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JohnDFX

DFX Market Analyst
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  1. JohnDFX
    Trump Threatens to Move Forward With Dec 15 Tariff Escalation, Considers Section 301 
    There have been a few critical developments these past few weeks that could have significant deescalated the daunting momentum of global trade wars. However, with each small improvement, we are met with an asterisk that could quickly undermine the good will as well as an alternative stab to weaken the outlook for global trade. For the US-China engagement, the White House backed off of the planned tariff escalation scheduled for October 15th after the countries agreed in principal on a Phase One trade deal. Now over a month since that relief, the two countries have not made any material progress. Sure, there have been bouts of optimistic rhetoric, but the enthusiasm has fluctuated back to cynicism just as frequently. Whether ‘confidence’ or warnings, market participants have grown increasingly ambivalent to the situation. What can carry greater certainty as we move forward is the threat of an escalation in the scope of US tariffs on Chinese imports scheduled for December 15th. It was presumed that if the countries were working towards a first step to ultimate resolution, this jump would be avoided. However, multiple administration officials suggested the pressure would not be removed for fear of the President losing support from his base in an election lead up and to discourage China from pursuing a strategy that is founded on a different US government this time next year. 
    Another seeming miss on the path towards further economic disaster was the passage of the October 14th deadline for the administration’s decision on whether or not to pursue auto tariffs. That date was itself the deferment after an extended review. While the White House has not said definitively that it was laying the Commerce Department’s investigation to rest, many believe that the matter is behind us owing to legal questions if not strategic ones. The European Trade Commissioner stated her belief that the risk has passed. That said, I would not forgot that this uncertainty is still somewhere in the wings. In the meantime, Europe still finds some of its agricultural exports to the US under a hefty 25% tariff rate, deciding whether and how to retaliate – and knowing there is a WTO ruling to come sometime near the beginning of 2020. Adding another layer of trouble, there was suggestion from some close to the US government’s strategy that the a Section 301 investigation may take the place of the 232 in order to keep the pressure on the EU (and potentially other major trade partners) to capitulate under trade pressure. This evaluation looks into broader trade practices rather than specific sectors under a national security assessment. 
    Recession Risks Slowly Recharge 
    Back in August, fear of an oncoming recession had hit troubling levels. With a host of warnings by supranational authorities (IMF), central banks and even governments; search interest in ‘recession’ through Google hitting a decade high; and a surprising mainstream interest in the otherwise wonkish interpretations of the Treasury yield curves; it was clear that there was serious concern about the further reach of the already mature global economy. Yet, with a few disarming updates and a shift in favor towards more speculative measures, the threat seemed to deflate through the subsequent two months. Now, to be clear, the economic trouble never really vanished. The US and Europe are still in extremely tepid course of expansion, there are certain key countries (Germany and Japan) that are oscillating quarters in contraction and China is running its slowest tempo in three decades. Instead, investors, governments and consumers simply just grew larger blind spots. 
    This past week, it was even more difficult to ignore the signs of trouble ahead. The OECD lowered its outlook for global growth yet again to its worst standing in 10 years. The 2019 forecast stood at 2.9 percent with the 2020 projection nudged down another tick to the same pace. That is itself troubling and indicative of skepticism that a recovery is ‘around the corner’. To ensure that the world does not simply hold course on its current mix of beliefs and dependencies, the group extended its outlook to 2021 with a disconcerting 3.0 percent pace. That more distant prediction, it was mentioned, was only possible if significant risks like trade wars and China’s economic struggle leveled out. Warnings like these have come frequently and just as readily overlooked (OECD, IMF, World Bank, etc); but data is a little more black and white. Just this past Friday, the November PMIs crossed the wires with a clear warning in their mix. The Australian, Japanese, German and UK overview readings were all in contractionary territory (below 50). The Eurozone figure slowed to just barely positive territory (50.3) and only the US improved in a measurable way (to  51.9). 
    Some may consider that US reading an opportunity to pursue a further run in the country’s assets to relative return. However, it should be said that a single country – even the world’s largest – would not hold back to the crushing tide of a global economic retrenchment. That is particularly true when we consider the excess built into the system through investment, borrowing and public debt. 

    Trading Against Risk Versus Holding a Position Through Quiet 
    Complacency is a danger in the financial markets just as much as it is in life. However, there is far more threat when we throw caution to the wind and actively pursue a line that attempts to extract ever-smaller rates of return as the risk profile we must adopt to chase it grows larger and larger. The evidence of complacency is abundant. Record high Dow and S&P 500 are perhaps the most obvious and the most aggressively rationalized. Consider the performance of this favorite capital market benchmark should represent some combination of ideal economic trajectory and/or the greatest potential for forward returns. There is nothing of the sort on our horizon, but many are perfectly happy to live on confidence central banks and previously-unmatched stability in the speculative future – the preferred opiates of the masses. Other risk-sensitive markets are not pushing such extraordinary levels, but the steadiness is still a feature. Meanwhile funding pressure is starting to show up even in the US short-term – arguably one of the most liquid areas of the global markets – but the rise in the Fed balance sheet is again putting most at ease. 
    Yet, when we consider these conditions without the benefit of a blind faith in the unique profile of our present market mix, there are plenty of obvious threats that we face: including the trade wars, economic struggle and stretch valuations mentioned before. There is good reason to be concerned about the fundamental landmines that we continuously weave, but my principal concern is not with what straw breaks the camel’s back nor how indicative of the big picture it may be. Rather, the real risk is the collective exposure that the masses have taken. Adding to leverage despite the underlying risks with smaller returns to cushion any unfavorable winds, raises the serious threat of a panicked exodus from the financial markets. When leverage is applied, the losses accumulate much more quickly. I maintain that the best single asset analogy to the present conditions is the speculative interest behind the VIX futures contract. The net position has pushed a record short these past four consecutive weeks…despite the measure of activity already standing at an extreme low of approximately 12 throughout that period. This is a profound lack of reasonable return against an enormous amount of risk and in extraordinary volume. 
     
  2. JohnDFX
    We Have Unresolved Trade War Issues Guided by Rumor or Complete Blackout 
    We closed out this past week to a broad swell in risk appetite. This enthusiasm wasn’t consistent for the global markets throughout the week, however, with most of the asset benchmarks that I follow for scope were struggling until the Friday pop. The exception to the rule was once again the seemingly impervious US equity indices. Whether you were evaluating sentiment for the Dow and S&P 500 through the week or the global bump on Friday alone, the popular justification seems to have been the same: improvement on the trade war front. Given its importance to the course of the global economy, the contentious trade relationship between the US and China was naturally a point of regular speculation over the past week. The announcement of a ‘Phase One’ deal by the two economic powerhouses was announced back on Friday, October 11th. Since then, there has been far more speculation and rumor than there has been tangible policy change. Perhaps the only concrete development since that hailed breakthrough was the deferment of the planned October 15th tariffs escalation by the United States. This past week, the balance of headlines was neither consistent in trumpeting improvement nor did it offer foothold for genuine progress. Concern that China was cooling on agricultural goods purchases and balking at enforcement mechanisms while demanding rollback on existing tariffs contrasted the cheerleader-like language from some US officials (Trump, Ross and Kudlow).
    It is hard to tell which of these headlines gives us the most accurate picture of this important economic relationships, but there is more consistency in the market’s interpretation of it all. Skepticism has set in some time ago and it only deepens with each week that passes without black and white terms for the Phase One deal for Presidents Xi and Trump to sign off on. As an aside, reports that a deal could be approved on the deputy level should raise concern. It suggests that it is not something the leaders would want their names affixed to; which should be a ‘win’ that they would want credit for, but would instead be viewed as either a more mediocre step or capitulation by both sides that could receive blowback by both constituencies. Keep a wary eye on the headlines for updates on this discussion as we pass implicit deadlines and the contentious explicit dates, like the December 15th increase of the United States’ tariff list of Chinese goods. 
    Perhaps even greater a threat of volatility – or opportunity for removing risk – is found in trade spats the US is fostering with the ‘rest of world’. This past Thursday was the supposed deadline for the Trump Administration to decide on the Commerce Department’s Section 232 evaluation for auto imports. This was the deadline after a previous six month extension. Through the weekend, there was still no word on whether import taxes on foreign autos and auto parts would be implemented, avoided or a decision postponed once again. Should it be delayed or completely avoided at this point, it would likely offer little boost to sentiment, but a sudden implementation would certainly trigger a significant slump in the global markets. Another dispute to keep on the radar is that between the US and EU. We have received very little insight on how negotiations are going between these two developed world leaders, but we know the US-applied tariffs on imported European agricultural goods is sowing ill-will among leaders. 
    Dow: Recharged Rally, New Plateau or Blow-Off Top 
    Though there is always room for debate, the performance of the US indices qualifies as one of the most remarkable of the global financial markets this past week. While ‘rest of world’ shares markets, emerging markets, junk bonds, carry and other sentiment-sensitive asset classes were sliding for most of the week, the Dow, S&P 500 and Nasdaq were holding steady or even advancing. This is not an unusual disparity of late. While the performance metrics change depending on your starting point, as a general benchmark for year-to-date 2019, a rolling 12-month comparison or plotting from the beginning of the recovery after the Great Financial Crisis concluded (roughly March 1, 2009), we find the ‘US market’ pacing the financial system. Determining the source of this outperformance can give critical insight into whether the bullishness will continue for local assets and whether it can establish more reliable traction across the world and asset classes moving forward. 
    There are some traditional fundamental measures that can referenced as sources of relative strength. The broadest measure of economic growth for the United States is certainly not roaring by historical standards, but it has held rather steady at its moderately expansionary tempo through the past years. That has in turn afforded the Federal Reserve an economic backdrop that allowed for rate hikes up through 2018 and offers some support for their stated intention to level out the benchmark rate range around 1.50 percent for the foreseeable future. A rate of return from the US offering a substantial premium versus most liquid counterparts while also having room to operate should future risks demand response is also beneficial. However, I believe much of this backing to this climb to record highs is based in sheer speculative appetite. Investors are willing to commit to their complacency, but they prefer to seek exposure where the progress is most consistent as that is where the greatest theoretical return would be made – while some may also justify their decision from a supposition of safety out of that climb. 
    Sentiment is fickle. Sometimes it can bulldoze through troubling updates while others it falters at any supposed crack. I would not, however, consider it reliable when you must dramatically increase exposure in order to extract further value out of the deal. If we consider the US indices’ particular outperformance paired with the lack of tangible fundamental catalyst through Friday, that impressive bullish breakout to end this past week does not look nearly as inspiring. Sure, the Dow gapped higher to clear out one of the most congested periods in the past few years (measured as a nine-day historical range as a percentage of spot), but follow through at progressive record highs requires steadily greater conviction. Unless something more tangible – like the wave off of auto tariffs – occurs, a recharged rally is really low on my probability list. A plateau would likely depend on some ‘catch up’ in other areas of the risk spectrum while pull of risk rebalance will be a constant force. 
