts for approximately three-quarters of output from the behemoth.
    That said, if the service and manufacturing reports from the group point to the same general direction, the implications are far greater. For a global perspective, there are Markit-observed PMIs are due for Asia, Europe and North America. We are expecting ‘final’ readings for Japan, the Eurozone and US; but the figures for China, Italy and UK are just as important to the overview. As with many fundamental dimensions nowadays, there is a significant bias in terms of impact for different bearings. A firmer showing would act as mild justification for the already optimistic slant from the markets. A worsening conditions will draw further and further on the discrepancy in speculative view and excess market pricing. 
  8. JohnDFX
    There is Way Too Much for the G20 to Cover 
    Typically, the G-20 summits that brings together leaders for some of the world’s largest developed economies cover matters that are important but not especially urgent. For the meeting in Osaka, Japan this coming Thursday and Friday (June 28-29), the members will officially and unofficially have to cover topics of exceeding importance. That would seem unusual considering we are still in the longest bull market on record and the closest state to general peace that we’ve seen in some time. On the official agenda are: global economy; trade and investment; innovation; environment and energy; employment; women’s empowerment; development; and health. As you can imagine, there will be certain themes that are more loaded than others and likely to generate more friction in group discussion as well as sideline talks than others. 
    Trade wars will be the most frustrating topic to discuss for most of the members. In particular, the US and China have used this gathering as a timeline for the next stage of an ongoing trade war between the two economic giants. Since negotiations last broke down and the US raised its tariff rate on $200 billion in Chinese imports – to which China moved to match the tax on $60 billion in US goods – the rhetoric between the two has ranged between mild encouragement to outright threats. If President Trump’s timeline holds, the stakes are high for a breakthrough between the two. After the last move to raise the stakes, the White House said it would expand its onerous levy against its trade partner to encompass all of its goods coming into the US (another $300 billion or more) in ‘three or four weeks’. That time frame has come and gone which prompted negotiators to move out the deadline to a natural conversation between Trump and Xi at the summit. 
    If these two fail to come to an understanding in order to de-escalate their economic conflict, it will represent the biggest notional curb on growth thus far. It would also almost certainly usher in the next stage of unorthodox measures as the options for retaliation have expended standard arsenal. China cannot meet the US like-for-like with straightforward taxes and will therefore need to consider actions on rare earth materials, blacklisting US entities, US asset exposure levels, exchange rate manipulation and other as-yet unmentioned options. The circumstances between these two giants is enormous but it is even more desperate for the other countries around the world who are caught in the middle as collateral damage. Further, depending on how President Trump views the benefits-risk balance of the affair with China – and conversely Mexico and Canada – there is the persistent risk that the Trump administration could expand its trade vigilantism against host Japan, the Eurozone and many of the other G-20 members. One thing is clear from previous gatherings of state leaders, President Trump does not respond well to multiple countries ganging up on him whether through aggression or frustrated pleas for reason. 
    While trade will likely take up a disproportionate amount of the mental focus, there are further matters of flagging economic growth and geopolitical tensions to discuss. Trade is compounding a general cooling of economic activity and there is an unmistakable awareness as to the limitations of over-extended monetary policy. Further, protectionism is casting plans to offer more through burdened central banks and even plans for fiscal policy as provocative means to compete to the detriment of global peers. As for global relationships, there are many points of fray, but the only area where a military war seems a genuine risk at the moment is between the US and Iran. The downing of a US drone by Iran followed by reports that a retaliation was green lit then forestalled has raised the threat level enormously. Perhaps after these ‘manufactured’ issues are thoroughly covered, we will see a serious discussion on ingrained concerns like the environment and gender equality. 
    The Market Prefers Its Own Interpretation of the Fed’s Options 
    Sentiment in the global markets is a force of nature. It can readily overpower subtlety which is what happened this past week following the FOMC rate decision. At its ‘quarterly’ gathering, the world’s largest central bank held its policy mix unchanged with a benchmark rate at a range of 2.25 to 2.50 percent while its balance sheet efforts held trajectory. While the market had afforded an approximate 25 percent probability of a cut, there was little actual surprise and repositioning to be registered by the market. When it came to forecasts, however, there seemed to be outright disbelief; and the markets were willing to run with their own interpretations of what the future held. Looking to the group’s own Summary of Economic Projections (SEP), there was an official forecasts for no change to the current rate spread through the remainder of this year, one 25-basis point cut projected in 2020 and a subsequent rebound to our present altitude in 2021. That strayed dramatically from the market’s own debate over two or three cuts this year and further easing at a similar pace into 2020. 
    After the Fed’s attempt to throttle expectations, the markets only solidified its forecast with Fed Fund futures and overnight swaps showing the probability of three quarter-percent cuts this year rising to near certainty. Now, to be fair, the breakdown of the SEP’s rate forecasts shows an optimistic outlook for growth while the ‘blue dots’ indicated beyond the median vote that 8 members expected cuts and 7 of those assumed two 25bp moves.  It would not be difficult to tip that balance should the economy start to flag more seriously. While capital markets are holding relatively steady through this disparity (and the Dollar has finally started to show the risk of lower returns and the economic state that would necessitate the response some deference), the divergent paths these forecasts represent are extreme and necessitate a convergence. That merging of views will come with significant market response whether it is speculative enthusiasm closing the gap to the central bank’s forecasts or vice versa. 
    Given the nature of speculation, we will be left with a state of hypervigilance around data and rhetoric from Fed officials that reinforces the market’s skepticism or contradicts it. There are many prepared speeches among various members scheduled this week. That is likely on purpose as members make an effort to reinforce forward guidance. The members more on the extremes of the policy curve will be important to watch but the centrists and Chairman Powell’s scheduled speech are arguably the most important. On the data side, the Fed’s favorite inflation indicator, the PCE deflator, is due. Keep tabs on forecasts for Fed intent, because the record high from the S&P 500 that encouraged other risk assets higher, has drawn much of its lift from favorable US monetary policy. 
    My Greatest Concerns: Recognizing Monetary Policy’s Bark is Bigger than Its Bite and Trade Wars Turn Into Currency Wars 
    While my greatest fears for the future are ultimately a global recession, financial crisis or the beginning of a global war (much less all three); there are certain intermediary events that are more probable and could more readily usher in those systemically disruptive states. And, as it happens, they relate to both the aforementioned concerns. As chaotic as trade wars seem to be through their development and potential risk to the norm, they are at least conducted in measured and definable steps. The Trump administration has signaled its intent and indicated the criteria for which would trigger further escalation or a walk back of existing burdens. The other countries engaging the US or other global players have done the same. It is true that the decisions to intensify or cool the fight have been flippant at times, but it seems to always followed a clear lines of tactics and escalation. This is not the same pace that is employed when the fight shifts to exchange rates. 
    Currency wars are inherently messy. They can confer significant economic benefit to those employing the tactics and detriment to all others. There is significant disagreement as to what constitutes a country pursuing this unfair line of policy which leads to fights out of sheer misunderstanding. And, ultimately, there is tendency for a retaliatory policy to escalate rapidly. We haven’t seen many genuine claims of currency manipulation over the past few decades, but the Japanese authorities were forced to quickly backtrack on a ‘misstatement’ and the Chinese Yuan has a permanent question mark next to it. That said, with trade wars underway and the US President not shy of labeling China’s and Europe’s currencies unfairly devalued, it seems risks now are far higher than they’ve been in generations. It is difficult to pull up from a currency war, and evidence shows these are not the leaders that are likely to let cool heads prevail. 
    The other escalation that plagues my fears is: what happens should the markets develop an unshakable sense of skepticism around central banks’ ability to maintain control? The past 10 years has enjoyed an unprecedented climb in capital markets and underwhelming average pace of expansion. The world’s largest central banks had to cut their rates to near zero and inject the system with extraordinary amounts of stimulus in order to make that happen. While we have long ago restored record highs for the likes of the Dow and seen GDP stabilize in expansionary territory, most of the banks kept going. The reasoning was that either the extreme support was needed to keep the peace or it was worth it to leverage just a little more growth. Regardless of the justification, it meant that there was very little effort to re-stockpile policy ammunition for any future troubles. 
    Now, as pressure seems to be building up once again, the markets are clearly looking to the Fed, ECB, BOJ and others to head off crises. If we were to reasonably evaluate what happens in the scenario where we face another slump, there should be little confidence that monetary policy could truly hold back the tide. That said, limitations for future troubles will start to trace back to an assessment of the current structure’s ability to keep the stability we currently enjoy. If central bank credibility were to truly falter, the fallout would be severe -all the more for the fact that it would commence from record high prices (with arguably a record gap to value). 
  9. JohnDFX
    It’s Okay, This One is On the Fed 
    There has been a notable shift in the market’s mood in just the past week. A sense of dull complacency that traders who were active during the first wave of the large scale, central bank stimulus infusions would recognize has bolstered key assets. After the benchmark S&P 500 and Dow topped at the beginning of May, a steady slide in the indices encouraged the same sinking feeling in conviction that was dependent on complacency. Evidence that we are the late stages of the economic cycle, the business cycle and the market cycle is piling up. Normally, as the pace of expansion flags, we find the market’s tolerance for lowered speculative potential is partially offset by higher rates of return as the demand for funds drives yields higher. However, the record-breaking bull trend that we have enjoyed over the past decade defied that particular convention as its initiation and extension was supported through extreme accommodation from central banks – first lowering interest rates to record levels and then adoption quantitative easing measures. While this would help stabilize financial markets and help stimulus growth, it would also necessarily lower rates of return to be expected from the investing. 
    After a while, it grew more and more apparent that the latter waves of support produced less and less traction towards economic objectives (bolstering economic output and inflation) but they nevertheless ensured a lower baseline for expected returns. With a presumption of indefinite support by monetary authorities and a highly competitive financial market, it should come as little surprise that moral hazard would thrive. It is that base assumption that exceptional risks taken in recent years to drive assets of questionable value to record high prices (like the S&P 500) would be discharged by the Fed and its international peers. The anticipation is impossible to miss in the markets with Fed Funds futures pricing in an 85 percent probability of a 25 basis point cut by July and a healthy chance of multiple cuts before year’s end. Considering President Trump has called out the central bank multiple times over the past months and economic warning signs like the inversion of the 10-year/3-month yield curve have garnered greater attention, the assumption of more assistance comes as little surprise. Language from the Fed Chairman Jerome Powell, other board members and even official communiques have also made clear a willingness to step in should growth stall. 
    My concern is not whether the Fed and others will step in should we lose traction, but rather what happens as we realize their limited capacity to extinguish further financial fires. The Fed arguably has the greatest capacity of the major central banks as it has tightened rates around 200 basis point  since its first hike in December 2015. Yet, that isn’t a particularly sizable arsenal when we consider how little economic amplitude we leveraged from the massive stimulus programs and given how much more premium in capital markets they are expecting to keep propped up – the S&P 500 rose another 39 percent beyond 2015’s peak. If actions by the Fed fail to steady the market, it would do far more damage to sentiment 
    Don’t Forget the Trade Wars Are a Thing 
    With the recent rebound in speculative market benchmarks, there is an innate tendency to seek out favorable fundamental winds in order to justify the prevailing bias. Anticipation of further support from the Federal Reserve is one such rationalization for speculative lift, but another potential source of confidence heading into the new trading week is the Friday evening news of a trade war breakthrough. Following the week’s end market close, President Trump announced in a tweet that a deal had been reached with Mexico for the country to take action on stemming migration through the country destined for the United States in order to avoid a 5 percent blanket tariff on all Mexican exports destined for the US. This warning was made less than two weeks ago and it was roundly criticized by members of Congress, US business leaders and (reportedly) even White House senior staff. That means the market likely maintained a hefty skepticism that the threat would ever be put into action. As such, we now await the new week’s open to see if there is a flush of relief rally to play out or if the markets will struggle despite the faux breakthrough. 
    Meanwhile, progress on one front of trade dispute for the US could be used as justification to escalate tensions on another in a bid to force capitulation. The last official action in the US-China standoff was a hike in the tariff rate by both countries on each other’s list of target goods ($200 billion and $60 billion worth respectively). Treasury Secretary Steven Mnuchin said over the weekend that the President would be “perfectly happy” to fulfill his vow to expand the list of taxed imports to all of China’s trade – over $500 billion in goods and services. If imposed at the prevailing 25% rate, that would translate into an incredible 250% jump in the notional bill of the trade war on just one side of the battle line. Perhaps even more troubling would be China’s inevitable retaliation. The country has already maxed out the like-for-like goods for which it can impose a tax. That would mean it would have to resort to further unorthodox means. 
    With the US already moving to ban Huawei, it seems inevitable that the Asian giant would move to blacklist a number of important US technology companies. It is also very likely that it would throttle shipments of rare earth materials – for which it is the world’s largest producer – to hit the production of cellphones and other consumer technology. While that bill will add up over time, it is likely that China will pursue additional means of pressure in order to have a more pointed effect. A concerted selling of US corporate assets is the next logical line, but many are watching for Yuan depreciation or a strategic selling of Treasuries. Those are unlikely however as the financial repercussions would be too severe with necessary losses in their own capital exposure and a high probability that other countries rally to the United States’ cause. 
    An Inconvenient Time to Worry About Eurozone Stability 
    With the US Dollar losing viability owing to its pursuit of trade wars that undermine global stability, the Pound plagued by a directionless Brexit and the Japanese Yen lost in a deflationary quagmire, there is an acute need for a stable benchmark currency. Despite its many fundamental shortcomings, the Euro showed itself willing to offer an outlet for liquidity over the past few years as the recovery from the region’s sovereign debt crisis between 2009 and 2012 seemed to offer a sense of hard-fought stability that was prized above all else. When the European Central Bank (ECB) veered off its course to normalize policy following the December cap on its open-ended stimulus program – by implementing a new targeted-LTRO – the Euro’s appeal deflated significantly. With a renewed sense of dubiety, we have seen attention turn to other cracks in the Euro’s perceived durability. Perhaps the most tangible of the unique risks facing the shared currency is the pressure brought by its third largest member: Italy. 
    The coalition government of staunch anti-EU parties has struggled to find a common cause outside of the general revolt against the European cause. After the Prime Minister threatened to resign over infighting by his government, the coalition parties seemed to settle their differences for now but that would not translate into any renewed support for the Union. In fact, the unifier between these extreme parties seems to be their agreed-upon discontent. Last week, one of the deputy Prime Ministers stated clearly that Italy would not change course from its plans to offer its citizens relief through tax cuts. In the meantime, the European Commission found the country warranted a preparatory document on disciplinary action over its financial position. According to deputy PM Salvini, this could amount to a 3 billion euro hit. The country and Union leadership can draw this fight out for some time before we reach the limits of financial stability as Greece showed us nearly a decade ago, but the market is unlikely to allow the pressure to build up for that long before it starts to price in a systemic threat. In the week ahead, the Eurozone and European Union finance minister meetings will no doubt discuss this situation, and any uniform positions will not pass unnoticed. 
    Generally-speaking, the Euro would not retain the same global reserve that it represents today if one of its core members were to make a credible threat of withdrawal. That is still very unlikely, but there are first stage cracks that are being threatened that could build an unplanned head of momentum: It has been suggested that Italian authorities are considering the use of an ‘alternative currency’ to service its debt, a move that naturally ushers in reasonable speculation of a stability concerns underlying the Euro. As the second most liquid currency comes under pressure, it is natural to keep tabs on the only more ubiquitous benchmark – the Dollar – but I believe gold is the best measure to our particular set of financial uncertainties as the 2009-2011 period surge stands out for those seeking alternatives to the traditional currencies.  
  10. 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. 
  11. JohnDFX
    Are We Turning the Corner on Global Trade Wars? 
    There were a few very prominent, positive developments on the trade war front this past week, but is it enough to systemically change the course of the global economic standoff back towards the cooperative growth of the past? Throughout the past week, there was a building din of unconfirmed reports that US President Donald Trump would delay the decision on whether or not to apply tariffs on auto and auto part imports at the May 18th initial deadline to the Section 232 report the administration ordered to investigate the competitive field. As the headlines channeled unnamed officials trying to assuage investor fear, the market slowly stabilized and started a tepid climb. Full confidence was withheld however as participants were still shell-shocked from the sudden reversal on US-Chinese relations the week before. Rather than wait for a weekend reveal to potentially leverage news cycle response and a Monday market swell, the President confirmed Friday morning through his press secretary that he would delay the decision ‘up to 180 days’ as negotiations continued. Technically, this is only a delay, but previous stretches of peace have been occasion for speculative interests to rally in the past. Interestingly, the market responded to the official news with a weighty skepticism, squandering a recovery developing through the second half of the week. 
    There was another chip to play to potentially rouse the bulls to life. The stalled progress on the North American economic pact – replacing the long-standing NAFTA accord with Trump’s centerpiece USMCA – could find a jump should the White House drop the steel and aluminum tariff quotas on Canadian and Mexican partners. That would lower Congress’s reservations towards the deal and perhaps secure a clear ‘win’ in the course of a global trade war. The administration issued another confirmation Friday that it had done just that - removed the metals tariffs on those key trade partners – and Trump issued remarks shortly thereafter calling on the Legislature to pass the stalled deal. Yet again, the news was met with an apathetic response. Averting a dramatic escalation of ongoing trade wars (autos) and making strategic moves to realize previously stated plans (USMCA metals) carries limited sway when compared with the full stride of the US-China trade war. 
    A week after the US ramped up tariffs on $200 billion in China’s goods from 10 to 25 percent and China retaliated on $60 billion in imported US goods (also up to 25 percent), we have seen strong language from both sides and reports that efforts to restart talks have thus far failed. This standoff is not a practice in academic curiosity but an earnest throttling of economic activity. We have seen the consequences of the higher costs and restrictions bleed through in the wide run of Chinese indicators while the US sentiment surveys and inflation reports show a more subtle, but still nefarious, influence.  There are still approximately three weeks for the two sides to make headway according to the President’s warnings before the US expands it imports tax list to include all of China’s goods (they estimate another $325 billion). Speculative appetites may be such that they simply won’t run simply because they have a little longer leash. However, my concern is that we are already seeing the fruits of full expectation that this trade war will be resolved. If all of these artificial encumbrances are removed and the market still fails to gain altitude, the recognition of a decade-long cycle end may be difficult to miss. 
    Is the Second Quarter Going to Cap Recovery Hopes
    Since the United States issued its better-than-expected first quarter GDP update, there has been a notable shift in the outlook for global economic activity. Before that milestone, there were mounting concerns that the cumulative effects of trade wars, central banks easing off the accelerator on monetary policy and feet dragging on fiscal policy were converging with natural late-cycle economic struggles. What the official quarterly growth update from the world’s largest economy was less of a definitive turn in conditions and more of a boost to sheer sentiment. Mere collective bias can dramatically change the way market’s move in terms of direction and tempo by amplifying the ‘favorable’ developments and tempering the fallout from the ‘adverse’. This prejudice of systemic speculative appetite will be put to the test moving forward on a number of key issues. The resurgence of the US-China trade war turns the focus onto the snowballing pain absorbed as long as the fight continues and any sign of intent for central bank support moving forward can be offset by a practical appreciation as to what the stretched monetary policy authorities can even hope to deploy. There real traction on sentiment however will always take more readily from unambiguous data. While sentiment surveys are still vitally important to translating the abstract issues into intent for investors, consumers and businesses; there is more mileage in price action from clear growth data points. 
    On this point, we will be processing a number of updates through the forthcoming week that will cut right to the heart of the growth question. The most comprehensive ‘backwards’ update will come in the form of the advanced PMIs (Purchasing Manager Indexes) for May. We are due updates on manufacturing, service sector and composite activity readings from Japan, the Eurozone and the United States among other countries. As we’ve discussed before, the correlation between these proprietary – and timely – economic measures and the official – and slow – quarterly GDP figures is remarkably high. A strong showing in this run of data could beat back growing concern, but it will struggle to topple an entrenched bias. On the other hand, a poor showing could shake loose the hold outs in the financial system like the S&P 500 and other US equity indices to compound fears. There is plenty of complementary growth data that can subtly change course but much of it is dated (like the Japanese 1Q GDP update) or too narrow in focus (such as the US durable goods). If you are looking for a better line to project growth, keep an eye on the OECD’s updated growth forecast. As far as supranational group economic projections go, this group tends to hit close to the mark. 
    The EU Parliamentary Election’s Influence Over Euro’s and Pound’s Future 
    Perhaps one of the most influential events on the docket for the coming week is the European Parliamentary elections starting Thursday the 23rd and running through Sunday. As far as systemic but abstract fundamental themes go, there is enormous economic and financial influence from the pursuit of nationalistic interests. Frustrated by slower measures of growth these past years, global citizens and politicians have taken to escalating the portion of blame to be assigned to strategic economic and diplomatic relationships with other countries and regions. Never mind that the leverage from global growth over the past decades would have been far less expansive if it had been just the collective efforts of domestic agendas. In Europe, the threat of populist interests could turn into a existential risk. 
    The European Union and Euro-zone (the narrower monetary collective) are held together by the belief that economic might – and no small measure of militaristic security – is dependent on their cooperation. That said, there has been an unmistakable rise in nationalist fervor across Europe with previously unrepresented parties gaining significant presence in governments. Perhaps the most prominent example of this political shift comes from Italy which is ruled by a coalition government that ran on a platform that was not shy about its anti-EU views. Alone, Italy represents a threat to stability for the EU and the shared Euro. Deeper rifts may develop as representation in the EU Parliament is sorted if we see a universal foothold in anti-Union sentiment. The stronger the showing from anti-EU/Euro representation is, the more fragile the future for a collective Euro. If there were an overwhelming threat to the economic alliance to draw from the results, it would not be a stretch to expect EURUSD to fall to parity through 2019. 
    Another perspective to watch in the vote is the UK’s position. They have opted to participate in the election even though they intend to withdrawal from the EU as a requirement to earn an extension on their Brexit proceedings. The rhetoric from the British government has born little-to-no fruit with the allowance of additional time, and now the citizenry is likely to punish the principal political players for their inability to move forward and compound economic loss along the way. According to recent opinion polls, the Labour party was still in the lead for intended votes but it gave up a significant portion of its base to the new Brexit party. In the meantime, the Conservatives that are currently leading government are expected to drop back to fifth in the standings losing the bulk of their support to the aforementioned new entrant. This vote will also be used as strategy to force a vote on the Withdrawal Agreement and the timeline for the Prime Minister, Theresa May, stepping down. The Sterling does not need more reason to succumb to pressure. 
  12. JohnDFX
    Trade Wars Between the US and China – Perhaps the US and the World
    The world seemed to be on a very different path a week ago. Through the close on Friday, May 3rd, the rhetoric serving as forward guidance for the US-China trade war was clearly being directed to suggest the end to the economic conflict was at hand. That took a dramatic turn two days later when US President Trump contradicted the leaks of an impending compromise and deal by stating clearly that the United States would raise the tariff rate on $200 billion in Chinese imports that were being levied 10 percent to an even more punitive 25 percent. True to his word, the President ratcheted up the trade war between the world’s two largest individual economies. While this may not have the same level of shock impact as the first venture into the current trade wars, it is notionally the largest escalation and a peak in this period of ‘growth at the expense of others’ policy. With the upgrade in the tariff rate, the White House issued a further direct warning making it clear that the US is willing to push forward and tolerate its own economic and financial blowback to redirect the course of a trade partner that has long defied the conventions of free markets by pursuing emerging market tactics. According to the Trump administration, China has ‘three to four weeks’ to compromise on the United States’ key demands or the trade burden will expand to another $325 billion in Chinese imports (though 2017’s total imports was only $505 billion). Given last week’s unexpected escalation, there is increasingly less skepticism that Trump will avoid further dramatic moves that hold economic consequence for the US as well. 