    An Steady End-of-Year Coast for S&P 500 and Risk Markets Ala 2017? 
    If the genuine fundamental backdrop isn’t improving to support a stretch higher in capital markets, the next best thing seems to be complacency fueled by a perceived reduction in risk. We measure risk in the volatility of the underlying markets, and it is in that assessment that we find another questionable perspective whereby we seem to be pricing in perfection. The VIX volatility index has slid back to a remarkably deflated level around 12, which is the approximate low back to October 2018. Even more impressive though is the realized (versus implied) measures of activity. The past month (20-day) realized measure of volatility for the underlying S&P 500 is the lowest since the extreme quiet registered in the second half of 2017 – a period of such quiet itself, that we hadn’t seen anything comparable to it in half a century. We have further seen other exceptional readings such as the longest stretch with out a back-to-back loss for the same benchmark in decades and an exceptional record of days with lower than 1 percent registered moves from close to close. It is in other words very quiet.
    With this quiet and the blatant complacency the markets have fallen back upon, it is easy to understand the efforts to ‘justify’ the next steps for a contentious climb. Reference made to the extreme quiet – and still-impressive progress – forged through the latter half of 2017 makes an appealing case study for bulls that may lack a more traditional foundation of conviction. There is another, more common point upon which investors may rationalize their interest in pushing their penchant for steady capital gains that can compensate for lost, reliable income through financial investments: seasonality. November and December are two of the most favorable months in terms of gains for the S&P 500 of the calendar year going back three decades for reference. Volatility also tends to retreat over this period which would add to that same incredible compression through the end of 2017.
    Yet, be mindful of the reassurances you are willing to accept to keep on extreme risk. Just as many market participants will remember February 2018’s explosion as those that recall the third and fourth quarter of 2017. What’s more, there is even greater appreciation as to the exposure that has built behind this controversial speculative perch. A record net short positioning in VIX futures has made it into headline news. So has the general leverage in risk assets across the system – even record debt levels for consumers, governments, businesses and central banks. Suspension of reasonable risk rules paired with great awareness translates into a market that is more likely to be flighty and prone to avalanche. By all means, take advantage of prevailing trends; but don’t blindly continuously build your risk profile for steadily deteriorating return potential. 
  3. JohnDFX
    Critical Fundamental Themes to Keep Watch For Next Week:
    Volatility Slipping Back into Habit of Complacency as Liquidity Fills [Indices, VIX] US-China Trade War – Beyond the Point of De-Escalation? [AUDUSD, USDCNH, Indices]  A Climb in Risk Appetite as More Fundamentals Fall Away [S&P 500, Dow] Recession Warnings In the Market Converging with Those in Data [Indices, Yields, Gold]  Monetary Policy Ability to Stabilize Growth, Markets [EURUS, ECB, Fed, BOJ, Gold] Politics Increasingly Core to Market Outlook [S&P 500, Yields, Gold] Natural Growth Versus Monetary and Fiscal Stimulus-Led Growth [Indices, Dollar, Gold] UK PM Johnson – Parliament Fight Over No-Deal Cliff on Oct 31st [GBPUSD, EURGBP, FTSE100] US $7.5 Bln in WTO-Approved Tariffs Threatens US-EU Trade War + General Auto Tariffs Back to November [EURUSD, USDJPY, USDMXN, USDCAD] The Threat of Currency Wars [EURUSD, USDJPY, USDCNH, Risk Assets] Gov’t Bond Yields and Commodities as a Growth-Leaning Risk Asset [Dollar, Euro, Yields, Oil] Specific Safe Havens: Dollar, Treasuries, Gold, Yen [Dollar, EURUSD, GBPUSD, USDJPY, Gold] Excessive Leverage / Debt in Public and Private Channels [S&P 500, Yields, Gold]
      US-China Trade Progress: The Boy Who Cried ‘Progress’ 
    My favorite flawed, risk benchmark in the United States S&P 500 index jumped to a record high through the end of this past week. A technicians overview would suggest that intensity of a gap higher, a daily candle that opened on the low and closed on the high as well as the clearance of a long-term rising wedge top added considerable luster to an already momentous achievement. It wasn’t a stretch to assign this thrust – shared by most risk-leaning assets – to either a general state of speculative complacency or perceived improvement in US-Chinese trade relationships (I believe it is a combination of both). After a few swings in rhetoric this past week, investors were bequeathed a rare perspective of enthusiasm in negotiations into the weekend. The headline that charged bulls reported on Chinese sources remarking that the two sides had reached a “consensus in principle” on the ’Phase One’ deal. 
    It is important that this perspective would come from China rather than the US. Beijing has been the most dubious of its counterpart’s intent and commitment since the Washington changed direction dramatically following the G-20 meeting where both sides seemed to have struck an accord. The reported breakthrough in this first stage deal would requires China to purchase US agricultural goods, open financial services markets to US companies and maintain stability behind the Yuan (ironically, what would be technical manipulation). On the other hand China requires the US to ensure it is dropping the planned tariff escalation – to encompass essentially all of the country’s goods – on December 15th. 
    If we see this effort move forward, it would indeed offer a significant measure of relief. How would we judge a step in the right direction without President’s Trump and Xi signing on a finished plan? An official date and time for a summit would represent a tangible milestone for intent. Yet, as important as it is to ease back on the accelerator of growth-killing trade restrictions, we should not treat this as a wellspring of untapped growth. This is avoiding greater pain. To fully de-escalate, we would theoretically need to see the passage of the ‘Phase Two’ which would have far more difficult requirements to agree upon. Agreement would need to be found on intellectual property rights, enforcement, state run enterprises and the full reversal of the onerous tariffs applied to this point. That is a high hill to climb for two countries that are attempting to use their size and position to avoid capitulation. Against this backdrop, we need to consider just how much lift such a first step deserves for something like US equities where it is technically already pricing in perfection. 
    A More Extreme Signal of Risk Appetite Than SPX Record: Record Short VIX Interest 
    I am a considerable skeptic when it comes to the record highs the major US equity indices reflect. From a landscape perspective, the S&P 500, Dow and Nasdaq are significantly higher that global equity counterparts and pushing far greater excess relative to alternative asset types with a risk connection. While you could point to relative yield, an assumption of growth or perhaps an element of safety in US assets; it is more than a stretch to afford this degree of premium relative to counterparts. Furthermore, speculative measures are broadly running far afield of traditional measures of value. We would expect peak growth, peak earnings and/or peak yield to push record highs on capital measures. We are far, far from those milestones. Yet, here we find ourselves. That is the biproduct of speculative conviction/complacency, growing leverage, extremely generous monetary policy and no small assumption that fiscal support will offer a backstop should the other two nodes fail. Should these joists of risk appetite be truly tested, it is very unlikely to hold up. 
    Yet, as we track the fundamental weather between economic health updates, trade wars and monetary policy effectiveness; we are also finding optimists latching on to familiar runs such as seasonal norms. We have entered the month of November whereby the S&P 500 historically averages a strong advance as volume drops. The November/December climb is one of the most fruitful of the year and is often associated to holiday activity and other year-end efforts. Yet, another seasonal norm that raises serious questions is the expected drop in volatility through this month. We are already at extremely deflated levels as investors grow incredibly sanguine on the increasingly discussed risks. To assume we will just ride out with prices of perfection and a horizon with nary a wave of trouble is simply impractical. To give a sense of just how extreme the expectations are in volatility terms, we can look at the speculative positioning on VIX futures. The securitized product of what was meant as a hedge has attracted aggressive trading these past years. At present, the speculative interests in the future market are holding a record net-short position on the volatility measure. That is despite being substantially deflated. That smacks not just of complacency but of outright hubris. 
    Top Event Risk - for Volatility Rather Than Systemic Trend - Through the Week 
    When you are looking for the biggest fundamental impact, it is best to find the systemic undercurrents that can strike a nerve for the entire market and thereby develop true trends. However, those measures are not always clearly directed and properly motivated, as is the case seemingly for the week ahead unless something comes out of the blue. That doesn’t mean however, that we cannot expect event-driven volatility for different currencies and regions’ assets. Here are the events that I think can carry the greatest impact and why through each day this week. 
    On Monday, there are some interesting events like the UK House of Commons voting on its new speaker, but it is new ECB President Christine Lagarde’s first official speech in her new role that is most interesting to me. There is a clear rift at the central bank which either threatens to curb the aggressive support it has issued these past years or threatens to call into question the effectiveness of their efforts – that latter scenario may happen regardless. On Tuesday, I will be watching two key events: the RBA rate decision and US service sector activity report from the ISM. The Australian Dollar is a carry currency and it depends heavily on its comparatively higher rate of return to draw foreign capital – especially now when the health of China is called into question. If this group offers a mere escalation of the dovish rhetoric – and not even a cut, the Aussie Dollar has some pent up premium that can be cut back. Ultimately, the US services report is one of the most important indicators overall because it represents the vast majority of output in the world’s largest economy. The manufacturing sector in the US has contracted for four months and services has been keeping overall growth afloat; but it has been showing signs of wear. 
    On Wednesday, we are due Germany factory activity which is a good proxy for this key economy’s malaise as well as plenty of Fed speak. My top event though is the earnings report from Baidu, the Chinese search company. This is an important business update for the economy (as with the likes of Alibaba and Tencent) which can offer a more reliable gauge of the country’s health than even official and private figures that relate directly. The Eurogroup meeting on Thursday will produce the economic outlook from the European Union which can tell us how one of the largest economies collectives in the world is doing from their own perspective – far more important than a BOE decision and economic forecast which is constantly snowed in by the Brexit uncertainty. On Friday, Chinese trade will be a figure to watch, but I won’t hold my breath for volatility. Instead, the US consumer confidence figure from the University of Michigan can leverage bigger moves in US speculative markets given how aggressively they are priced. 
  4. JohnDFX
    Two Important Trade War Votes and A Lurking Threat
    We have had a few weeks of relative respite from the 2019’s constant headline generator: trade wars. That hiatus is past, however, as we are expecting key updates on global trade relations over the next few weeks. In an unusual twist though, the developments may be positive ones. Dead ahead on Wednesday January 15th we are expecting two opportunities to improve the collective growth trajectory. The most prominent of these is the planned signing of the Phase 1 trade deal between the United States and China in Washington DC. Though this deal was proposed back in October in an effort to ease the crush on business sentiment, we are only now coming to signatures. It is still unclear exactly what is entailed with this agreement besides the deferred tariff escalations due this past December, and it is likely the details are left ambiguous even though the two sides will declare it a black-and-white improvement. If we go back global indices or the USDCNH, the market is taking an optimistic view which will make it difficult to ‘impress’ while broadening the potential scenarios that ‘disappoint’. Easing more of the painful tariffs and seeing progress towards increased purchases as well as intellectual property rights policing is a matter for Phase 2 which President Trump waffles between commitment to steam ahead on and wait until after the election. 