    Given the US has pushed forward with an exceptional escalation in the trade wars as of early Friday morning, the market’s reaction through the session that followed comes as quite the surprise. After an initial tumble across the board through morning hours, the week’s final session closed to gains for the S&P 500, the VEU rest-of-world equity ETF, the EEM emerging market ETF, junk bonds and a broad swath of carry trade. We have seen the markets write off other ambiguous issues over the past weeks and months, but the implications behind this situation are unmistakable: there will be negative economic and capital flow repercussions from this situation. Suggestions that the impact will be minimal or that this about face was priced in are nonsensical. Optimism sourced in the fact that the two sides are still talking or that a tough stance by the US will rebalance a global bias that is detrimental to most does not fit with the market’s short-term focus. It would be disingenuous not to mark this market disconnect to some degree of complacency. At what point does the market start to register the pain in the way that we would reasonable expect? Chinese markets (Shanghai Composite, Yuan) will start to process the pressure when government intervention is overridden by the markets. The emerging market and non-US developed market economies are already trading at a substantial discount to the US assets which receive a disproportionate amount of attention. When – not if – the Dow and S&P 500 cave, we are at even greater risk of catalyzing an accelerated and universal ‘de-leveraging’. In the meantime, it will be important to watch the spread of financial troubles beyond the US-China quarrel. The USMCA is still facing an insurmountable wall so long as the metals tariffs persist, there are two direct threats from the US to levy taxes against the EU that have yet to be activated, and the Trump administration has to make a decision on broad auto tariffs as the initial 90-day review process of the Commerce Department’s Section 232 assessment ends on Saturday, May 18th. 
    The Expanding and Abstract Threat  to Markets from Political Risks
    When the markets are looking for threats, there is usually an emphasis placed on those risks that are well-defined and carry an explicit date/time. The ‘convenience’ of counting down to a trouble with certain boundaries can help with preparation for its occurence. And, in such situations, the known unknown can also significantly reduce the sense of fear and in turn dramatically temper their impact. In contrast, those storms beyond the horizon that could inflict unknown damage offer poor preparation and conversely amplify the fallout that accompanies surprises. When we consider the dominant fundamentals winds trading influence over the global markets, there ware fairly well-defined criteria to recession fears (global growth), clear timelines for trade wars and key policy decisions that carry greater weight over the influence of monetary policy as a temporary prop and artificial amplifier of speculative excess. The concern that has constantly lurked on the border of our apprehension is the simmering threats from various points of political risks. Political discourse in general has deteriorated over the past few years with economic and defense-based relationships like the TPP, NATO and Iran Nuclear accords all facing existential pressure. Yet, the pressure isn’t simply reserved for ‘external’ trade partners. Nationalism has taken root across the world with an inevitable result of dissonance and resistance to progress where the benefits cannot be guaranteed to be evenly distributed. This is not the first time in history that such a tide has risen, and it will not be the last. When will it have run its course and give way to alliance and progress – as messy as that inevitably will be? That remains to be seen. 
    In the meantime, we will continue to see the strife that arises from all players pursuing self-interests. The most overt example of this ongoing conflict is between the UK and European Union. The past weeks’ headlines offered little to be enthusiastic over when it comes to compromise for a favorable resolution to both sides. There is nevertheless a time limit in place – whether that be the late October extension deadline or participation in the EU Parliamentary elections from May 23rd to the 26th. Speaking of the forthcoming elections in Europe, there is an unmistakable presence of typically anti-EU nationalist participation and a host of top roles that are up for grabs (head of the European Parliament, European Commission, European Council and European Central Bank). While there are some disruptive voices in the campaigning, no one is as antagonistic as the Italian leadership which is committed to pushing forward with pursuing fiscal support for the economy despite its deficit forecasts ballooning to levels north of the Union’s allowances. In the Middle East, the United States is pushing hard to isolate Iran which is driving energy prices higher and threatening stability in the region – prompting the US to send war ships to the area to prevent rumored threats – while the developed nations fight over the relationship. Asia has multiple points of tension but China’s efforts to promote a sense of cooperation through its Belt and Road initiative are increasingly falling on skeptical views for those monitoring the progress of the US-China trade war. The internal conflict is worst in the  United Sates itself. Hopes of massive fiscal stimulus in the form of a $2 trillion infrastructure spending program (necessary to pick up the reins from flagging monetary policy) are potentially held hostage by the growing warnings of constitutional crisis and pressure to pursue impeachment for the President’s perceived transgressions. Any one of these issues could take a severe turn for the worst with enormous consequences for financial stability. For more tracked out Political risks, keep tabs on the known elections around the world – beyond the EU and after Africa’s results have come in, we also have India and Australian campaigning underway. 
    Volatility Measures are an Imperfect Tool We Too Often Find False Confidence
    Considerable weight is afforded to volatility measures as a definitive measure of sentiment. However, there are many caveats to these typical benchmarks that undermine both their presumed timeliness as well as their ability to even verify sentiment. This past week, there was a notable swell in volatility readings across asset class and region – though unusually not in the aftermath of a confirmed escalation of the US-China trade war as mentioned above. FX derived volatility measures hit the highest in six weeks as did measures for yields and oil, while the S&P 500-based VIX volatility index hit an intraday high last seen back in the opening days of January and the emerging market measure exploded to its highest levels since February 2018 when the market first made its transition from an environment of total complacency. There is little doubt that the fundamental gears were turning through the past week, but the concerns starting the engine turning were clearly not deep enough to undermine the markets such that a true market retreat would set obvious, deep roots. It is worth a refresher on the source of these activity measures. The popular indexes are almost universally ‘implied’ figures which are backed out of related options – the VIX is for example measured from S&P 500 options. Given all of the aspects of the traditional pricing model are known with the contract, that means only the ‘implied volatility’ as a measure of uncertainty and thereby the cost of protection are unknown. Also the underlying index may be traded in both directions, but the vast majority of capital behind the benchmark asset are dedicated to a buy-and-hold mentality. That makes options predominantly hedges, and therein lies the negative correlation between the performance of the index and the direction of the volatility measure. 
    Tracing these indicators back to its fundamental originations, we can better understand their short-comings and perhaps derive some underappreciated signals to use towards our evaluation of the markets and our trading decisions. One of the most overlooked issues is that indicators like the VIX are not indicative of activity itself but rather strong bearish movements in the underlying. That may not seem a problem, but experienced traders will recognize that there is often an erratic nature to markets with violent moves higher or chop back and forth before that intensity is channeled towards a frenetic deleveraging. Another critical shortcoming for such indicators is the fact that they are hedges for which traders frequently disregard at the most inopportune times. Back in the second half of 2017, the US equity markets were defying concern over the upheaval in politics, the growing concerns over global growth forecasts and a march towards a trade war with an incredibly stolid march higher. The run of days without a one percent or greater decline from the S&P 500 hit a stretch not seen in decades. A push to record highs through a period of improbable quiet was destined to ‘revert to norms’ with a slide that would almost certainly offer violence to balance to roaring quiet. It is at such times that there is the most to lose and therefore hedges would be most important to hold. Instead, the VIX printed a record number of days below 10. Of course, we saw how that period ended, with a February collapse across all risk-leaning assets. As misleading as these indicators can become, we can use the lack of counterbalance the indicator should offer as a sign of how disconnected and exposed the participants of the system have become. When ‘realized’ (or actual) activity starts to rise and anticipation remains stoic, there could be systemic risk building that results in not only violent correction but follow through to the unwind. 
    There is also something to be said about the picture of volatility across the financial system. Most will base their assessment of the market-at-large on a single measure like the VIX, but that is as flawed as using the S&P 500 as litmus for the entire capital market. There can be bursts of activity for certain asset classes with some leading depending on catalysts that can turn systemic (like monetary policy failure driving the FX and Treasury yield volatility measures to life), but there are few better confirmations than ‘fear’ spreading throughout the most liquid asset classes. This is much the way I feel about the direction and tempo of the different key assets like US and global equities, emerging markets, junk bonds, government yields, carry trade and more.
  13. JohnDFX
    The Fed Finds Themselves in a Market, Economic and Credibility Quandary 
    There is a lot of high-profile event risk – both data and events – on the docket this week. The distinction of importance for these potential catalysts is defined by their capacity to tap into more systemic fundamental themes. By that evaluation, there is a lot that can further shape our collective interests/concerns through trade wars, concerns over stalled global growth and the inadequacies of monetary policy as a financial firefighting tool. However, the most influential among the deluge will be the event/s that can reach as many of the major themes as possible. Naturally, there is connection between the aforementioned matters: earnings is an economic benchmark, trade wars stunt growth and recession threatens to expose central banks lack of tools.
    I would argue that the most loaded item on the menu is Wednesday’s FOMC (Federal Open Market Committee) meeting. This is not one of the quarterly meetings for which we expect the Summary of Economic Projections (SEP) and upon which every rate hike that has been pushed through in this cycle occurred. That won’t preclude a significance to this update however. The interest in this event is more a product of the broader market circumstances rather than an anticipation for any change in rates or unorthodox policy. There is essentially no anticipation for change at this meeting but there is approximately a 65 percent chance of a cut by year’s end according to Fed Funds futures. That is a dramatic reversal of course from where we were at 8 months ago. Before the market’s epic tumble through the fourth quarter (yes, market performance and policy intent are connected), the Fed’s members expected three rate hikes this year while the markets believed it would be more on the order of fourth hikes. 
    What prompted this dramatic about face? Inflation forecasts were generally in line with the central bank’s targets and the unemployment rate is still hovering around its multi-decade low. That would put the onus on forecasts and external factors. The assumptions of follow on pain from the government shutdown and year-end financial market volatility clearly shaped expectations. Therein lies the problem. The US markets have recovered dramatically through the past four months. Trade wars are still a burden with the threat that they will spread to envelop the US and European lines, but the US-China relationship seems to be improving materially. And, just this past week, the 1Q GDP release signaled that we wouldn’t see the world’s largest economy stall out in the immediate future with a 3.2 percent annualized reading – though the inflation figure that is derived from that comprehensive data notably dropped further below objective. Market’s cheered the general dovish shift by the world’s largest central banks, and none offered more relief than the Fed’s turn off of a steady course of rate hikes.
    So, what is the US central bank to do? Most likely they will default to patience with status quo settings through the foreseeable future. Meanwhile, the White House will continue to berate the Fed for not doing more and the market’s will cry out with any stall in the climb from indices. If there is a sharp drop in output potential for the US economy through the second quarter, response rate will be delayed owing to the strong 1Q figure, and that in turn may raise the interest in financial market performance to avoid late response. In this environment where everyone has different views on what the next stage will be for economic and market health, even the status quo from the Fed will draw out concern from some and speculative leverage from others. 
    Earnings Season Fades as Trade Wars, Recession Fears and Monetary Policy Return 
    Raising our focus from the top event to the steady drumbeats of more systemic fundamental issues, there is reason to anticipate the range of frequent systemic winds these past months to once again sweep across our markets. Before the ‘oldies’ to return to form, we will first see the recent top headline relinquish its influence. Earnings season in the US technically extends for a few more weeks, but the number of economically-important companies issuing their numbers to tout a greater influence over global growth forecasts or shape the other systemic matters in the financial system is dwindling. Most of the top listings are concentrated to the first two days of the week. Google and Apple will tap into the speculative leverage of the tech sector, Eli Lilly and Pfizer hits the worst performing major sector of late, General Motors will weigh in on trade wars, and General Electric will be another representative blue chip.
    Shifting the focus back to monetary policy, the Fed decision is the obvious focal point while the Bank of England decision is essentially a reflection of Brexit concerns. Beyond the official meetings, we should keep tabs on regular data and any sign that participants of the financial system are starting to question the capacities of central banks to foster growth and avert market crises. Speaking of economic activity, the sentiment around this fundamental health gauge has certainly jogged higher these past weeks. Both the US and Chinese 1Q GDP readings beat expectations – though the latter’s beat simply avoided a further multi-decade low. 
    We have another official growth reading from a key economic center: the Eurozone figures. Yet, as we have seen from speculation preceding these official figures, fear can arise from less-comprehensive monthly data or even external measures like the US yield curve inversion. Trade wars will once again prove the least predictable overarching concern. Through the end of this past week, President Trump once again suggested he expected his Chinese counterpart in the US soon (insinuating a deal they could sign) while President Xi echoed a similar belief that the end of the negotiations is within sight. As for the market’s interest and ability to leverage this belief; headlines such as the second largest Chinese e-commerce companies being put on the US blacklist raise concerns, we have already seen the markets recover significant lost ground (‘erase the discount’), and new fronts threaten to open on the global trade war. Should Trump follow through on any of his three general threats against the EU (the $11 billion in tariffs in retaliation for Airbus subsidies, the loose threat to seek retribution for trade restrictions on Harley-Davidson earnings and the general threat to put levies on imported autos and auto parts), the market is unprepared and the ultimate economic impact would be far more severe. 
    A Spat of Breakouts a Plenty of Reason to Question Conviction
    I’ve weighed in on this question before, but the occasion calls for a revisit: what constitutes a true breakout? We just happen to be facing potential technical breaks for the benchmark for global equities, the FX market and commodities. And, a side note before we delve in on the topic: ‘breakout’ is a non-directional term. Owing to the default long-only perspective of so many market participants (particularly those in equities), the association is immediately made for ‘favorable’ developments. If we are experiencing a bullish clearance from congestion, the proper term is a ‘breakup’ or ‘bullish break’ while the opposite conclusion would be a ‘breakdown’ or ‘bearish break’.
    With quibble out of the way, we have certainly witnessed some charged technical intent this past week. The most remarkable breaks would come from US indices which found the Nasdaq drive to record highs while the S&P 500 hit a technical high on the close, the DXY Dollar index surged through a near two-year range high which translated to EURUSD sliding below 1.1200, and crude oil tumbled through $65 and then below its 20-day moving average for the first time in 50 days (the longest bull run in years). For many, a technical cue is all that is needed to register a break, and the switch flips in their minds to expect a committed move to follow in the marker’s wake. That is supremely presumptuous. What if very few traders considered the same level relevant and therefore there was little intent to drive the market following the ‘break’ that an individual may have put emphasis on? I live by the axiom: it isn’t about the break, it’s the follow through. Yet, follow through is the result of intent. While sheer speculative appetite or an extremely popular technical level can occasionally heft its own influence over the market, the case is a rare one. Far more common in successful technical breaks evolving into robust modes of follow through is a scenario that involves a fundamental motivation that can help secure the tentative break but more importantly draws more speculative interest in or fuels the absolute need to abandon the market. 
    With the aforementioned three market leaders, we should consider their motivation rather than just the fact that they surpassed their technical boundaries. Crude oil’s slump through the end of this past month is the least convincing of the three. It’s tumble seems to have a very particular catalyst in President Trump’s suggestion that he reached out to OPEC members to encourage them to lower the market price for the commodity. Given the spotty record of his demands and the subsequent market movement over the past year, a bearish drive will depend far more on either a clear downturn in global growth and/or a systemic drop in risk trends. From US equities, the Nasdaq Composite readily cleared its previous record highs from September/October and extended the move beyond that level. That said, the S&P 500’s break was purely ‘technical’ with a new high based on a close over close basis. There were no intraday highs. Meanwhile, the Dow hasn’t even reached its previous high. Robust growth or a chase for yield are the best motivators for equities, but that seems far-fetched in our present environment. The Dollar arguably holds the most probable bullish scenario. The currency can find charge from more favorable relative growth or through a rate advantage leveraged through more dovish counterparts. Alternatively, a full-tilt global risk aversion can revive the Greenback’s absolute haven status. At present, neither end of those extremes seem probable, but they can certainly arise. 
  14. JohnDFX
    Amid Extreme (Low) Volatility, Determine Your Approach and the Eventual Change 
    Volatility continues to sink into extreme levels of doldrums – and this is a theme that all traders should take time to appreciate at regular intervals. Low volatility is a defining feature of a financial landscape. Whether fundamentals catalyze a cascade of value repricing or a technical cue is capable of triggering an avalanche of entry/stop orders is predicated on the conditions first laid out by the depth and activity level of the speculative medium. First and foremost, the type of markets we are dealing with should determine the trading approach we take. If we were to expect a high probability of key breakouts or simply expect such explosive moves to be relatively frequent in the broader market, we would expect volatility to be high and liquidity low – the thinner market depth helps amplify the ‘run’ from sudden jolts of activity. For trending markets, low volatility is a prevailing theme; but liquidity or market breadth are usually generous as participation in the move remains strong. In markets were both volume and volatility are low, observance of ranges (or imperfect congestion patterns) is more common. Recognizing the state of our markets alone is of incredible value for all traders. If my specialty is momentum trading in trends, I would want to remain sidelined when range trading prevailed or endeavor to create a robust range strategy and a barometer to tell me when we are transitioning to different speculative states. Yet, just as the phases of matter (solid, liquid, gas) are all related, so too are the phases of a speculative market. Range can transition to breakout with the application of volatility which then transforms into trend when liquidity follows the spurt of activity as the uncertainty in the volatility itself settles. 
    In the conversion of these different forms, it often proves difficult to determine what kind of market we are dealing with – not even the market is certain – and thereby what type of trading approach we should take. Arguably one of the least forgiving transitions occurs from the quiet and steady ranges into the more explosive breakouts. The shallow liquidity can precipitate enormous moves beyond just the first bloom of volatility. This is often the ignition to sudden speculative collapse as with February 2018 or the eruption of a full-blown financial crisis as with the Dot-com bust. We are once again facing this particular fluid state. Some are comfortable in the range that they are seeing from the likes of the EURUSD which has carved out one of its longest, controlled ranges (as a percentage of spot) since the Euro began trading. Or even more dangerous, there is a default assumption of trend like that from the S&P 500 or Dow which are in the midst of recovering from the last explosion and are not yet returned to the decade-long bull trend so many have profited from through a passive strategy approach. From the trend assumption, there is an assumption of slow capital gains and modest dividend income against a backdrop of risk that is unrealistically low. So, how do investors/traders approach such an ambiguous situation? Use the strategy most common with range trading. Shorter term trades, more reasonable targets, awareness of important levels and more engaged observation of market conditions will make for active trading but also faster reaction time should conditions truly start to change. 
    Trade Wars and US GDP: Top Theme and Top Event 
    As we move into a new trading week with the recognition that market conditions are extremely restrained, it is natural to assume continuation of the same. Yet, as we discussed above, that is an assumption that leverages far greater risk than potential. When we consider the exact conditions for transition, there are various circumstances that can bring about a transition of indecision to trend or low volatility to explosive. That said, the evolution of quiet to volatile is very rarely based in sheer technical originations. It is possible that the rank and file grow so complacent and liquidity so shallow that an unexpected technical development triggers an outsize market drop that then cascades into wholesale deleveraging as everyone returns from the sidelines with a single motivation: to exit quickly. Far more common in the annals of transitional market history is a fundamental spark that draws mass participation and trading intent all at once. And, for those already familiar with the inverse correlation between the S&P 500 and VIX, the more capable driver is the one that is bearish and/or stokes fear. With that flight path established, we should take into account what the most promising/threatening theme and event risk are through the period ahead. 
    On the theme side (meaning a general fundamental influence that is steadily a concern with flare ups around scheduled or impromptu developments), trade wars are presently the most ominous  circumstance. It is true that we have a key growth-based risk (US GDP) and dependency on depleted monetary policy has leveraged an impossible future, but recognition of global recession or a hopeless backstop aren’t inevitable do to their existence alone. In some contrast, trade wars are starting to draw greater and greater scrutiny as burden to the global economy and circulation of capital around the world. What’s more, there are a number of threats being juggled presently and any one could drop. The US just recently threatened to apply $11 billion in tariffs against the EU in retaliation for subsidies the latter has given to plane manufacturer Airbus – and of course, the EU has said it is ready to retaliate as soon as the threat is acted upon. With the United States’ direct neighbors, there are hurdles being erected to the USMCA negotiated as a revamp of the previous NAFTA; but the real risk resides with the President’s threat to shut the Mexico border and/or apply tariffs to imports of Mexican auto parts if the country doesn’t do more to stem the flow of illegal immigrants into the United States. Then there is the universal risk of President Trump weighing a universal import tax on all autos and auto parts, a measure that will predicate a global trade war (or at least US versus the Rest of World) that assures a stalled economy. If we are looking for a capable threat with a clear date and time, the US 1Q GDP release will act as top event risk. The world’s largest economy is a bellwether for the globe with so many troubling figures coming cross the wires these past months and open risks like the monetary policy losing its ability to stabilize and the impact of trade wars leeching through. Market it on your calendar. 
    US Earnings Will Have More to Say Than Just the State of US Corporate Profitability 
    For systemic themes, the most frequent three in the rotation these past months has been: monetary policy; concern of economic recession and trade wars. However, these are not the only complicated matters that can spur fear (or greed in positive turn). One typically-seasonal consideration that will return to the forefront in the week/s ahead is US corporate earnings. We have actually had updates from a few major corporations over the past two weeks, with a greater concentration on the top banks. Thus far, we are left with an impression that registers as continuation of the questionable enthusiasm the markets has sustained for quarter after quarter stretching out through some years. If we are to maintain that questionably content view of profitability and growth through the weeks and months ahead, this week’s run will play a particularly important part in setting the course.  At the top of the list, we have the likes of: Amazon; Microsoft; Anthem; Caterpillar; Exxon Mobil and Procter & Gamble among many others. These are some of the largest companies in a variety of different industries and they will naturally account for a strong overview of the entire systems health. 
    However, there is another aspect to this bout of earnings season that we should consider: the thematic influences that will be touched upon in the underlying economy and financial system. If you were looking at the ‘bleeding edge’ of speculative appetite, there is good evidence to suggest that the tech sector continues to hold the torch that investors in most other areas of the economy and markets continue to follow. If you want to look at a quantifiable measure of this preference, consider the general performance of the tech-heavy Nasdaq Composite to the blue-chip Dow – or even the ratio of the two. A leader can be a boon or a burden though depending on the direction it takes. If tech were to pitch lower into a speculative dive, it would likely undermine confidence across the system. With that in mind, consider the largest players in Amazon and Microsoft or a more forward guidance-leveraged FANG member like Facebook as greater risk than reward. Another theme that we will touch upon is general economic growth. The largest companies in the indices or a look into the core of economic activity through the likes of Procter & Gamble, Anthem or Exxon will give some direct lead in to the GDP figures due. Then there are trade wars. We have seen these concerns flag as the threats are days or weeks old – and in the case of the US-China, negotiations are progressing – but the financial impact cannot be overlooked. The likes of Caterpillar who has registered negative impact in the past, Boeing who is at the center of the EU threats via Airbus and even Harley Davidson who was a target for President Trump last year can tell us the state of play.
  15. JohnDFX
    A Return to Extreme Volatility and Realization It Won’t Stay This Quiet for Long 
    Any way you cut it, the markets are experiencing extreme levels of inactivity. And, for those that are satisfied with the superficial and textbook interpretations of the mainstream measures, this seems like a cue to leverage exposure and commit to the decade-long bull trend which blossomed under the controlled conditions. Previously, traders would have been readily satisfied by the readings and thrown in with the assumptions. However, there is an unmistakable air of skepticism surrounding activity measures with indicators of exposure and uneven performance for ‘risk’ assets drawing focus back to the extreme bouts of volatility this past year. While market participants have shown a penchant for overlooking troubling fundamental backdrop and conveniently forgetting previous lurches in the financial system, the proximity and severity between the February-March and October-December storms were too prominent to simply slip quietly into afterthought. With that said, the question then must be raised as to what could trigger another wave of concern. While the best motivations for trend development in my opinion are systemic fundamental themes that can draw the largest swaths of market participants; during these periods of speculative interlude complacency can raise disputes over the urgency of otherwise serious themes. When we get into these self-sustaining periods of complacency, one of the best sparks to break clear of speculative opportunism borne of quiet is to see a uncomplicated slump across the capital markets. In other words, price-determined risk aversion. 
    While the strongest indication that the markets are succumbing to their own fears is an intense deleveraging across all or most assets with a heavy dependency on speculative appetite, there can be fairly reliable precursors before we get to that undisputed scale. At present, one of my favorite leading indicators is the S&P 500. Representing the most ubiquitous asset class in the capital markets and in the largest economy, it is well placed at the center of focus. Further, its outperformance in this role has once again afforded it a position of carrying a heavy mantle of keeping the fires stoked in other assets and regions due to its approximate return to record highs over the past quarter. Most other preferred assets for the trading rank are significantly behind in their recovery efforts – rest of world equities measured by the VEU index is only now passing the midpoint of its 2018 losses. This attention isn’t just a benefit to the markets though. If the US indices were to falter in an overt and troubling way, it can spell disaster for other areas of the financial system that were considered far less resilient. A stall for the S&P 500 and Dow before overtaking a record high could certainly achieve this throttling for global sentiment, but a more complete obliteration of future efforts to recharge confidence would likely come from a scenario whereby the benchmarks overtake their respective highs, struggle briefly to mark new progress and then collapse. Currently, we find measures of volatility like the VIX back at lows last seen in October which is appropriate comparison. Yet, in other asset classes we find more incredible readings like FX implied volatility at levels that are only comparable to a few points in history (like the Summer of 2014). In historical terms, the Dollar’s range (an equally-weighted index) over the past 200-days is the smallest on records back to when the Euro started trading two decades ago. This misplaced association of confidence and lack of preparation sets up the market to be extremely exposed to a mere slump escalating into something more catastrophic. Trade with caution and diligence.