    Another update that was on the docket for Wednesday – but for which doubt has been revived – was the Senate vote on the USMCA accord, which is the proposed replacement to the NAFTA agreement. This is one of the final hurdles to restoring tangible trade program in North America, one of the largest trading blocs in the world. Despite what it represents, the market is remarkably sanguine on this topic from global sentiment to Dow to USDCAD or USDMXN. Speculative interests started discounting the risk in this regional spat some time ago when the White House started to show a different path towards negotiation than it was taking with China – not a ‘favorable’ approach but ‘not as bad’ as the US-China trade war. Similar to the situation with the aforementioned countries’ discussions, assumptions are set with heavy skew to discount an improvement and wide open for deterioration. 
    As established as these trade negotiations have been with significant market attention along the way, the trouble brewing between the United States  and Europe remains underappreciated. Perhaps due to the distraction of open economic warfare or the side effects of complacency, there has been little active discounting taken as the two largest developed economies have moved from threats to actions. After 2018’s metals tariffs by the US, the WTO ruling on Airbus subsidies by the EU spurred the White House to charge forward with more than $7 bln in tariffs on European imports. France decided late last year to apply a digital tax on large tech companies’ revenues in its country which raised the ire of the US, urging threats of reprisal all while the country remarked that it was considering further tariffs for an updated ruling by the WTO saying Europe had not yet fully halted unfair support for Airbus. France the US have reportedly set a commitment to find a compromise by the Davos Economic Forum next week. Further, the WTO is due to make its ruling on US support of Boeing sometime in the coming weeks. 
    Will Growth Retake the Crown of Most Market Moving Theme…for the Week? 
    Geopolitical risk was an unexpected top concern to open 2020 on thanks to the situation between the US and Iran which boiled over on escalating tensions between economic sanctions and an attack on a US embassy. Though the two countries have openly attacked counterpart’s key people and installations and their rhetoric is openly hostile, it seems that the situation is back to an uneasy suspension. Despite the market’s blasé attitude towards the situation, it is worth keeping a close eye on the situation. Further escalation towards outright war between the two can have substantial economic and financial implications – not to mention draw attention to the exposure to risk the markets have built over time. 
    As we move forward with little appreciation for the threat in the backdrop, there is a theme that may find more reliable traction in the week ahead. Since the surge in fear of an impending global recession peaked in August/September, we have seen concern over the health of the economy all but vanish. That is not to say the situation has improved measurably. All that has happened is the developed world economies’ service sectors have generally avoided contraction and the US-China trade war averted steeper tariffs. Sentiment seems to be content with this situation, but it is difficult to gauge when interest will start to go down hill quickly – it certainly isn’t just a matter of an obscure Treasury yield curve event to decide. Data, while not always reliable for the seismic influence necessary to charge the markets, is at least a threat with a time stamp. There are a run of growth-related indicators on tap this week, but few of them has a ready claim to global influence. 
    A monthly UK GDP, Japanese eco sentiment survey and US retail sales are just a few indicators that will carry local weight but seriously struggle to reach global proportion. The Chinese 4Q GDP on the other hand is a big picture update from the second largest individual economy in the world as well as a key trade war milestone. That said, this report has a tendency to see very little change nor does it surprise meaningfully relative to economist forecasts. Nevertheless, don’t fully discount it. Another event to take stock of is the start of the US 4Q earnings season. Banks are the focus with liquidity a more frequent topic of conversation given the Fed’s short-term funding efforts of late. I will also keep tabs on CSX, the railroad corporation, given its influence on trade and proxy nature to growth. Here too, the interpretation of a global growth concern would require a jump. 
    An Appetite for Momentum Rather than Value 
    Last week, I discussed the importance of knowing the collective motivation of the market whether you are a fundamentally-inclined traders or not. When we know that the financial system is on a course set by views of growth, rates of return, unorthodox monetary policy or some other unique but systemic influence; it is easier to spot when market movement will pick up, separate a short-term jolt from a true trend and recognize which scheduled event risk will gain traction versus that will be readily overlooked. An extension of this consideration is the separation between a market that is motivated by a clear drive or one that is otherwise fed by outright speculative appetite. Impetus doesn’t have to be a traditional measure of value like the outlook for growth. It can be the easing of potentially disastrous economic pressure as with the trade wars. Also, there can be a temporary convergence of influences (e.g. Fed cuts, trade tension easing and Brexit breakthrough) that tips enough momentum to look like a singular cause – though such runs usually peter out far earlier as one or more nodes falter.
    Alternatively, there are situations in which a climb or tumble from the market has no basis in fundamental perspective – whether singular or a patchwork. That is more properly defined as a market driven by either greed (when bullish) or fear (when bearish). These phases are not always so overt as to be a universal tacit agreement that we will let our collective enthusiasm or pessimism carry us undisturbed. There is often fundamental justification that is made to give a sense of greater conviction behind the self-indulgent trend, whereby events or themes that challenge the prevailing trend are downplayed and tepid measures of support are given much greater prominence. It is this market type that I believe we are in with risk-leaning assets – particularly US indices. There are various ways to establish this – capital flows, divergences in key assets, erosion of economic potential, etc – but I am currently partial to the reach of specific risk-leaning benchmarks. When base risk appetite is the foundation for investment appetite, there is less interest in seeking value for long-term potential and far more interest in the immediate return to be found in priced-based established momentum. One of my favorite examples of this is the relative performance of US equities relative to their global counterpart. The ratio of the S&P 500 to the VEU is just off a record high, and EPS potential I certainly not that remarkable.
  5. 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. 
  6. 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.
  7. 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. 
  8. 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. 
  9. JohnDFX
    A Habit of Cutting Down Progress Towards Ending Trade Wars 
    This past week, optimism was dangled in front of the markets and violently snatched away before it became too established. We have been dealing with the escalation of explicit competition in trade policies for the since March, and each hint of progress in turning the major players back from economic stalemate has been consummately dashed. This past week, there were two fronts on which it seemed we were heading for an important breakthrough. The first upswing would come from the NAFTA negotiations. After US and Mexican officials seemed to come to an understanding on bilateral conditions, it was reported that Canada was coming back to the table to see if it could hash out its own understanding with the United States. With a soft ‘deadline’ presented for this past Friday it seemed there was the will and momentum to secure a trilateral agreement that could provide stability in the relationships between these major economies. Instead, Canada’s Foreign Minister announced they had not come to an agreement. In a now-familiar style of reaction, President Trump said the US was ready to go without Canada and said Congress should not interfere in the negotiation. 
    The US President would also dash building confidence that the US and EU would head off a more threatening economic standoff between the two largest economies in the world. EU Trade Minister Malmstrom made remarks earlier in the week saying the Union could cut tariffs on US auto imports to zero if the US would do the same for European cars coming into their country. That was seemingly what the President was looking for in previous remarks, but rather than voice pleasure that talks had taken a favorable turn, Trump stated it was ‘not enough’. These developed world trade threats are ominous for global growth and the healthy flow of capital across the world’s financial centers. However, they are not as yet as intense as the impasse between the US and China. There was no material sign of improvement from which we could garner a fresh sense of disappointment this past week. The previous restart of talks between the two superpowers notably led to little traction according to US leaders. There has been little in the way of encouraging rhetoric from either side in the meantime. 
    Furthermore, there are reports that President Trump is intent on pushing through the next, more onerous round of tariffs on the largest foreign holder of its sovereign debt. The open period for the public to weigh in on a proposed additional $200 billion in taxes on Chinese imports was original set for August 30, but was supposedly pushed back to September 5. Either way, the ultimate decision by the administration is likely soon – with some administrators believing news could come as soon as next week. This begs the question: at what level of total taxes or number of active trade war participants will global investors turn their fear over ill effects into action?
    What to Watch for as We Turn to Fall Trading
    Summer in the Northern Hemisphere doesn’t officially end until September 22; but for most intents and purposes, it came to a close this past Friday. Historically, August is the last month of the doldrums and the week preceding the US Labor Day holiday weekend is the final true week of passive drift. There is not a definitive flick of the switch from Friday August 31st to Tuesday September 4th where markets turn from listless chop back into full-fledged trend. That said, same seasonal factors the market abided by to overlook pressing issues such as trade wars, growing political risks and central bank commitment to normalize monetary policy will transition into active trade for a month that historically averages the only loss in the calendar year for the benchmark S&P 500 and is one of the top standings for volatility according to the VIX. 
    It is possible that anticipation has been building up to this cyclical pivot and the weight of all of the aforementioned risks will come crashing down on the complacent market. More likely, we will see the ill-effects of eroding fundamentals slowly wear away at the speculative resolve that has promoted a situation where the S&P 500 is at record highs while the Vanguard’s World Index ex US fund (VEU) and Emerging Market ETF (EEM) are carving out multi-month bear trends. Important with monitoring the balance of the markets moving forward are the measures of general speculative activity and the relationship across favorite risk assets. Volume is almost certainly to increase over the coming month, and there is a long-standing correlation between turnover and volatility. For those keeping count, volatility has an inverse relationship with risk-leaning assets such as equities and carry trade. Open interest – essentially participation – will also be important to monitor. 
    Are bulls significantly adding to the S&P 500 via cumulative shares, the SPY and eminis as it traverses new records or is stagnating (perhaps even declining)? As markets deepen and volatility increases, the discrepancy between risky assets (and typical havens) will demand reconciliation. If a broad appetite behind speculative benchmarks does not return, the incongruity will draw increasing unwanted attention from those looking to honestly evaluate the risks of their portfolios. 
    Who is Devaluing their Currency and Why
    Not long ago, President Trump lobbed accusations against Chinese and European authorities for devaluing their respective currencies to afford unfair trade advantages. This was likely a means to add further justification for pursuing aggressive confrontational trade policies against these major economies that draw painful retaliations against American consumers and businesses in the process. It could also be the pretext for the US exacting its own FX policies that would categorically touch off a financial crisis as the market re-assesses pricing, reserves and economic relations wholesale (something we’ve discussed before). With big questions ahead of us, it is worth assessing who is utilizing policy currently that can fit classification of currency manipulation or may have in the recent past. The most frequently accused world player is China. And, there is obvious policy adopted just recently that qualifies it for the label. One of the country’s primary FX administrators (the People’s Bank of China or PBoC) announced a change to its pricing method that was clearly aimed at reducing volatility – and not so subtly meant to prevent the continued decline in the offshore Reminibi. That was a move that was likely taken in part to take the wind out of Trump’s manipulation claims sails as well as to head off concerns that there was a building wave of capital flight. These are moves that can be labeled efforts to curb political stress and prevent a financial crisis, but they are most definitely manipulation. And, distortions imposed long enough eventually lead to crises. 