    China GDP Next Week’s Top Event – Could the World Survive Its Stall? 
    In a holiday-shortened week with speculative focus blurred, the top event risk is unmistakable. The Chinese 1Q GDP reading will come along with a run of monthly readings for March that are influential in their own right. While the employment, retail sales, industrial production and other monthly data are worth taking stock of to establish direction for specific nodes of the broader economy – important for projecting where problems or resurgent growth could arise in the future – it is all superseded by the comprehensive growth report in the short term. The world’s second largest economy is expected to slow even further from a 6.4 percent annual pace to a fresh multi-decade low 6.3 percent. That will still sit comfortably within the growth target lowered from 6.5 percent to a range of 6.0 to 6.5 percent the last National Peoples’ Congress. Nevertheless, the international market’s more critical eye towards growth and unorthodox threats will disproportionately raise the risk for impact form a negative outcome. The implications for China and its markets are relative straightforward when it comes to the forecast for the soft landing that officials are trying to engineer against the backdrop of struggling global growth and amid a trade war. Though rhetoric around negotiations with the United States has improved, a year’s worth of economic pain has built up. The March trade balance offered a timely mixed picture this past week with a significant surplus for the month resulting from a distinct drop in imports (a poor reflection of domestic economic health). 
    For the global economy, this particular economic update holds significant weight over assumptions for the future. As the world’s second largest economy and the stalwart through the Great Financial Crisis, a slide that seems to be picking up momentum outside the central authorities’ control will leverage serious concern about what the smaller economies with significant less control are facing. For countries that supply China with the many raw materials that it consumes for its unmatched manufacturing machine (Australia, New Zealand, etc), the restriction in export demand and likely drop in foreign investment flows will expose an unbalanced economy. For the rest of the world, the buffer China has maintained will mean the country’s demand for trade partners’ goods will not pose the greatest risk, but rather its carefully-controlled financial connections will represent the true destabilizing influence. Potential delay in impending efforts like the Belt and Road initiative and the tentative vow to ramp up purchase of US goods are tepid relative to the cascading exposure we would see if the country was forced to repatriate in order to shore up its own system which is heavily built upon leveraged and low-quality lending initiatives. The question I would pose is whether the world could survive a stall in Chinese growth – which would occur well above 0.0 percent GDP – given how troubled the globe’s future currently looks? I doubt it. Should China tip into a market-defined economic stagnation or contraction, it would infer one of the key players in the world’s stage has lost control over its reliable ability to plan and direct activity. The environment that would force that loss of control would be a serious threat to the rest of the world as the shock would eventually hit other shores like a financial tsunami. 
    Brexit Delayed Six Months and Pound Range Trading Reinforced 
    A sense of relief washed over the Pound this past week – though not that kind that can readily supply buoyancy to the battered currency. In an increasingly familiar story line in Europe, we have found the Brexit situation has resorted to the comfortable solution of punting an unsavory decision to a time significantly into the future. This is the same path we have seen taken when it comes to Europe’s monetary policy (ECB), political standoffs and external diplomatic issues. This is not to say everyone is simply defaulting to this delay. This results from serious impasse between parties that believe strongly in their solutions as well as the folly in crossing their red lines. At the direction of Parliament, UK Prime Minister Theresa May requested an extension from the European Union, with an initial suggestion of a hold out until June 30th. After a long summit, the EU-27 agreed to a six month delay that would move the cutoff date to October 31st. In the interim period, the UK is expected to participate in the EU Parliamentary elections which will take place starting May 23rd and for which some in May’s party and her own government are piqued. The question on most peoples’ minds are whether the additional time will offer the opportunity to overcome the impasse or whether it will just draw out the misery. According to the IMF, uncertainty will only accumulate greater economic deterioration over time – and given the state of data over the past year in particular, that is not difficult to understand. 
    In terms of how that translates into the competitive position of the Sterling and UK-based assets, many would see this as a window for a speculative influx on discounted markets. In previous years when complacency was de rigueur, that is almost certainly what would have transpired. An appetite for even marginally underpriced assets would have triggered an avalanche of speculative influx which would have quickly sent GBPUSD above 1.3500 and the FTSE 100 rushing towards 7,900. However, as discussed above, there is a deeper sense of skepticism built into the system. As such, the sudden drop in implied volatility measured by currency options or the CME’s index is as likely to short circuit momentum as it is to prompt it. Whether you agree or not as to the potential in the Sterling moving forward, think it through to establish a bias and set criteria for when that view shifts. Having thought the situation through beforehand will better set your expectations for an event like the GBPUSD’s inevitable break from a wedge this past month with boundaries currently stationed at 1.3125 and 1.3050. If you think a more robust recovery is possible then you may see more intent on a bullish break – and be confounded by a move lower. 
  16. JohnDFX
    The US Yield Curve Flipped Back to Normal, Is the Recession Off?
    A lot of attention was paid this past week by the financial media to the inversion of the yield curve. To understand the signal, it is important to define the circumstances. The yield curve is a comparison of the yield – in this case, on US Treasuries – of different durations. Normally, the longer the duration, the higher the yield should be owing to the longer tie-up of exposure. When a curve inverts, we have an atypical circumstance where there are lower yields (and thereby it is construed lower risk) to hold US government debt of a longer maturity than that of a shorter variety. That is unusual but not at all unheard of. When looking at two proximate maturities – such as 2-year and 3-year debt – brief, technical inversions can occur owing to issues like liquidity. Yet, what we saw last week tapped into the extremes: the 10-year / 3-month yield curve inversion. These are the most extreme of the top liquidity issues and thereby a favorite measure of economists to gauge economic potential. In fact, this specific spread is one of the economists’ favorite recession measures. So you can understand the wave of concern, and media interest, when the 3-month yield overtook its much longer termed counterpart. However, I was (am) skeptical that this signal is as useful as it has been in the past. Thanks to the Fed’s adoption of quantitative easing so many years ago, we have seen a serious distortion in monetary policy that comes to the forefront with their effort to normalize – starting with rate hike before addressing the unorthodox policy outlook. Given my skepticism of the signal’s efficacy with the inversion, I am equally as indifferent to the fact that the curve flipped back to positive this past Friday. There are some interesting considerations from this yield comparison, but they shouldn’t be taken at face value as they have in the past. 
    So, where to from here with this traditional economic measure? I am of the opinion that the yield curve has been distorted and its ability to reflect economic pacing has been seriously undermined. However, the interest should not be in the tool that measures sentiment but rather sentiment itself. While I am dubious of what the 10-year / 3-month yield curve represents, its inversion just so happened to coincide with other more convincing indications that the economy is at risk of capsizing. Measures of economic activity virtually the world over have signaled a throttling while readings considered forecast (such as sentiment readings) continue their own slide. Add to that a speculative market that recognizes the unquestioned safety net of the past through central bank commitment will no longer support the kind of speculative excess we are dealing with, and we find traders are more cognizant of their personal exposure. Where few risk benchmarks are as excessive as the favored US indices, there is still a remarkable amount of speculative appetite / complacency built into most sentiment-dependent measures. As the realities of the economy and practical rate of return deepen, the systemic appetite for ‘risk’ exposure will continue to struggle. In short, recognize that the market is increasingly attentive to troubles on the horizon rather than the ‘troubled’ or ‘return to normal’ signals that we register from some of these traditional measures. 
    The Start of a New Quarter and Greater Scrutiny Over Sentiment
    Depending on how you evaluate this past week, you could be left with a dramatically different opinion of market intent moving forward than some of your market peers. With this past Friday’s close, we have not only capped the trading week; but it was also the end of the month (March) and the first quarter. If we look at performance via the largest of those time frames, the recent past was extraordinary. Both the S&P 500 and crude oil posted their biggest quarterly rallies in a decade – 13 and 31 percent gains respectively – which is fantastic for diehard bulls that had grown nervous in 2018. That said, this performance was far from uniform across all assets with a sentiment bearing. Global indices regained much less of their lost ground compared to their US counterparts, while both more overt risk assets and growth-dependent benchmarks were seriously struggling. What’s more, the impressive rally follows a period of even more intense loss for these assets. The fourth quarter of 2018 suffered the kind of loss that we can only compare to the Great Financial Crisis. Mounting a recovery from such a severe retreat naturally insinuates a certain degree of pacing. Yet, it does not automatically imply intent. If we put these past two quarters into further context of the previous year, regular bouts of volatility and focus on fundamental maladies speaks to a lost momentum to self-sustaining speculative inflow. A rebound, in other words, is easier to accomplish. Fostering new sense of enthusiasm and a fresh wave of investment is a different beast entirely. That is not what we have registered recently. 
    As we move into the second quarter of 2019, we continue to face a number of systemic fundamental threats: trade wars, fears of monetary policy limitations, fading growth forecasts, and more. If indeed the temporary discount from emergent, manufactured threats (like trade wars) has already been tapped; fostering further gains will prove very difficult as the global economy struggles and central banks are forced back into the role of protector. A contrast in market performance will be even more critical to keep tabs on. The performance of US equities relative to their global counterparts is one point of clear division that makes clear confidence is not global. Emerging market assets underperformance speaks not only to the lack of return the markets expect from this high-risk assets, but also the concern that global central banks are unable to close the gap. In particular this quarter, my interests will be the relative health of those assets that are more explicitly speculative in patronage compared to those with deeper ties to the genuine health of an economy. Commodities are just such an asset type that finds itself in the latter category. If GDP is throttled, demand for these goods flags which is an inherent weight on prices. Perhaps the most interesting market to keep tabs on for the overall health of the financial system is government bond yields. Historically, yields on these products are positively correlated to risk benchmarks like equities as capital moves away from their haven appeal thereby raising the return necessary to draw interest. Yet, we have to add to this the economic implications that are starting to garner greater interest as well as the central banks’ distorting influence through stimulus – a dubious structural support. If government yields continue to tumble as stocks rise, it is much more likely that equities are the market that capitulations to close the divergence. 
    Brexit, Now What? 
    Like a chess board cleared of all but a few pieces that are constantly moved to avoid a conclusion, the outcome for Brexit has been officially delayed (again) and the remaining possible outcomes is dwindling to fewer – and in most cases, more extreme – options. This past Friday, March 29th, was the original Article 50 conclusion date. Before this milestone was hit, Parliament attempted to wrest control over the directionless ship with a series of indicative votes that put to tally solutions that MPs believed could overcome the lack of support for Prime Minister May’s repeatedly rejected plan. All eight of the proposals failed to hit the critical market necessary to signal clear support. Empowered by this outcome and perhaps imagining strategic advantage in growing concern of a ‘no deal’ outcome, May put her scheme to vote once again on Friday. The third time was not the charm as 344 rejected her effort against 286 that supported it. After the outcome, the European Commission’s Donald Tusk called for a council meeting for April 10th while the EU stated, for both dramatic and practical effect, that a ‘no deal’ outcome is now a likely result. As a reassurance to local citizens and businesses, European officials said that they were prepared for such an outcome. Underlining this pledge is a not-so-subtle ding against the United Kingdom, insinuating that they, in turn, are not prepared for course they don’t seem to be able to navigate away from. 
    The next critical date on paper for the divorce proceedings is Friday April 12th. That is the time frame that was given for the UK to find a deal or ask for an extension. It was previously offered by EU officials that if May’s withdrawal agreement – agreed between both sides late last year – then they could offer time out to May 22nd, just before the EU elections to work out the details. On the docket over the coming week, we have specifically penciled in another House of Commons run of indicative votes with MPs making the same assumption that May did that support will be mustered behind recognition that time is frighteningly short and the solutions extraordinarily few. These votes are non-binding and the mood of the crowd doesn’t seem to have shifted materially. Instead, what progress we do find on Brexit this week is likely to originate from unexpected headlines. A change in support from the DUP, surprise concessions from the EU, allowance for a ‘people’s vote’; while these may seem low probability, they are as fair to consider as an ‘accidental’ no deal would be. Don’t be surprised to see either some unexpected shift in the landscape or the plug to be pulled altogether. Anticipation and fear will keep liquidity in the Pound tempered and thereby volatility high. That makes for very difficult to trading, so don’t let the flash of sudden movement lure you in like a fish to hook. That said, it is worth noting that one of my top trades for 2019 was – and remains – a long Pound view when we clear on the outcome of the divorce. If it is a deal, the earnest recovery will begin soon after confirmation is delivered. If it is a no-deal, the rebound will take longer as the market acts to work out its exposure.