    As for the allegation directed at the Euro, the 2014 monetary policy connection the ECB made to EURUSD at 1.4000 was rather egregious. However, the application of rate cuts to zero and expansion of its balance sheet afterwards didn’t deviate far from many other large central banks – they were just late to the game and thereby less effective. Keeping up the argument recently finds much less weight as the Euro rallied in 2017 despite the Fed’s persistent hike pace while the European bank itself has signaled it plans to normalize in the foreseeable future. If the British Pound has purposefully been devalued to afford it trade advantage in this world of plateauing growth, using Brexit to afford this advantage would have to be the worst possible route. Japan has a long history of outright intervention on behalf of its currency owing to its dependence on trade, but both the Finance Ministry’s direct Yen selling and the Bank of Japan’s (BoJ) indirect monetary policy effort have seen their effectiveness fade after so many successive rounds. Both the RBA and RBNZ have attempted to ‘jawbone’ (talk down) their currencies, but that is something nearly every major central bank has done and it is just as ineffective for all. We could label the groups’ passive monetary policies as moving them out of favor as carry currencies, but that would be a poor plan as well as they will not attract foreign capital to help establish financial stability. 
    The SNB clearly enacted a program meant to devalue its currency with negative rates and a hard EURCHF floor, but that effort failed spectacularly and the central bank now has to deal with the fallout from a lack of credibility. And, then there is the US Dollar. Was the Fed’s piloting the QE program after the financial crisis evidence of an effort to gain trade advantage? Perhaps expanding to a QE 2 and QE 3 even though the economy and financial system was no longer in crisis was the evidence? Or perhaps the Trump administration’s efforts to play down the long-held ‘Strong Dollar’ policy or the President’s ruminations over Fed policy and accusations against other trade partners? In some way, everyone is engaged. 
  10. JohnDFX
    US-China Trade War Moving Beyond Boundaries
    As expected, the relief from trade wars didn’t last long. Not a week after US President Trump and EU President Juncker announced an armistice on tariffs between the two dominant economies, the former revived pressure on its favorite target: China. Trump had issued threats of escalating tariffs against its trade-dependent counterpart over previous weeks, but the impact of the warning seemed to come with shorter half-lives than what we had experienced through previous iterations. With a strategy that seems to center upon keeping steady pressure on China, the administration seems to have adopted two new means of pushing its efforts. The first drive follows the familiar policy approach of escalating the stakes, just at a faster pace.
    This past week, the President advised his trade officials to explore raising the tax rate on the previously threatened $200 billion in tariffs against China from the initially stated 10 percent to a far more onerous 25 percent. Following its vow to match the United States’ efforts in kind, China said it was looking into a further $60 billion tariff on US goods. This is notably smaller, which reflects the reality that the country is reaching the limits of this ‘conventional’ economic ordinance as China only imported $130 billion in US goods the previous year. That said, the escalation is unlikely to stop there. The targets and methods will evolve - and the US may have be ushering in the next stage of the trade war engagements.
    Late last week, the President’s Chief Economic Adviser Larry Kudlow essentially took to trash talking the Chinese economy and financial system. In remarks he suggested data is suggesting the Chinese economy was slowing and suggested the slide in the Yuan may be evidence that capital was fleeing its financial system. Though seemingly modest compared to the political Molotov cocktails tossed so frequently nowadays, attempting to incite panic among a competitor’s investors is dangerous and diplomatically belligerent. Above all else, China is concerned with stability: economically, financially and socially. Threatening this calm is likely to provoke a more aggressive – and now unconventional – way. And, lest we forget how connected the world is today, if a crisis erupts for either economy, it will spread to the other – and the rest of the world. 
    The Next Major Leg of a Broader Dollar Trend? 
    There has been a notable increase in forecasts projecting the forthcoming next leg of a larger dollar bull trend. That is certainly possible, but given the larger themes guiding the benchmark currency, it is far less probable than ensuing slide. I approach evaluating any currency or market with the belief that it can ultimately rise or fall. To assume certainty in a directional view is to delude yourself and make you less capable of adapting on the fly – cutting losses or taking advantage of the unexpected – when circumstances don’t go to plan. For the Greenback, I can certainly think of conditions that would foster further advance. That said, they are less likely to occur, less capable of sustaining influence or more likely to be overpowered by more commanding influences.
    The most favorable alignment would come through the combination of the Fed maintaining its hawkish bearing, risk trends holding buoyant (favoring its yield forecast), major counterpart currencies torpedoed by their own troubles and trade wars somehow encouraging capital to flow into the economy. That said, these are broadly unlikely conditions. Growth forecasts are starting to fade and volatility is materializing in the financial system more frequently. That undermines conviction in the ‘risk on’ bearing and the Fed’s divergent monetary policy bearing is likely to capsize in turbulent market conditions. Trade wars render no winners whether initiator or target, and the United States’ indiscriminate pressure on so many major trade patterns dramatically increases the risk of painful blow-back.
    The most promising fundamental spark moving forward would the broad collapse of the Dollar’s major counterparts. That is possible in systemic risk aversion where the market takes time to evaluate the eroded capacity of central banks to fight fires through diminished monetary policy. However, fleeing to the US for safety amid trade wars is a particularly thin fundamental scenario. Yes, it is possible that the DXY overtakes 96 and EURUSD slips 1.1500 to reconstitute the reversal in April and May. However probabilities don’t favor that outcome. 
    Apple Passes $1 Trillion Valuation and Calls Attention to Where Value is Being Assigned
    Investor sentiment has proven impervious to various fundamental and speculative hits over the past years. This strength has been formed through a mix of genuine economic recovery, exceptional monetary policy and raw speculative appetite. Yet, over time – and speculative reach – we have seen some of these pillars of support fall away. Economic growth has leveled out and is now at risk owing to populist pressures and extreme accommodation at central banks has plateaued. This leaves investor appetite itself an anchor of enthusiasm. And so, the focus turns to the correlation between assets along the lines of investor sentiment with leading exemplars of speculation carrying much of the market’s weight. As far as ideals for risk trends, there are few more concentrated reflections than the FAANG group.
    Registering out-performance across liquid, global asset classes; US equities have registered one of the strongest runs since 2008. Within US stocks, the tech sector has proven a leader. And, further at the core of that sector are the market cap dominant members comprising the FANG. The previous week we notched the split between relative impressive reports by Google and Amazon compared to the objective pain suffered by Facebook and Netflix. That left the unofficial ‘A’ (Apple) to break the tie. And, break the tie it would with a robust earnings that catapulted shares to a record high and beyond the historic milestone that marked this firm as the first publicly-traded company to surpass a $1 trillion valuation marker. This is a significant milestone in financial history, however, it will not alter the course of our immediate future. There was a time in past market cycles where surpassing a major ‘psychological’ level – like 10,000 for the Dow Jones Industrial Average – was treated as a turning point whereby markets would seemingly never sink below the same baselines ever again. Of course, looking back, that seems ludicrous to suggest; but it is easy for market participants to be swept up in the mania just as completely as it does with panic.
    Beyond the headlines, Apple’s performance was impressive but it didn’t produce a particularly extreme charge to reach this new milestone. Further, its ability to carry broader sentiment to a further bull trend has already proven lacking. Ultimately, Apple’s performance serves to remind us how extraordinarily rich markets currently are and the shift in dependency from traditional (‘tangible’) value to more speculative means. I asked in a poll this past week what would be worse: if Apple earnings missed and its shares sank or if they beat and markets sank anyways. Clearly AAPL and markets at large advanced, but if it were to turn lower this coming week, it would carry the same sentiment as the latter scenario. And that scenario is the one I am more worried about. 
  11. JohnDFX
    This blog post is to update everyone of the themes that DailyFX expects to focus on in the week ahead. Given the focus of previous weeks, the backdrop market conditions and the event risk ahead; the three topics below will be particularly important in our coverage. 

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

    Fed monetary policy can only disappoint from here
    We don’t have a FOMC meeting scheduled for this coming week; but in some ways, what is on the docket may have greater sway over monetary policy speculation. The US central bank has maintained a policy of extreme transparency, going so far as to nourish speculation for rate hikes through their own forecasts and falling just short of pre-committing. They cannot pre-commit to a definitive path for policy because they must maintain the ability to respond to sudden changes in the economic and financial backdrop. And, making a sudden change from a vowed move will trigger the exact volatility the policy authority is committed to avoiding.
    Yet, how significant is the difference between an explicit vow on future monetary policy and a very heavy allusion in an effort at ‘transparency’. The markets adapt to the availability of evidence for our course and fill in with whatever gaps there are with speculation. This level of openness by the Fed sets a dangerous level of certainty in the markets. With that said, what is the course that we could feasibly take from here? Is it probable that the rate forecast continues to rise from here – further broadening the gap between the Fed and other central banks?
    That is what is likely necessary to earn the Dollar or US equities greater relative value given its current favorable standing isn’t earning further gains. More likely, the outlook for the Fed will cool whether that be due to the US closing in on its perceived neutral rate, economic conditions cooling amid trade wars or the increasing volatility of the financial markets jeopardizing onerous yields. Where the Dollar may have underperformed given the Fed’s policy drive in 2017, it still carries a premium which can deflate as their outlook fades. This puts the upcoming June US CPI reading and the Fed’s monetary policy update for Congress in a different light. All of this said, this is not the only fundamental theme at play when it comes to the Dollar. There is trade wars, reserve diversification and general risk trends. Interestingly enough, all of those carry the same skew when it comes to the potential for impact.
     
    Any questions, just ask.
    John Kicklighter
  12. JohnDFX
    The Trade War Spreads to More Critical, Global Growth Organs 
    We have been unofficially engaged in a global trade war since March 2018. That is when the United States moved forward with a tariff on imported metals (steel and aluminum) from any destination outside of the country. Since this opening salvo, there have been small actions against countries outside the singular focus of China, but the incredible escalation between Washington and Beijing has drawn most of the global attention. With tariff rates running as high as 30% on over $350 billion in goods between the two economies, it is no surprise that we evaluate the growth-crushing competitive efforts on the basis of these two superpowers alone. As it currently stands, we are still awaiting another wave of products receiving a hefty tariff rate upgrade in approximately two months’ time while talks are set to resume on Thursday between the two parties. That said, reports over the weekend indicated China was not impressed with the Trump administration’s most recent efforts to find middle ground. It is important to keep tabs on the situation between the US and China, but at this point the markets seem to place greater emphasis on the data that reflects the tangible repercussions of their fight. If you want to watch the next stage of painful escalation in this systemic threat, it seems clear that the tension between the US and the European Community is the emergent battlefield. 