  17. JohnDFX
    Fed Sets the Tone for Global Monetary Policy Expectations
    Global monetary policy trends have shifted towards a more accommodative stance as forecasts for economic activity have stuttered and worries of ‘external risks’ have gained traction. This has sharpened the relative value of currencies as market dig into the grey areas trying to determine which groups are taking greater strides to loosen than their peers. However, it is crucial that all investors – no matter your preferred market nor time frame – keep sight of the collective impact the world’s central bank effort has on the health of the economy and stability of the financial system. While there has certainly been a boost to economic activity and all of its trappings through this past decade’s bull trend, there is undoubtedly a divergence between the extraordinary performance of capital benchmarks like the US equity indices and the more tepid clip of expansion we have registered lately. In fact, I would go so far as to say that the past four to five years of speculative abundance was chiefly the work of the largest monetary policy groups. The course change towards halting normalization efforts and entertaining further easing looks to tap some of the speculative magic of the past, but there is a definitive diminishing returns to successive waves of support. 
    From central banks like the Bank of Japan (BOJ) and European Central Bank (ECB), the limitations are more overt as the scale of easing grows exorbitant. The BOJ for example owns an extraordinary percentage of the country’s ETF market and in turn holds an astounding amount of its capital market. That smacks more of desperation than safety net, and other regions are at risk of shifting to that unflattering distinction. Just how precarious that balance is finds more distinctive measure not at the most dovish end of the curve, but rather the most hawkish. The Federal Open Market Committee’s (FOMC) two-day policy meeting will conclude on Wednesday with no anticipation of a rate hike to follow on the ambitious pace of 2018. In fact, looking at Fed Fund futures, the market is pricing in a slight probability of a 25 basis point cut to the 2.25-2.50 percent range. The group’s view of the future is where the market will set its focus. This is one of the ‘quarterly’ meetings for which we are due the Chairman’s  press conference and the Summary of Economic Projections (SEP). In the December update, the median forecast set expectations for 50 basis points of tightening this year (two standard rate hikes). Given the rhetoric used by most officials of late, that forecast is likely to drop at least one hike and could very well put even one move in 2019 under serious debate. If there is still a forecast for two, expect the Dollar to jump as the market has fully written off any moves (with nearly a 40 percent chance of a cut priced in by year’s end according to futures). 
    The monetary policy statement and Chairman Powell’s remarks will offer important insight into the plans for the balance sheet reduction effort. We have already seen indication that they are planning on throttling the effort soon which will cap longer dated rates in the market – which will also mean rates of return will flag. Is this backing away from a tighter policy setting more supportive of economic activity or more troubling as clear indication that the world is in need of external support – support that is exceptionally limited compared to the past? Meanwhile, we are also due the Bank of England (BOE) rate decision which will be a conduit for Brexit uncertainties for better or worse. The Swiss National Bank’s (SNB) policy is a more extreme example of desperate policy that has lost traction, so its only true insight into global perspective is to amplify fears that the guardians of stability have failed. It is further worth registering what the Brazilian and Russian central banks do with their own policies as the emerging market draws direct connection to US health and risk trends register far more readily here. 
    Trade Wars are Increasingly an Underappreciated Threat 
    There is a hierarchy of systemic themes that rotates in its influence over the global markets and its participants. ‘Basic’ appreciation of economic potential was the focus these past two or three weeks owing to targeted economic data and troubling forecasts (such as China’s lowered target for the coming year at its National People’s Congress). Attention on this particular intersection of market-wide health will not simply vanish – we have important measures to contribute to forecasts like the Fed’s GDP forecasts and March PMIs on Friday – but appreciation will likely soften as catalysts offer a more obvious update. Monetary policy will offer the most tangible impact on a fundamental basis, but there is another theme that has garnered less attention of late but which should not be forgotten: trade wars. The course for competitive economic policies via trade pacts has shown definitive improvement in the status quo from six or nine months ago. 
    The outright US-China trade war has seen the course of steady escalation frozen by the Trump administration as they continue to negotiate towards structure improvement as well as balance of consumption equity. Of course, the President’s threats that they could walk away if the deal is not favorable and President Xi’s calls for a clear time frame remind us that this is not a done deal. Another assumed reversal of fortune that is once again raising concern comes from the revamped relationship between the United States, Mexico and Canada. The replacement of the NAFTA accord with the USMCA deal was considerable relief for Mexico and Canada while simultaneously promoted as a success for the Trump Administration’s appetite for aggressive negotiations to hash out trade deals. That bargain is starting to come under significant pressure however as Congress threatens to scuttle what was agreed to amongst the three countries’ negotiation teams. Where we are already in the weeds on these two fronts of US trade, the threat of new economic conflicts garner even less appreciation. 
    That is extremely shortsighted given the financial repercussions of the past year to the other efforts and the volatile nature of dealing with the US. A month ago, the US Commerce Department delivered its findings on an auto tariff probe that it conducted at the behest of the White House. We don’t know the results of that report and the President still has two months to decide whether to pursue something. However, we have seen explicit threats by the White House against countries with perceived unfair trade advantages for their auto industries – as well as vows of large scale retaliation by those in the crosshairs. If the President considers dealings with the USCMA and China a success, it is more likely that they pursue the same line on autos, particularly should political popularity rankings flag and/or domestic economic activity measures continue to crawl. 
    A Third Meaningful Vote and an Update on Brexit Scenarios
    I don’t think anyone will miss Brexit when it is done. Nonetheless, we need to keep close tabs on its progress as it continues its uncontrolled tumble down the hill. This past week was loaded with votes – and subsequently volatility. Prime Minister Theresa May put up a rejiggered proposal for vote in Parliament this past Tuesday and the MPs dismissed it outright once again – though this iteration wasn’t a record-breaking defeat for the PM. That in turn led to the debates this past Wednesday which resulted in a decision to direct May to avoid a ‘no deal’ scenario at all costs, which definitively beats back the range of uncertainty inherent in this saga. Sterling traders took notice as we saw GBPUSD produce its largest single-day rally since April 2017. With a seeming cap on the economic repercussions this event may pose, the next question was whether May should be directed to request an extension from the EU on the Article 50 end date (set for March 29th). Approval of that particular leg is perhaps the least surprising of the week’s discussion points. Yet, with direction to seek deferment on the divorce date, serious questions followed asking whether more time would actually translate into a feasible deal. Given the state of discussions after two years, there is reason for skepticism. In turn, some hold outs have begun to signal a willingness to take a more moderate stance in order to find some compromise. 
    That has encouraged the Government to put up proposal from May – it doesn’t look like she expects to have further concession – for another meaningful vote (MV3). Set against this Wednesday vote, we have seen the slogan turn to a simple arithmetic of May’s deal or risk a protracted period of uncertainty or even no Brexit at all. There are suggestions that some in Conservative party are willing to throw in some support in exchange for the PM’s resignation, but that does not come close to guaranteeing a majority. If the proposal is rejected once again Wednesday, focus will turn to the mood of the UK-EU negotiations. If support does not significantly shift in favor of the Government and May sticks to her warning that rejection will necessitate a long extension, then we will start to run up against the EU’s restrictions. EU elections will create further tumult in negotiations with the UK at risk of holding under the Union’s influence without say over the course the collective is taking – a very unattractive proposal. 
    When assessing the Sterling and foreign investor appetite in the UK, the ultimate question is not the detail nor political advantage of one outcome versus the other. The basic question of taking risk or not is uncertainty. The longer the uncertainty is for the course of the UK’s economic and financial relationships moving forward, the greater the perceived risk for investors. That does not mean the Pound will just continue to drop throughout the imposed purgatory, but it will add volatility and cap the ambitions for substantial rally. 
    Critical Fundamental Themes to Keep Watch For Next Week:
    -    Recession Signals in Data, Markets and Forecasts [Indices, Yields, Gold]
    -    Monetary Policy Supporting Risk Trends or Falling Short [Fed, ECB, BOE, EURUSD, GBPUSD, Gold]
    -    Gov’t Bond Yields and Commodities as a Growth-Leaning Risk Asset [Dollar, Euro, Yields, Oil]
    -    Brexit Article 50 Extension [GBPUSD, EURGBP, FTSE100]
    -    US-China Trade War Deal Detail Headlines, Trump-Xi Meeting Time Frame [AUDUSD, USDCNH]
    -    Threat of US Implementing Auto Tariffs [EURUSD, USDJPY]
    -    Excessive Leverage / Debt in Public and Private Channels [S&P 500, Yields, Gold]
  18. 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. 
  19. JohnDFX
    Pricing in Trade Wars Versus Pricing in Recession Risks
    Investors are starting to see a path form for the United States and China to find a way out of their economically and financially-damaging trade war. After months of little more than a few words of optimism from only one side of the table – which was frequently reversed only days later – we are starting to see conviction from high level officials on both the American and Chinese sides. This past week was the most encouraging period for this year-long economic conflict, even offering a few tangible policies to break through some of the skepticism that had calcified these past months. Following an announcement of five MOUs (memorandums of understanding) to form the backbone of a deal, negotiators made a concerted effort to dazzle the markets Friday suggesting that significant progress had been made and that a summit between Presidents Xi and Trump was being arranged, perhaps for the end of March. And, while some of the US team qualified that some structural policies and intellectual property protection were unresolved, reports that an agreement was already made to prevent current manipulation and that China was prepared to buy $1.2 trillion in US goods indicated serious collateral to push the deal through. 
    So, now what? Will committed breakthroughs and tangible deadlines prompt successive legs of a sustained rally? We have already seen a significant recovery through the opening two months of the year offset much of the painful slump through the fourth quarter of 2018. This wasn’t a recovery forged ‘in spite of’ the unresolved situation between the two superpowers. There was invariably a healthy measure of speculation that a breakthrough would be found in the foreseeable future. It is unlikely that the full weight of this fundamental threat has been fully shed by opportunistic interests (just look at the Australian Dollar or emerging markets), but we would not likely see a full economic recovery even if the issue were fully reversed. For trade wars, there remains the uncertainty that the US could engage other major economies. In particular, there is reasonable concern that the Trump administration could apply hefty tariffs against imported autos and auto parts. That would put a severe strain on relationships with the EU and Japan (some of the largest developed world economies), and the former has taken pains to spell out its preparations for retaliation should the US move forward with the Commerce Department’s recommendations. How much concern for future possible engagements is already weighing the market, it is impossible to tell; but the sheer economic implications suggests it is not being taken seriously as yet. 
    Pricing in the rise and fall of trade wars can be complicated and volatile given the variable scale of the impact and the flippancy of headlines involved, but some of the direct economic impact related to this threat are not so capable of being fully accounted for in prevailing market prices. In other words, we can fully discount a full blown trade war in the short-term with a sharp decline in assets, or completely alleviate the pressure with speculative appetites reverting to complacent norms. In contrast, the implications of these efforts tipping the economy over the edge into recession cannot be adjusted for in spot. There is no ‘sell the rumor’ on true economic contraction that can see a ‘buy the news’ as the pain unfolds. The markets simply continue their tumble as capital is divested from financial, fixed and human assets. This is where market participants should tread more carefully about their calculations for the near future. The trade wars may have seen their peak, but economic data suggests the momentum if dragging us closer to the cliff. 
    Central Bankers to Testify to Their Governments and the Markets 
    Monetary policy around the world is in a difficult transitional phase. After years of unprecedented easing and venture into unorthodox stimulus programs, it seemed that we had finally found the central banks’ nadir. Though the Federal Reserve was the only major bank to actually take meaningful steps towards ‘normalizing’ its balance sheet and rates, many other outfits had taken small moves or had signaled their paths had leveled. Considering this shift was taking place years after the global economy had righted itself from the Great Recession and markets charged back towards record highs, the sentiment the transition engendered was a mixed one. While in part a sign of confidence that conditions had improved, it had also left the markets with the clear impression that the effectiveness of their policy tools had all but collapsed. If these officials had years for the economy and markets to return to cyclical norms while their own policy settings slowly reset to afford a future crisis-fighting platform, this lack of capacity would fade into the backdrop and perhaps not even resurface in the next economic slump. 
    Yet, conditions are already getting rough and there is virtually no buffer rebuilt. Now some authorities are starting to recognize the trouble in the environment and the impotent position for which they find themselves. There are a few strategies being pursued to inspire confidence. The least surprising tonal change is the commitment to turn back to a dovish setting and provide further easing should conditions warrant it. While not unexpected, it raises serious concern as it highlights the lack of capacity they were hoping to paper over. The other unofficial approach to dealing with 2018’s volatility and the unmistakable slide in growth forecasts is willful ignorance. As all paths of the future are a set of probabilities and they have little ability to affect systemic change by their hands, why not just profess optimism and try to inspire consumption, investment and expansion through their own enthusiasm. Neither of these are the kind of options that could genuinely fend off genuine trouble, but it is where the policy authorities currently find themselves. The Fed’s minutes this past week has built on the speculation that new hikes would come this year (priced into the markets) with clear suggestion that the balance sheet wind down would stop – still around $4 trillion. 
    This will make Fed Chairman Jerome Powell’s testimony in Congress this week that much more important. The conversation goes where the Senators and Representatives steer it; but expect assessment of his economic forecasts and evaluation of external risks. We may also find our way to some incisive questions as to the lack of means left to the world’s largest central bank. There will similarly be a Parliamentary testimony delivered by key members of the Bank of England (BOE) – as well as an open presser on a separate day. Here, the attention will be more directly fixed on a specific fundamental risk to the local economy: Brexit. There are other speeches scheduled by members of other central banks along with important data that often goes into authorities’ separate mandates. Yet, almost regardless of how the data populates or how the central bank members come off (optimistic, fearful, dovish, etc), the markets will be more critical with the overt troubles on the horizon. 
    Another ‘Meaningful Vote’ as Brexit Realities Come Into Play 
    As of Wednesday, there will only be 30 days until the scheduled March 29th Brexit date whereby the United Kingdom and European Union are due to spilt ways. Given how much back and forth there has been on this process, it is easy to forget that lawmakers were looking for a deal sometime this past September or October from which they could begin preparations for the actual Brexit date. Now, they are simply scrambling to secure a legally-binding agreement rather than end with the ambiguity of a ‘no-deal’. There is little doubt that some parties are using the pressure of the clock to draw more submission from their counterparts for a better overall deal. Traditional game theory applies, however, with the parties needing to have a degree of cohesion within their own rank and a general acknowledgement of the risks that their side faces. There isn’t strong evidence that these factors are present in this particular match. 
    With a few painful defeats for the Prime Minister this past month and the EU making little movement to meet the requirements laid out by Parliament’s amendments to their leader, we are coming upon another important day in the Commons. On February 27th (Wednesday), MPs are set to debate whether they should take over greater control over the divorce proceedings from May. Previous votes looking to do exactly this were rejected, but time is growing very short. Furthermore, there have been a number of Conservative and Labour members who have publicly left their party owing largely to the lack of meaningful progress in the negotiations. Another crimp to the process are reports late this past Friday that senior members of May’s government have called on the Prime Minister’s resignation by the month of May.
     That could be construed as troubling, but it could also signal acquiesce to a deal in exchange for a change in leadership. Over the weekend, May promised a vote on her latest Brexit deal by March 12th, looking to buy a little more time at home and likely to avert a more serious defeat that could make negotiating with European counterparts armed with grand threats all but impossible. How much good will does Theresa May have to buy more time to negotiate when so little time remains? We will find out on Wednesday. In the meantime, concern by investors, businesses and consumers – already showing hints of panic – will increasingly translate into action. Investors will move their capital out of the Pound and Euro, businesses will push forward with their ‘no-deal’ contingency plans and the more alarmed Brits will look to safe guard their accounts from financial jolts. Anticipation and fear can carry very real world and lasting impact. 
  20. JohnDFX
    Don’t Forget Trade Wars Aren’t Isolated to US-China
    Trade wars remain my greatest concern for the health of the global markets and economy. There have been threats in the past where a localized fundamental virus has turned contagious to the rest of the world by unforeseen circumstances – such as the Great Financial Crisis whereby a US subprime housing derivative implosion infected the wider financial markets by destabilized a foundation built on excess leverage throughout the system. When it comes to trade wars though, there is no need to connect the dots. The systemic implications are apparent. The world’s two largest economies (and markets) are engaged in an escalating ****-for-tat economic conflict. There is little chance that the fallout from such a profound distress would be contained to these two contestants. The United States is the world’s largest consumer of finished goods and China is the principal buyer of the commodities. Whether appetite is trimmed owing to trade policy or stunted economic growth, its smaller trade partners would feel the pain.
    Yet another organization that is warning over the risks these two are charging was the United Nations whose trade group said further planned escalations could severely impact GDP (it estimated ease Asian economies could drop by $160 billion), trigger currency wars and generally promote contagion. That said, the headlines this past week should raise serious concern among traders. Reports (and remarks) signal the White House does not expect a deal to be struck between the two countries by the end of the 90-day pause on the planned tariff hike. What’s more, sources say President Trump is not going to extend that date and intends to increase the tariff rate on the $200 billion in Chinese imports from 10 percent to 25 percent on March 2nd. That is a severe escalation and one that Chinese officials will not likely take in stride. As tensions rise, there is movement in Congress to curb the White House’s powers to pursue this economic war through its utilization of Section 232 of the Trade Expansion Act of 1962 – this at the same time Trump is attempting to leverage more control.
    As this effort progresses, it is important to remember that this is not playing out on a single front. Where it seemed that the United States’ pressure on Mexico and Canada via the NAFTA agreement was resolved by the creation of the USMCA, Congress is now signaling that it may reject the effort if material changes are not made. What’s more, we may see the pressure expand yet further. The loose threats by Trump to place tariffs on auto imports have been made multiple times over the past year. A deadline is finally in sight of this threat to potentially gain serious traction. Next Sunday, the Commerce Department is due to give its recommendations following its evaluation of auto imports. Given Secretary Ross’s disposition, it is likely to be a charged report. If the US were to implement tariffs on imported automobiles, the economic and diplomatic impact would be far more significant than what we have seen between the United States and China thus far. Global economic stagnation would follow soon in such a development’s wake. 
    Paying More Attention to Rates as Outlook Weakens
    Monetary policy as a financial theme never truly lost any of its influence over the global markets these past years. However, investors’ attention has waned on this critical pillar of speculative reach as appetite for yield has solidified complacency. Yet, conditions are beginning to change with economic activity slowing and volatility in the capital markets picking up. That in turn draws attention back to the backstop that so many have based their convictions – whether they realized it or not. To some, fear that markets are at risk of retrenchment bolsters expectations that the largest central banks are going to step in to temper volatility and lift risk assets by flooding the system with cheap funding once again. For those whose confidence remains, they still consider the likes of the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ) forces of nature. Closer examination of these groups’ current policies and the available tools still at their disposal, however, should raise serious concern.
    While the Great Financial Crisis is a decade behind us with growth having stabilized and markets surged in the period since, collective monetary policy has changed little. While the Fed may have raised its benchmark rate range over 200 basis points, none of its largest counterparts have moved significantly off of their own zero bound. Furthermore, there remains an enormous amount of stimulus awash in the system with central banks’ balance sheets bloated with government bonds, asset backed securities and even more traditional investor assets. If push comes to shove and markets started to avalanche lower despite the present mix of support still in place, what would these authorities be able to do muster in order to counterbalance? There is no meaningful capacity to lower global rates and QE has gotten to the point where its effectiveness draws as much cynicism as assurance.
    Adding more support against a persistently incredulous market would only solidify the realization that central banks are no longer the effective backstop for speculators they once were. And then where do we expect to turn for help? A coordinated effort from global governments when they cannot even maintain existing trade deals? As our markets remain volatile and economic forecasts soften, expect scrutiny over monetary policy and its effectiveness to increase. We have seen that already take place with the market’s response to the Fed’s dovish shift and even the RBA’s and BOE’s growing concerns this past week. Rate decisions, speeches and even data close to policy mandates will leverage greater focus – and likely market reaction – moving forward. 
    Dollar Can Compensate for Issues By Advancing on Euro, Pound Pain 
    The Dollar is in a complicated fundamental position. There are numerous domestic issues that represent a serious fundamental weight on the benchmark currency but global troubles will consistently work to counteract the loss of altitude. Of course, the likelihood of a perfect equalization is highly improbable. One development or the other will prove more severe than was expected or the market will decide a particular issue is of far greater consequence to the financial system. It is not clear which node will trigger a tidal wave of capital market flows, so we need to keep tabs on those themes that will exert greater influence on the benchmark as the dominant force will likely arise from these known quantities. On the economic front, the US economy has shown signs of economic slowdown and a sharp drop in sentiment readings from consumers to businesses to investors. This was only accelerated by the US partial government shutdown and the risk that it closes once again is worryingly too high. The stopgap funding runs out on Friday.
    The delayed economic readings with the status check before the shutdown impact was full felt are starting to trickle out and the GDP reading seems to be due next week. An ineffectual government looks to like it will increasingly be a core issue for the world’s largest economy moving forward with promising programs like infrastructure spending increasingly relegated to the dustbin of unrealized campaign promises. And of course, with the promise of economic wealth fading and sentiment withering, the Federal Reserve’s intention to further raise rates to establish a higher rate of return on US investments will naturally recede. Yet, all of these shortcomings will have powerful relative corrections. While the Fed may very well halt its monetary policy ambitious of the past three years, to stabilize at a 2.25-2.50 percent benchmark range while major peers like the ECB, BOJ and BOE shift to a dovish course from zero rates and expansive stimulus will maintain relative advantage to the Greenback.
    Should risk aversion build globally, the Dollar has more investment interest premium built up over the past years that could leach away, but a tip into severe risk aversion (which would be difficult to avoid in a committed downturn) would leverage the currency’s absolute haven appeal. What’s more, where the political infighting in the US is more localized, it is not a unique trouble to the United States. Further, it is persistently applying greater pressure on trade counterpart around the world through the trade war. Perhaps one of the truly untested and underpriced risks to the Greenback however is the intentions of the US President. Over the past year, Trump has voiced his consternation over the level of the currency as an impediment to his strategy for course correct trade and perceived inequities to trade partners. In the event of universal risk aversion which puts serious pressure on the global economy, we are unlikely to see an effective collaboration across the world’s largest countries as the game theory in their competitive efforts will more likely intensity under the weight. With demand or Treasuries resulting in a rise for the Dollar, it would not be out of the question to imagine the White House responds with unorthodox policy aimed at driving the currency lower. The real trouble would only begin if the world’s largest player touched off a currency war.
  21. JohnDFX
    With the Fed’s Language, Global Central Banks Signal Softening Policy
    Global monetary policy has shifted more noticeably to the dovish extreme of the scale over the past months, but investors were overlooking this questionable support because the markets were under serious duress. Yet, after the three-month tumble leveled out into a meaningful recovery into January, market participants began to look for fundamental reasoning to justify their growing confidence for their exposure. With the Fed’s unmistakably dovish transition between the December and January policy meetings, conviction in central bank support started to return to levels that mirrored the zombie-like reach for yield that defined the low-volatility, steady climb assets between 2011 and 2015. The terms of ‘plunge protection team’ and ‘QE infinity’ as applied to the world’s largest central banks are frequently voiced as skepticism by those that think extreme accommodation is ineffective and far more costly than central banks and the average investor appreciates. However, those phrases are just as significant to the bulls who have grown to depend on group’s like the Fed to keep an artificial calm over the financial system.
    There is good reason to believe the US central bank has taken a meaningful turn in its policy regime. The December Summary of Economic Projections (SEP) lowered the 2019 forecast for rate hikes, but last week’s rhetoric made clear that the water mark for even a single hike this year is likely beyond the reasonable threshold. The US central bank is only signaling a curb to future plans of rate hikes following 225 basis points of tightening, but that is arguably one of the biggest alterations of course that we’ve actually seen. There is little mistaking that the course is such that the comfort in slowly normalizing extreme policy easing has all but vanished amid slower growth, breaks in global trade and threats to financial stability. That will incur more concern amongst those in the markets than speculative opportunism. Benchmark risk assets are not trading at a value-based discount and our proximity to the extremes of traditional as well as unorthodox policy will curb hopes for the recharge for milestones like the S&P 500 to make it back to record highs – much less surpass them. Of far greater concern in monetary policy in my book is the consensus recognition among investors that central banks have no recourse to fend off a genuine crisis should the need arise. And, if we follow this path, the need will come.