    There are already a few active trade levies between these two largest developed world economies, but most of the systemic threats have been reserved to an escalation in mere threats….until now. This past week, the WTO (World Trade Organization) ruled that the United States could raise $7.5 billion in tariffs against the EU for unfair subsidies supporting the region’s principal airplane manufacturer, airbus. The US Trade Representative’s office wasted no time in moving forward with the punitive action. That itself is not a surprise nor even a serious controversy. What was provocative were the details of the United States’ plans. The country announced a 10% tariff on imported airplanes, but it would slap a far more punitive 25%  tax on European agricultural and industrial goods. That is a move that registers more directly as a trade war action, moving well beyond the cover of WTO ‘sanction’ (the group urged negotiations) and encouraging reprisal. To their credit, the EU held back from retaliatory actions this past week, hoping that an understanding could be met. That said, they EC will not wait forever. It was reported that they were ready to react immediately before the ruling, and they have been quick to respond verbally to all of the US threats over the past months. If we go down this route of a trade war even half the scale of what the US and China have committed to, expect forecasts for global recession to change from an outlier of the pessimists to the baseline view of the investing masses. 
    A Near-Daily Update on Recession Fears 
    Until late August, the word ‘recession’ was only uttered by conspiracy theorists or serial pessimists. That reticence was despite a growing wave of economic data, sentient surveys and supranational organizations warning that a stall could be in he not-so-distant future. That isolation has dissipated quickly over just the past few months. The inversion of the US 10-year to 3-month yield curve was the first distinct cue that the market and then media picked up on. With a moniker like ‘economists’ favorite recession signal’, the headlines wrote themselves. Once attention was called to the frailty of the longest running expansion on record (at least in the US), the other holes started to become more overt. In the US, the NY Fed’s own recession indicator listed the probability of contraction for the world’s largest economy over the next 12 months above 30 percent – a signal that has indicated momentum into the genuine article in all but one instance going back decades. Meanwhile, the warnings from global groups have been taken more seriously: such as the OECD, WTO and IMF over these past two weeks – warning of significantly slower growth though not necessarily full contraction. Data has similarly indicated trouble from US and Chinese manufacturing contraction (‘recession’) to some full GDP readings around the world actually printing a negative monthly or even quarterly report – an official recession is two consecutive quarters of contraction according to the NBER. 
    Ultimately, the market determines what is important or market moving. We have seen numerous data points and warnings shrugged off by the markets over the past years because the speculative bias was such that market participants were happy to allow complacency to dictate a capital market drift higher. That does not seem our undercurrent at present however. Since the February 2018 plunge, we have seen a serious struggle among speculative interests to lift the markets back to their previously-set all-time highs, much less beyond them. The US indices were the most bubbly among the traditional risk assets and even they have not progressed far beyond the early 2018 swing high. Most other recognizable benchmarks are significant lower than their respective peaks from that year. In other words, the markets are paying closer attention to warning signs and are more willing to leverage their occurrence into meaningful market movement. With that setting in mind, there are a number of indicators this week that can stir our imaginations for the worst including: China service sector PMI; China foreign reserves; Eurozone investment sentient; Japan household spending; Germany industrial production; US small business sentiment; US consumer confidence; UK July GDP and Germany factory orders among many others. Keep tabs on the economic calendar as well as the headlines (Google search of ‘recession’ is quite informative).
    Gold – When Fundamentals and Technicals Conflict
    Gold is perhaps one of the indicative signals from the market as to the state of the global financial system and economy that you can find from any single source. The precious metal is a well-known safe haven, but its climb this past year has deviated significantly from the performance of fellow measures like the Dollar and sovereign debt not to mention risk assets like US indices. Its position as an alternative to traditional fiat is far more important. With central banks once again turning to expansive policy regimes while economic forecasts barely budge, there is a natural depreciation of all assets that represent this quandary: which includes currencies and government debt. There are few reliable alternatives to these traditional stores of wealth – especially when they are all dropping in tandem (Dollar, Euro, Pound, Yen). One of the very few, historical benchmarks that can meet the test is gold which is global and has played its role as a means for exchange many times through history. Given this unique role, consider the outlook for the economy and markets. Even if you don’t believe a recession is at the door, the threshold for significant expansion is very high at this point. Further, there is not much room for easy speculative gain but enormous room for retrenchment. Where would you seek safety and stability if push came to shove? 
    We – the market at large – were faced with that existential question to some degree this past week. On a technical basis, the precious metal took a remarkable bearish jog, a move that textbooks would place a high probability on fueling an overwhelming bearish trend. This past Monday’s drop cleared two months of range resistance that happened to also stand as the ‘neckline’ on a large head-and-shoulders pattern over the same period. There are few more preferred reversal measures among pattern watchers. If unencumbered by fundamental complications, speculative fear could have readily taken over and guided a more significant move for the bears. Instead, the reversal stalled immediately upon launch. This is the conflict that can arise when two favorite analytical techniques conflict. There is considerable debate over which measure is more indicative and reliable. In reality, they both have their merits and place. The backdrop and depth of catalyst can tip the scales of influence from one method to the other. Yet, if you are a trader willing to considerable a broader picture of the market in order to identify more reliable signals, it is better to find opportunities where the techniques coincide rather than conflict. Yet, in this world of contradiction, it is worth watching gold on a regular basis whether you intend to trade it or simply use it for signaling purposes. 
  13. JohnDFX
    Is Trump Responding to the Dow – and Would He Prioritize Index Over Dollar? 
    This past week generated another heavy round of criticism from the US President. In both ad hoc press conferences and tweets, Donald Trump scrutinized a number of economic and financial hurdles that he believes is threatening the health of the US economy. The most familiar critique continued to target the Federal Reserve and specifically its Chairman, Jerome Powell. Trump took to the wires to levy blame against the monetary policy authority essentially every day. His specific accusations were of a familiar flavor, but they boil down to an essential accusation that the independent setter of interest rates was keeping the Fed Funds baseline higher than it should be which is choking off growth. His specific targeting, however, shows some internal conflict over his interests and the paradox for which his own demands would not be met even by a fully compliant central bank. The most frequent issue the President has taken with Fed policy has been the level of the US Dollar – which notably closed this past week at a more-than two-year high, or EURUSD two-year low. An accusation that other authorities are manipulating their own currency (the ECB with the Euro and PBOC with the Yuan) isn’t his chief concern, but rather that the Fed isn’t responding in kind. 
    From his remarks, it seems he is less concerned over the economic pain a stronger currency may bring, but rather that the transmission of the trade war efforts employed by the Administration are watered down by the exchange rate adjustment. Therein lies one conundrum as an effective policy push by Washington would lead to a weaker global counterpart and thereby weaker currency. Therefore, some extra-ordinary effort needs to be employed to keep the currency steady or to force it to depreciate alongside the transmission of the pressure – hence the badgering Powell. Conversely, when the stock market begins to sag, the focus from the White House shifts to the level of the Dow or S&P 500, though the stated interest remains the same in a reflection of strong growth. It should be said, the economy is not necessarily the market. As the market slips and recession signals multiply, there is an effort to identify the source. Relatively little attention is paid to the age of the maturity of the economic and financial cycle alongside the disparity of expansion and unrealistic investor expectations as there is a collective obsession for singular catalysts (a function of crowd psychology). 
    There has been a growing din of criticism around the negative impact of the trade war tariffs in economist assessments, business sentiment surveys, earnings reports and more. The President has stated clearly though that he will not let up on the pressure mounted against China. With the blame building, Trump has instead started to redirect towards American businesses. This past week, he blamed auto manufacturer GM for not moving the operations it has in China back to the US. That same day, he also stated that companies that warned earnings could be negatively impacted by the trade wars were “weak” or “badly managed”. This does not exactly warm investor enthusiasm over the health of the markets. So, will the President continue to push for a lower Dollar and shame US businesses into amplifying the effort to transmit the tariffs or let up on the economic conflict to keep the markets buoyant? You can’t have both and eventually bouncing between the two objectives will seem conditions fracture. 
    The Bank of Canada and Reserve Bank of Australia Kick off a Season of Critical Monetary Policy Decisions 
    September is a month for which nearly every one of the major central banks are due to weigh on their local monetary policy; and this year, we happen to find this ‘external’ influence on economy and market performance at a particularly critical junction. Markets are buoyant – some like the US indices are much higher than others, but they are broadly trading well beyond value – and the underlying strength of the global economy has clearly eroded. This has put increased pressure on the world’s monetary policy authorities to compensate for where the markets lack in traditional form. Unfortunately, rates are already extremely low and there is already an enormous amount of stimulus (over $20 trillion from just 6 central banks alone) sloshing around the system. What more could these groups reasonably do? What would we as market participants assume policy efforts that have already earned limited economic performance and has more recently struggled to offer capital market lift can do through further iterations of the same? I am skeptical that there is the same delusion that has translated into convenient complacency that we’ve seen in previous years standing in wait to provide further lift through the foreseeable future.
    The limited capacity of the Fed, ECB and others is no longer an academic conversation but rather Main Street fare. We are due some critical rate decisions later in the month – the ECB on the 12th expected to introduce an open-ended QE, the Fed on the 18th is targeted with a demand for another cut, then a combo of BOJ, BOE and SNB is on the 19th – but we have a few decisions we should watch this week as well. The Bank of Canada (BOC) is currently the most hawkish major central bank, not for its current level but rather its reticence to commit to a dovish course. If this group capitulates, it can be a big Canadian Dollar charge, but it could also nudge views of global monetary policy. As for the Reserve Bank of Australia (RBA), the group is already into easing mode and generally contemplating unorthodox policy. This is significant on a global basis because the Australian Dollar’s position amongst the majors is in large part a function of its yield – it is a carry trade. As that trait falters, the systemic view of returns and value are further distorted. 
    Seasonality Takes an Extreme Swing in September Through the S&P 500 and VIX 
    With Friday’s close, we have brought to an end the week, month and season all at once. This period traditionally marks a serious transition of market conditions that usually moves from quiet listlessness and beneficial complacency into a period of significant activity and substantially higher risk of capital market losses. Historically, the month of August is the most reserved period of the calendar year according to the performance of the S&P 500 over the last four decades (see the attached image). While the index averages out a moderate level of gains for the month, what is truly remarkable is the volume behind the market. When adjusted by active trading days, August registers less trading than February or December (which have fewer total days). When we look to the reasoning behind such restraint, there is a certain level of self-fulfilling prophecy to the receding tide. Investors expect that quiet will dictate the decisions of other investors so they themselves accordingly with smaller adjustments to position that leave the systemic and long-term balance to another time. What is interesting is that the month of August is actually quite active when referencing the VIX volatility index. That mix of restraint in progress but rising volatility was actually in clear display this past month as the S&P 500 spent much of the period bouncing rapidly back and forth in a restrictive span. That sets the stage for September. 
    With the US Labor Day holiday, we transition from the full ‘Summer lull’ to the active Fall trading season. Volume picks up, but volatility hits new highs through the month – peaking between September and October. Notably, this activity starts to register more progress in price action. Referencing back to the seasonal measures, the S&P 500 has averaged only one month of losses back to 1980 and that is during the month of September. This likely has as much to do with the markets living up to its fears as any repeatable development timed specifically during this part of the year, but it occurs with statistical relevance nonetheless. What’s more, the market has plenty to worry over at this juncture between the fears of recession, the persistence of trade wars, wavering confidence in the leveraged dependency on central banks and more. Often times, investors are simply waiting for a collective reason to de-risk from exposure they already consider excessive, and this gives a familiar anchor into the mass psyche. 
     


  14. 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.
  15. 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’.
  16. JohnDFX
    The Return of Geopolitical Risk (the US and Iran Again)
    For almost the entirety of this past year, the dominant force of motivation among investors fit within a rotation of just three major themes: trade wars, growth concerns and monetary policy. Even when these matters weren’t under full steam, their influence and too many instances of sudden changes in the fundamental weather meant that they lack of bearing led to a similar absence of conviction in speculative performance – momentum if not direction. All three of these matters stands to hold considerable influence over the global market going forward; but for now, there is a pause in their respective tempest. Just in time for a familiar alternative risk to step in: geopolitical uncertainty. 
    Compared to trade wars or the Brexit which are more specifically a controlled break in economic relations, I consider geopolitical risks specifically issues that threaten the chance of escalation to a full-blown military conflict. The tension between the United States and Iran has been on the rise since the former announced that it was backing out of the Nuclear Treaty (JCPOA). Since then, we have seen plenty of threats and even actions to threaten oil shipping, but the measures were such that breaking the cycle of escalation wouldn’t threaten one side or the losing face. That may have very well changed this past week when the White House approved a drone strike on a convoy in Baghdad that killed Iranian Major General Qasem Soleimani. President Trump and officials stated that the decision was made to head off a planned attack on US military forces, but reasoning doesn’t curb the threat should Iran retaliate. 
    The country has said that it was prepared to attack military targets while the US President said Saturday they were already targeting 52 Iranian sites should the country seek reprisal. The implications of hot or cold wars are extremely variable but the worst case scenarios can be severe for economies and financial markets. Such uncertainty is the very definition of risk. This situation may plateau allowing the market to simply lose interest over a long enough period. Then again, it could also catalyze without warning. How willing are investors to discount the uncertainty and how well hedged are they for greater risk? 
    Central Banks are Trying to Head Off Carry Over Trade War Risk 
    Trade relations seem to be thawing to enter the new year – or at least some of the more potent threats have yet to be acted upon – but that doesn’t mean the economy is imminently positioned to resume the carefree climb that existed before the manufactured hardship was applied. The impact from nearly two years of rising trade barriers has material carry over influence economically and some of the more critical pain absorbed in previous months may very well prove permanent. Consider the agricultural purchases that China is supposedly set to pursue in order to meet the Phase 1 trade deal and for which the government has supplied large subsidies to stabilize the industry during the trade dispute. Farm coalitions have warned that even if the tariffs were fully lifted – a prospect well into the future – they may never see their relationships reestablished. Sentiment (business, investor, consumer) has a lot to do with this equation, which makes the open threats along more established and critical lines like between the US and EU added pressure that we do not need. 
    I visualize this as a large vehicle that is pumping its breaks but momentum continues to carry it closer to a critical cliff (an economic stall whereby external catalyst is no longer the critical ingredient). The world’s largest central banks no doubt see it in a similar fashion. Most policy statements or minutes have stated the concern around trade conditions as a serious external risk and many individual policy officials have expounded upon the unique risks that exist. This is likely the principle motivation behind the largest to add accommodation or hold open existing generous accommodation policies. The ECB was seeing unflattering growth figures and the uncertainty of Brexit, but is that enough to justify restarting QE and pushing benchmark discount rates even further into negative territory? And despite saying it anticipated no changes to policy last year before each meeting, it cut three times. 
    Preemptive policy like this does not offer tangible benefit – rather it is the absence of greater pain that may or may not have been realized. On the other hand, there are very real costs that continue to accumulate like cholesterol in the veins of the financial system. My top concern was addressed in the FOMC minutes this past Friday when it was reported that some of the US bank’s members worried that extreme accommodation was encouraging excessive risk taking. Unlike inflation or employment (their dual mandate until they decide to change the mix), investor sentiment can turn quantitative to qualitative with no warning. 
    Mind the Means for Market Performance to Gauge Persistence 
    Why should we care what is driving markets higher so long as we are positioned to take advantage of the climb? Even dyed-in-the-wool analysts ask themselves this question at one time or another. Many pure technical traders answered this very quandary some years ago with a ‘we shouldn’t’ and likely never looked back. However, whether chart traders, analysts with a crisis of faith or hedge fund managers frustrated that market norms have been upended; everyone should account for the prime motivator of the masses. Knowing what is urging the masses to a bullish or bearish (or neutral) environment can tell us when the a trend will stall, when congestion turns to a break or we fast track a reversal. Timing sudden reversals or distinguishing temporary pauses from a stalled trend can be a serious struggle for many investors that shun the fundamental map. Keeping course doesn’t make you immune to the struggle, but it can certainly help avoid the worst of the pitfalls. 
    I’ve said before, but it warrants repeating: the fundamental overview of the market is a factor of accumulation. There are thousands of motivations among traders to take or cut a position at any given time. Their collective actions renders the prevailing winds. Yet, not all of the causes are wholly unique. There are often dominant themes that dictate the actions of large swaths of investors. Trade wars, monetary policy shifts and recessions can be consuming matters that enough of the market responds to make it a systemic driver. Working out what dominant themes are actively controlling the reins or are lurking on the fringes can make analysis far more effective. Further, appreciating that the vast majority deployed in the system is controlled by participants that don’t have short-term duration and who don’t even consult charts help us to avoid the frequent cry ”these markets just don’t make sense!” 
  17. JohnDFX
    Remove the Political Bias, Focus on the Volatility 
    There has been plenty of political risk keeping the markets at a steady simmer these past months. Some situations like Italy’s budget stand-off with the European Union and the Brexit negotiations are more overt concerns. However, the general rise of populism and the erosion of cross border diplomacy (trade wars, sanctions, failed trade deals, etc) represents a more systemic risk. Yet, despite the ubiquity of this fundamental influence, there is an explicit focus on this theme through the coming week in the form of the United States’ mid-term election. The discourse in the country has become toxic, which will leverage the domestic market’s attention and ensure a broad evaluation of influence to encompass the factors that can steer the economy. Further, given the pressure the United States has exerted on the rest of the world via tariffs and sanctions largely via the Trump Administration’s executive powers, the election takes on global significance. 
    While there is little doubt that the world is watching, there is considerable ambiguity over exactly how it will impact the markets. With tariffs or another break down in Brexit negotiations, it is easy to draw the lines to market influence. In the US election, there is far more social stake and clash of personalities than direct financial implication. That is not to say the ultimate effect on the economy and market are not significant – they are. However, it can be difficult to separate these elements. Nevertheless, it is crucial that we do so. The foundation of successful investing is removing emotion from the equation as much as possible. Besides religion, there is probably nothing more likely to elicit emotion than politics. When we put aside the anger and mania that radiates out from this event, we are left with few possible scenarios that can translate into key domestic and global policies that can impact the markets (see Christopher Vecchio’s article on this for more detail). This election will only translate to the legislative branch when we account for federal reach on key positions. 
    If the Republican party retains both the Senate and the House, that would be seen as the ‘status quo’ as it presents continuity to the situation we’ve had this past two years. It is far from a happy and functional government, but it would still be possible to generate short-term growth via a planned second tax cut plan and perhaps reviving the discussion of an infrastructure spending program. Yet, the growing debt load over the long-term paired against the risk of a slowing economy will loom. If the one or both of the houses of Congress flip to a Democrat majority, pressure will increase significantly. That will lead to difficult progress on programs and likely lead the President to fall back on executive powers to approximate his desires. Overall, that will punctuate the uncertainty and volatility in the markets moving forward – perhaps securing and hastening a more systemic risk aversion for which the market has been threatening since February. 
    The Asymmetric Potential in the Fed, RBA and RBNZ Rate Decisions 
    When there is an event like the US mid-term elections on the docket, it is easy to overlook event risk that is scheduled for release after – and even before – the systemic distraction. Exploiting a very different theme of speculative interest and source of growing concern over the coming week are three major central banks’ rate decisions. Each is expected to end in no actual change to their benchmark rate or other unorthodox policies, but the market is effectively tuned to the nuance for which they were reference in their accompanying reports. Before we consider the potential of each, it is important to consider the wholesale influence that they have on financial system. Whether individual market participants appreciate it or not, the stability and reach of their markets are heavily dependent on the extremely accommodative policies the major central banks have committed to over the years. 
    The abundance of cheap funds has lowered the assumption of risk while also deflating the rate of return – necessitating riskier and leveraged exposure in order to make a competitive rate of return. That translates into considerable risk taking. Should the spectrum continue to slowly shift away from easing to early tightening – following the lead of the Fed – the more readily the masses will recognize the risk in their exposure. That will raise the sensitivity to risk trends and encourage de-risking that can accelerate into a crisis. As for the individual events themselves, the Federal Reserve’s decision will garner the greatest global attention. Despite – or perhaps exactly because of – the Fed’s tempo of tightening, the market’s do not expect a hike at this meeting. The fourth hike the majority of the FOMC forecasted in the September SEP was given a December timetable by the market’s. No change, but language that confirms a fourth hike would leave the Fed untouchable as the most hawkish central bank for carry purposes, but the market will treat it as status quo. The most feasible surprise would come in more restrained language that would curb established rate expectations which would in turn sink the Dollar (and likely risk trends). 