    Only the US central bank has any leeway to purposefully lower rates, and that is only 2 percentage points to return to zero where the economy would once again find itself stuck in a financial hole. Returning to active stimulus expansion will only lead down the same path that the Bank of Japan has already found itself lost upon. The BOJ is stuck tying bond purchases to its 10-year Japanese Government Bond yield with no sign of reliably faster growth or sustained pressure for inflation to return to its target. The lack of traction for Japan’s central bank already draws enough unwanted attention to the state of monetary policy. If similar acknowledgement of a permanently disabled tool spreads to global monetary policy, we will find no other probable means to stabilize a market crash or economic slump by officials’ means alone. 
    With Sentiment on the Upswing, Expectation Rise for Trade Wars
    We have seen a few of the more pressing fundamental threats to the global order abate over the past few weeks. It comes as little surprise in turn that sentiment in the market has improved in tandem. A slow normalization of monetary policy was seen as a slow strangulation of stubbornly nascent growth. With the Fed, ECB and others signaling their submission to the rise of external risks and stalling economic measures; the leash on speculative excess has been let out a little. Another point of perceived improvement comes from the end of the US partial government shutdown the week before last. After a record-breaking, 35-day closure that cost the economy an estimated $11 billion – a hefty portion that will prove permanent – this large component of economic activity is once again contributing to expansion. Of course, there are a number of caveats associated to this situation that should leave traders uneasy such as: the threat that the shutdown could be reinstituted by the middle of this month; that the tangible impact on the economy may have pushed a tepid expansion into a stalled or contracting economy; as well as fostering a collapse in sentiment around a government incapable of finding critical progress when it may be most necessary (such as in the emergency of a crisis).
    More generally, these improvements are notable the lifting of a fundamental burden imprudently applied to the system rather than a genuine upgrade to the outlook. How much growth and opportunity can we expect from the correction of errors? Well, at the moment; the answer to that question is: at least a little bit more. With these and a few lesser issues throttling back the burden, the markets will be monitoring for what other temporary boosters can earn a little further stretch. One of the most extensive threats to arise this past year with an explicit price tag attached to it has been the trade war. While there are multiple fronts to this effort to grow at the expense of trade, there is no skirmish more costly than the standoff between the United States and China. With tariffs on over $350 billion in products, we have seen sentiment and growth measures on both sides deteriorate. However, rhetoric surrounding the discussions between these two powerhouses has recently elicited more enthusiasm from officials and the market.
    This past week’s discussions between the Chinese Vice Premier and a delegation of key people from the US (Trade Representative, Treasury Secretary, Commerce Secretary) was said to have gone well and that the conversations would continue in China shortly. Never mind that there were no tangible policies suggested nor that President Trump said he would likely keep to a tariffs hike at the end of the 90-day pause as of March 1st. With speculative assets on the rise and market participants believing that officials are doing what is necessary to foster buoyancy in benchmarks like the S&P 500 (speculation the Fed capitulated in the market slump while Congress and the President surrendered in order to avoid the negative weight), it stands to reason that the White House would divert its trade course to afford further gains. In the end, though, these will still be temporary gains. 
    How Important is this Week’s Bank of England Rate Decision?
    When it comes to the British Pound the principal fundamental concern remains the uncertainty that Brexit poses to the UK economy and financial system. This is more troubling for investors – foreign and domestic – than something more targeted and acute like a stalled GDP reading. There is no doubt that a halt to growth is a problem, but the issue would be a known quantity. From the details provided with the general update, we would know where policy and support would need to be targeted to course correct into the future and investors could still identify opportunities from those areas of the economy which are still progressing or are likely to do so from a temporary discount. When we are dealing with a complex and unwieldy situation like the UK’s divorce from the EU with a distinct countdown (to March 29th) and the sides obstinately at odds with each other, it can be extremely difficult to confidently assess the risks of your exposure.
    This same contrast will exist with the upcoming Bank of England (BOE) rate decision on Thursday. The central bank is very unlikely to change its key lending rate at this gathering and rates markets reflect that belief. However, this is one of the more nuanced gatherings with the inclusion of the Quarterly Inflation Report. The update includes pertinent information to assess the outlook for the economy and financial system – which Brits and investors are desperate for at the moment. Their growth assessment will no doubt reflect some of the troubled figures that we’ve seen via various timely sector updates. Further, acknowledgement of external risks and ongoing Brexit fallout (such as surveys showing businesses are actively looking to relocate or considering it) will be a central element to the update.
    Yet, will it be market moving? Governor Carney and his crew have warned of the risks to a ‘no deal’ split for some time now, and we have seen the market’s reaction to their concerns drop steadily over time. It is the case that the Pound’s recent climb these past weeks poses as certain degree of premium that could be cut down by otherwise routine concerns. However, if I were to see a headline suggesting a breakthrough or overt block in the dialogue between Prime Minister May and her EU counterparts, I would expect it exert far greater influence over the Pound than what the BOE could reasonable do. 
  22. JohnDFX
    The US Government Shutdown is Over, Now What?
    Late last week, US President Donald Trump announced from the White House that he would back a stopgap funding bill that would reopen the federal government in full. This would mark the end of a record-breaking (35-day) partial shutdown of the US government. Normally, that would be reason for a swell in market enthusiasm. An onerous pressure on the US economy – a 0.13 percentage point reduction in GDP – suddenly lifted would typically manifest in a sense of significant relief in both fundamental concern and speculative recovery. However, the markets were not set deep in discount when this news crossed the wires. The Dow and S&P 500 were already four weeks deep into a recovery effort that has already crossed the mid-point of the painful October-December tumble. In other words, there was no deep discount for speculators to readily take advantage of for a quick speculative rebound. And so, we are left to evaluate the outlook from a more-or-less ‘neutral’ backdrop. 
    Removing the burden of an open-ended and tangibly detrimental threat, is not in itself a positive development. It simply removes an active affliction. When such a shift charges markets, it is a sign more of the general conditions whereby speculators are looking for any reason to reach further. Given that US indices – a proxy for risk trends – are still on pace for the best month’s performance in years, we may still see a delayed response to the breakthrough next week. However, if we do not, the lack of enthusiasm will start to draw a certain level of concern. From the shutdown itself, we are only earning a temporary break. According to Trump’s statement, the agreement is to temporary funding for the next three weeks. He has said that if there is not funding for a border wall by that time, the shutdown will return and/or he will use emergency powers afforded to the executive branch to secure funding. That alone is a delay of concerns, not an resolution. Furthermore, there will be permanent hold over from five weeks of partial closure for the US federal government in the form of sentiment. In the period since the closure began, we have seen a marked drop in sentiment surveys from businesses to consumers to investors. 
    That is not just a reflection of this particular situation, but an environment souring doesn’t exactly improve circumstances moving forward. According to the calculations from the White House’s own economic council, this period has resulted in nearly two-third a percentage point loss in GDP. That is significant. Even more significant is the carryover effect of a market that is concerned that similar self-destructive policy breakdowns will happen again in the future. What if external risks touch off an economic slump, how will this inability to act quickly with accommodation impact the system? As the US debt load continues to rise to record levels, how will the threat to growth and tax revenue impact the United States’ credit rating? Even if this US government rift has been permanently closed – it hasn’t – be careful of reverting to a state of comfort that markets really can’t continue to live up to? 
    A Rising Pound and Another Critical Brexit Vote 
    We are heading into another important event in the ever-winding road towards the United Kingdom’s withdrawal from the European Union. A little over a week ago, Prime Minister Theresa May put her Brexit proposal up for vote in Parliament only to meet the worst rejection for a PM in British history. It is unlikely that she pushed forward without knowing that should would at least be met with defeat – and it is likely that she knew it would be a remarkable one. That suggests there was a plan involved – perhaps using the outcome to pressure her EU counterparts to offer further accommodation to appease a divided Parliament and finally find a way to create an amicable break. However, after three Commons’ sessions, the Plan B May was forced to submit for review seemed to draw the same general skepticism. The debate period will end Tuesday with a vote and the sentiment surrounding the scheme seems as if it is heading for another explicit defeat. Such an outcome would leave the UK in the same economic and financial straits it has traversed over the past months – yet this time, the sense that time is quickly depleting will be unmistakable.
     If there is no agreement to be found on Tuesday, it will be 59 days until the Article 50 period closes and the country leaves the Union. It is possible that May request an extension on the deal period – and a number of European officials have voiced willingness to grant additional time out to July – but May has repeatedly rejected the notion. If Parliament continues to maneuver in line with its previous efforts, the red lines may start to shift next week. Parliament may attempt to take greater control over the course this ship is sailing, but their inability to come to consensus has thus far been the most difficult roadblock. In the meantime, May and her colleagues have no doubt scrambled to secure some rung that can finally lift the situation out of its mire. Knowing that there is an active strategy being executed, it would be risky to speculate on a hard, binary outcome from this situation. 
    Nevertheless, the Pound has climbed remarkably over the past few weeks. For GBPUSD, the climb carried the benchmark pair above an eight-month trendline resistance and then the 200-day moving average. That is genuine progress, not the course of measured oscillations in normal markets. It is remarkable to see such explicit risk taking with a key event risk ahead (and leaning more readily towards disappointment). Is this perhaps a reflection of growing confidence in either a soft Brexit or second referendum or perhaps just a drop in probability for a ‘no deal’. The Sterling has certainly found itself at a discount over the past few years, and the chances that a bid for more time or a warnings towards more flexible conditions is a higher probability. Yet, that should not prompt traders to grow cavalier over their risk taking. 
    The Three Top Standard Events This Week: FOMC Decision; Eurozone GDP; NFPs
    If you were tired of abstract systemic issues and looking for more targeted market volatility events, the coming week should pique your attention. There are high profile, discrete (date and time determined) events due throughout the week. Though, before we dig into them, it is important to realize that the capacity of these data or speeches to prompt greater volatility and/or extend a run is founded in their connection to deeper, unresolved issues. It is therefore our present circumstance – with a market that teeters between a seemingly unrelenting sense of complacency and unmistakable slump in speculative assets across the world – that will dictate the amplitude that these events meet. For sheer number of events on tap, the US docket carries the greatest weight. Top event in my book is the FOMC rate decision. This is not one of the ‘quarterly’ events for which the central bank has consistently held off for in order to hike rates. However, we no longer seem to be moving at that steady clip. 
    With external and internal risks rising, market’s expectations for hikes through 2019 have tumbled since October. What makes this meeting more interesting is an expected press conference from Fed Chair Powell. Given the sharp increase in debate over the next move (one or two hikes or whether we have a hike at all), this event could charge a more aggressive speculative environment. If it were not for the US government shutdown, the 4Q US GDP update could serve as a crucial update to growing dispute over the course of the world’s largest economy. It is not completely clear, but it is very unlikely that the BEA will have enough time to release this week on schedule. To perhaps compensate for that more comprehensive report, the Conference Board’s consumer sentiment survey and Friday’s NFPs will touch upon some of the crucial aspect of the US economy – employment, wages, consumer spending intent, etc. Over the past few weeks, it has also grown more apparent that the Greenback has been less responsible for its own speculative bearing. That puts responsibility for key pairs like EURUSD in the hands of active and liquid counterparts. 
    The Euro will hit upon a number of its own key updates. ECB President Draghi will testify before the EU Parliament which may give us more insight into the central bank’s intent than what they officially announced at the recent rate decision. Top data will be a smattering of GDP releases, the most important of which are the Eurozone (the aggregate) and the Italian (the current firebrand) 4Q figures. Beyond that, we have a range of important data that can course correct rate expectations and growth like inflation, employment and sentiment data. For the next two liquid currencies amongst the majors, the Pound’s data will be overridden by Brexit while the Japanese Yen’s attention will be redirected to risk trends. Australian 4Q CPI, Canadian monthly GDP and Mexico’s 4Q GDP are a few other volatility-potential notables. 
  23. 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. 
  24. 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. 
  25. 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. 
  • Create New...