    In contrast, the Australian (RBA) and New Zealand (RBNZ) policy events are expected to end with no change and language that reflects the same ‘neutral with a modest dovishness’ that they have maintained for the past few years. Both the Australian and New Zealand Dollars have deflated for months to the point where they have significantly reduced their responsiveness to their detrimental yield bearing. Even if the groups raised the stakes on their dovish views, it would likely translate into a small market response. Alternatively, should they offer any improvement in their view and possible intentions, there would be a disproportionate rally from their currencies. 
    He Said, He Said: US-China Trade War, Brexit, Italy 
    Though we do not have the benefit of specific events and time frames on updates for some of the other more systemic concerns lurking in the financial system, that doesn’t make them any less potent a threat. Though the coming week, there are three general themes of ongoing concern that will remain on my radar. The First is the US-China trade wars. This situation has managed to avoid a clear path much less a genuine resolution to the point that markets are starting to grow wary of any remarks that could be considered signs of an improved path. This past week, we were reminded of the importance of this cold economic war when conflicting views were espoused – this time on the same side of the negotiation table. The US President voiced his optimism that a corner was turned in the negotiations after a call with his Chinese counterpart with reports that he had called on his cabinet to draft a proposal to find a solution. That helped extend the capital markets’ rebound. Yet, that optimism was quickly muted when Trump’s chief economic adviser said he was not given direction to come up with a plan and that he was less confident about the future of the relationship than he was in previous months. And, just to ensure we were fully confused on the point, the President made further remarks soon after the adviser reiterating his initial statement. 
    Look for any mentions of production discussions before the G20 summit over the coming week first as campaign rhetoric and after the election as planning. Across the pond, the Brexit situation seems to find itself steeped back into despair after brief interludes of optimism charged by supposed progress. At this point, the holdup is finding agreement on the UK’s side. Last week, the earlier reports that the Prime Minister was willing to make concessions on an important point of disagreement to make a breakthrough, progress yet again stalled as her cabinet revolted. There is a cabinet meeting on Tuesday. Theresa May will need to get an agreement from her own government under the new parameters whittled down with the last EU Summit rejection. In the background, there are rumors that a solution is being honed in on, but their rhetoric in public certainly isn’t doing them any favors in market and business sentiment terms. 
    Then there is the clear contrast in perspective between the Italian government and other European Union leaders. There is no ambiguity in this contentious disagreement. Italian leaders have repeatedly committed to increase spending well beyond what the EU considers acceptable. European leaders and central bank members have shown little interest in making an exception to the austerity rules for the region (and a backstop should market’s punish Italy in the latter’s case) for fear of losing stability internal and confidence externally. If capitulation is not found from one side, there is really no alternative solution as they head towards an existential crisis for another member finding its way out of the Union. And, unlike the UK, Italy is more deeply integrated as a member of the monetary agreement that shares the same central bank and currency. 
  18. 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. 
  19. 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. 
  20. JohnDFX
    It is Not Wise to Start Financial Fires in a Market so Parched for Value
    The financial markets find themselves in between two storm fronts. On the one hand, there is the seasonal liquidity drain that is associated with Summer trade. More historical norm than actual exchange closures, the ‘Summer Doldrums’ present a consistent curb on volume, open interest, volatility and productive trend year after year. However, the restraint is not guaranteed. Though not as common as those Fall (for the Northern Hemisphere) triggered crises and deep bear trends, there are certainly bouts of panic that originate in these quiet months. And that is why we should pay closer attention to the other storm front that has consistently stood at the border of our collective consciousness. We have watched as growth forecasts have cooled, the limitations of monetary policy to offer temporary support have entered mainstream discourse and protectionism has emerged to threaten one of the most consistent sources of stability in globalization.
    These are not new risks, but they have been regularly brushed to the side in favor of short speculative opportunities to be pursue distractedly. Yet, draining liquidity in these questionable conditions has acted to call greater attention to the risks at hand. And, now with the tension applied by the United States on peers and counterparts alike, we are seeing the growth of clear conflict threatening to force the issue of more candid evaluations of value. Trade wars had – and still has – the capacity to trigger a full scale deleveraging of excess risk, but the temporary stay in the spread of kind-for-kind retaliations among developed world giants soothed imminent fears. This front is likely to erupt once again in the not-to-distant future under more pressing circumstances.
    In the meantime, a sister action in the form of US sanctions placed on less-friendly countries may take up the reins on global sentient. The Trump administration reversed its participation in the nuclear deal with Iran (27th largest economy) and restored sanctions on the country much to the condemnation of the other participants of the deal. The US has also moved to apply new penalties on Russia (12th largest economy) in response to its supposed use of nerve agent on a former spy. The USDRUB soared to a two year high this past week. And, showing the most severe short-term impact of all was the quickly escalating sanctions that the US is placing on Turkey (17th largest economy) for ostensibly the country’s refusal to release a US pastor swept up during the failed coup. The country’s currency has dropped over 55% versus the Dollar (through Monday’s open), and this time the financial exposure for major economies (particularly European) was quickly seized upon. Let’s see if this fire can be contained. 

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

    Dollar Rally a Result of Policy and Justification to Devalue?
    On July 20, President Trump lashed out (via Tweet as his want) at the Euro and Chinese Yuan claiming the currencies were being manipulated to render an unfair competitive advantage to their respective economies. Such claims are dubious at best. With the Yuan, history shows the country has a penchant for exerting influence over the activity level and direction of its ‘Renminbi’ to help promote economic, financial and social stability at home. However, their ability to keep all these efforts leveled out on the horizon is increasingly troubled. What’s more, a steady charge higher for USDCNH is exactly what would be expected if the United States’ tariffs on China were having their intend effects.
    As to the criticism of the Euro, there is little evidence to support that view. Four years ago, the anger would have been justified when the ECB said it would applied monetary policy in order to prevent the EURUSD exchange rate from passing 1.4000 – there must have been an agreement behind closed doors to allow this given how blatant the effort. This claim now, however, finds little support in action or event threat. Again, this is likely evidence of a strategy with questionable execution. Making a claim that multiple major currencies are being unfairly devalued – one others may agree to out of historical assumption and the other more dubious – can be used as pretext for enacting a policy aimed at counteracting the stated inequity.
    If there is indeed interest for US officials to abandon the ‘strong Dollar’ policy as has been hinted at multiple times over the past months and actually introduce policy to sink the currency, that appetite will be significantly bolstered this past week with the surge for the USD versus both the ‘majors’ and emerging market currencies. Arguably the result of the Trump Administration’s own policies, it may nonetheless serve as the foundation for a new course of global financial conflict. 
  21. JohnDFX
    Anticipation and Scenarios Into the Sunday US Deadline for China Tariff Escalation 
    The active week of trade ahead will be pocked by a few very high profile events which will tap into key themes. Monetary policy and Brexit updates – both with explicit growth implications – are top listings while liquidity is readily available. Yet, one of the most potent potential events ahead has a deadline that occurs over the weekend. The United States warned some months ago that it would increase the tariff list on Chinese imports if the two countries had not reached a meaningful compromise. Though the two countries seemed to agree to the concept of a Phase One deal back in mid-October before a planned escalation in the tax rate on existing tariffs, the details on this accord have thus far been notoriously absent. White House officials and President Trump himself have stated explicitly these past two weeks that they intend to follow through with the escalation if a bargain was not struck. Of course, what qualifies as acceptable to reach a stage one accord and ward off the onerous escalation is open to interpretation, so the future is ambiguously in the Administration’s hands. We have been here so many times before (see the image) that the markets have grown numb to the risks that exist should the outcome be poor. That is a particularly dangerous brand of complacency. 
    With this uncertainty and hopefully a little more introspective appreciation of the risk it represents in mind, it is worth considering the scenarios. Through the active trading week, it is unlikely that US or Chinese authorities pull the plug early and make clear another wave of painful tariffs is in the cards. Rhetoric to reiterate what is at risk is very likely as both sides intend to pressure the other in their long-standing ‘game of chicken’ but that is par for course. That suggests that if there is any truly definitive development in this tense trade negotiation, it would more likely turn out to be a breakthrough that disarms the threat. That could very well offer a relief rally to risk assets, but there aren’t many that are deeply discounted at this point and it would struggle to recharge the year-end liquidity fade. More productive would be a rally for the Australian Dollar. The currency has suffered a crushing depreciation over the these past years as the same connection between the Australian and Chinese economy that helped the former avoid recession during the Great Financial Crisis is now steering it into the rocks. With AUDUSD also suffering from the lowest activity reading (25-day ATR) since 2002, conditions seem ripe for a spark.
    Alternatively, if we head into next weekend without a favorable resolution in hand, traders should consider thoroughly their risk tolerance with holding exposure as exchanges close through Friday. It is certainly possible that there is a last minute agreement in the hours before the stated US Trade Representative’s Office deadline, but that is a lot of assumption to put on the shoulders of politicians who have not committed to any significant de-escalation efforts since this trade war started. What’s more, the bullish case scenario is relative tepid as discussed above. Alternatively, the inability to strike an agreement, would increase the stress on global growth materially. Considering the US indices as a milestone for risk are just off record highs, there is worrying premium at risk should blind enthusiasm be crack. This revelation of pain could be made when Asian markets are online and thereby some liquidity to respond, but shallow market conditions amplify rather than absorb volatility shocks. Consider your risk tolerance. 
    The Genuine Concern Underlying Both the Fed and ECB Rate Decisions 
    There are a host of major central banks due to update their policy over the coming week. For the majority of them, no change is expected. That doesn’t come as much of a surprise given the general state of monetary policy across the globe as well as the condition in capital markets as of late. There has been a not-so-subtle escalation in global accommodation through 2019 that has included rate cuts (for some into or further into negative territory) and material purchases of assets. Growth measures of late may have also solidified the lackluster outlook, but the balance of risk assets removes some of the urgency to push support further into uncharted territory. There is a cost associated to everything, and the balance of global monetary policy is showing increasingly greater cost relative to the quickly fading benefit with each subsequent iteration. That is what traders should be truly monitoring when it comes to monetary policy events like these this week and into 2020; because should confidence founded on this support falter, the optimism that it has filled in for these past years will cause a likely-severe rebalancing of priorities. 
    Now, we have seen serious questions over the effectiveness in monetary raised these past few months, but the concerns have been beat back after some short pangs of concern. That said, so long as the global economy continues to flounder despite the efforts; the risk of recognition of an inevitably-bankrupt strategy and pillar of current stability will rise when the largest actors maintain or escalate their efforts. Thus approaches the Fed and ECB policy meetings. The US central banks is first and on the hawkish end of the scale. They have come off of a series of three consecutive rate cuts which leaves their benchmark at 1.75 percent but it is expected that they will hold this month with no commitment with further easing into the future. We will get a better sense of their policy course moving forward with the planned Summary of Economic Projections (SEP), but they have not been particularly aggressive with their forecasts. The stability this may insinuate is undermined by the short-term funding pressure that has pushed the Fed to flood the repo market with liquidity. This has led to a sharp increase in the central bank’s balance sheet which they are quick to remark is not a return to traditional stimulus efforts. I would agree that it is not the ‘traditional’ QE effort, but its purpose is even more troubling: to fend off serious financial stability threats rather than to simply accelerate growth. Watch references to this in Chairman Powell’s press conference along with any insight into the discussions on general strategy that the board has been engaged. 
    At the other end of the perceived policy spectrum, the dovish ECB is in just as profound straits as its US counterpart. With a negative deposit rate and actively engaged in quantitative easing (the traditional type), we already know that there is a serious measure of concern for this authority when it comes to growth and financial health. It is between his effort and the immediate concern of its effectiveness that we find the most tangible threat to a crack in the façade of cure-all monetary policy. There has been a well-publicized uprising in the rank of the ECB with a host of members openly questioning the effectiveness of their extreme accommodation and the dilemma it leaves them in should an actual economic downturn – or worse, financial seizure – necessitate an effective response. Will the market adopt and action these concerns? 

    Take the Global Traders’ Perspective of the UK Election 
    Passions inflame when it comes to politics – particularly if you are a citizen of the country heading to the polls. That said, when navigating the markets, it is very important to divorce one’s personal, social and even moral views of parties and candidates to consider the genuine implications to the financial system. That is easier said than done, but the mantra should be repeated. For the upcoming UK general election Thursday, there is a clearly impassioned populace. With Brexit still hanging over the future leader and party like the Sword of Damocles and economic activity sputtering, it is easy to see the financial line blur in the myriad of concerns. Is this a matter of economic recovery, the future of trade between the UK and its largest economic partner or just a binary assessment of whether the divorce will finally proceed to a conclusion? 
    While there are many important implications from this event, I believe the market for the Pound – and certain capital asset benchmarks – will respond first and foremost to the favor for party and proximity to a majority. The closer the UK is to a unified position towards negotiations, the more likely a path will be decided for Brexit with deadlines being kept rather than pushed back. As an aside, an outcome that sees a reversal on the Article 50 could eventually charge the Sterling much higher, but it is a very low probability and would not be interpreted as such a possibility immediately after the General Election outcome necessary as a first step. This past week, we have seen remarkably volatility behind the Cable, EURGBP and other Pound crosses owing largely to the polls signaling a clearer support for the Conservative party (again not a party preference but rather the clarity it suggests) The volatility signals just how much activity could follow this event. DailyFX will be covering the election through the day and evening with live updates, outcome articles and forecasts for Brexit next steps.
  22. JohnDFX
    The United States and China Jostling for Economic Supremacy
    The world’s largest economies are starting to update on the status of their health. And, though it may not seem to be the case in these speculatively charged markets, financial performance relies heavily on a healthy global expansion. This past Friday, China reported its third quarter GDP reading. The 6.5 percent clip would be an enviable pace for most of the developed world, but for this debt laden country, this is slowing to a pace that is more likely approaching ‘stall speed’. In historical context, the reading represented the slowest clip of expansion for the country in 9 years – a period that was plagued by a global recession that had in turn prompted the government to plow funding towards infrastructure spending to buy it more time. Time is crucial for the world’s second largest economy. It needs to be balance its relatively rapid pace of growth with financial stability long enough that it can solidify its position as one of the dominant economic superpowers. 
    For decades, the country has relied on the rapid growth that is borne from trade, financing, speculative appetite and practices that emerging market countries often utilize that are considered unacceptable among their developed counterparts. That said, it is odd that the second largest economy is still classified as an ‘emerging’ market and one of the roots of contention from the United States and others. Over the past three to four years, China’s intent and timeline have become more clear. Having avoided a the Great Recession, they had seen their standing in the global economy move up to a more stable plateau. To ensure they secured their position, the government has attempted to turn towards a more accepted growth plan and to reduce capital borders in order to become a full-fledged member of the globalized community. Without interruption, that initiative would have succeeded. Unfortunately for the Politburo, the Trump Administration has exerted enormous pressure on the country and threatens to undermine growth and/or tip the financial stability balance to create a permanent hurdle. 
    The question of how successful this effort to stymie the economic engineering effort will be is only one facet of the equation, there is also the question of how much fallout the US itself will suffer along the way. The United States’ effort to bring trade pressure against its largest economic peer will come with an economic cost to the instigator, which they are attempting to offset by fostering investment and business growth through tax cuts and fiscal spending – a combination that breaks norms of its own (deficit control). In the week ahead, we are due the United States’ 3Q GDP update. This is the period through which the trade war truly ramped up, and it will be used as an evaluation of whether the polices are boon or burden at home. Should this and other more timely economic readings head lower, buoyant sentiment readings over the past year will start to flag and make a self-fulfilling prophecy of financial concern. 
    The Euro’s Fundamental Path is Growing More Complicated 
    For the most part, the Euro has spent the past 18 months either in a fundamentally enviable position or simply a neutral bearing that could take advantage of weaker counterparts. Economic activity has been slow but steady with members bearing extraordinary austerity following the Eurozone sovereign debt crisis finally turning a corner. Further, the initial threat of the region having to pursue the same costly economic war against the United States was averted when EU President Juncker agreed with US President Trump to avoid further tariffs so long as both sides continued to negotiate. Meanwhile, the mere anticipation of a rate hike from the European Central Bank leveraged the kind of speculative front-running appeal for the Euro through much of the past year that so closely mirrored the Dollar’s own charge in 2014 and 2015. That passive state of speculative appeal is starting to falter however. While growth readings still seem to be following a stable path, the commitment to slower growth to achieve fiscal improvement through austerity is starting to break down. Populism is spreading across the continent. 
    Chief concern in the evaluation of Euro-area conviction is Italy. The country’s government has applied pressure and backed off in regular tide of ebb and flow; but through these phases, ever increasing the tension. It seems we have reached the point of no return where rhetoric will no longer be enough to satisfy markets. Heading into this past week’s EU Summit, the leadership of the Italian government made clear that it intended to rebuff budget restrictions to support growth and fulfil campaign promises. There was no mistaking the Union’s perspective on Italy’s intended path: they said the spending and deficit projections in their plans were unacceptable. This standoff remains unresolved, but the financial markets are starting to pull back to curb their exposure to the risk. The FTSE MIB is suffering more acutely than its large counterparts and Italian sovereign bond yields are climbing rapidly. A 10-year yield spread of over 400 basis points over the Germany bund equivalent is considered a level akin to serious financial pressure.
     We were just above 300 basis points to close out this past week, but that was before the news after the close that Moody’s had downgraded the country’s credit rating a step to Baa3. That will have an inevitable impact on funds that have to abide credit quality when dictating their exposure. In the week ahead, we have another assessment of Italy’s financial condition coming from Standard & Poor’s. This fundamental impact on the Euro is not the only theme competing for influence. Monetary policy is another fundamental strut that could buckle or hold the currency strong through the growing pressure. There is no change expected from the gathering Thursday, but there is growing concern over the internal and external risks for the Eurozone. If they cool expectations for the first hike coming mid-2019, there is still premium for the Euro to give up. A further complication to consider: if the Euro drops materially, expect the Trump Administration to raise its pressure on the regional economy. 
    Brexit Risk Jumps after EU Summit, Rumor of Border Breakthrough, Protests and New Credit Ratings 
    The Brexit countdown is taking on a Edgar Allen Poe-level resonance. The European Union summit this past session was specifically targeting discussion between the UK and 27 leadership to see if they could make a high-level breakthrough on the divorce proceedings. The primary hold up at the end of the gathering remained the border issue and the complications that it invites. It may seem that there is plenty of time to negotiate with a little more than five months until the official split, but there is considerable work to do in passing the proposal through so many different governments and working out the technical aspects thereafter. So long as this situation is unable to pass the critical step of an acceptable draft agreement between both sides, the Sterling is likely to see steady retreat as capital funnels out of the country to avoid the uncertainty facing London’s financial center specifically. With the risks growing, the attention on progress will intensify. 
    With that said, there seemed a possible breakthrough in the closing hours Friday when it was reported that Prime Minister May was prepared to drop their Brexit demands on the Irish border issue in order to earn a breakthrough. Such a move would likely earn the ire of Brexiteers who would balk at likely permanent participation in the EU’s customs union. It remains to be seen if the UK’s government would back such a appeasement, but it doesn’t seem enough for many Brits. Over the weekend, a protest in London calling for a second EU referendum drew reportedly between 600,000 and 700,000 participants – one of the largest in the capital’s history. It is unlikely however that the government will return to the polls on the issue unless there are a number of political turns that force the issue. Ahead, we will have to keep a very close eye on the headlines to see what transpires in the political environment in England as well as between the UK and EU. That doesn’t mean though that there aren’t any meaningful milestones on the docket to mark on our calendars. 
    At the very end of the coming week – after the close Friday – we are due two credit rating updates on the United Kingdom from Standard & Poor’s and Fitch. These groups have generally maintained a wait-and-see perspective until it became clear that there would be a compromise scenario or a crash out. However, time is a factor that they can no longer ignore in this equation. With each week that passes without a breakthrough, the economic and financial ramifications deepen. More stark warnings are likely if there is not a confirmation of the border issue and a downgrade is not impossible.  
  23. JohnDFX
    What Was and Was Not Announced in the US-China Phase 1 Trade Deal 
    Release the doves. The US and China announced last week that they finally were able to come to terms on the their long contentious Phase 1 trade deal. It seems to have conveniently slipped the market’s collective mind that the first stage of the promised reversal to the trade war was announced back on October 11. No tangible change had been put into place between then and now, but that didn’t slow the climb from risk benchmarks like the Dow. There is very good reason to be skeptical about how committed the two governments are to progress given the numerous starts and stops over the past six months (see the attached chart of the DIA). In an ideal scenario, the two sides flesh out the details to the armistice and offer breathing room to work on the Phase 2 leg. 

    That said, US President Donald Trump gave a conflicting view of when the subsequent step of de-esclation would take place as he said it could happen before the election in November and then remarked that there was no reason to rush it. There are notably $250 billion in Chinese imports that are still being taxed at 25 percent, blacklisted entities and a currency manipulator designation among other barriers still in place. However, before we assess the difficulties of next steps, it is important to keep close tabs on the presumed efforts for this current chapter. Absent in the announcement were the size of Chinese purchases of US agricultural goods, enforcement procedures, structural change to IP protections, methods of tracking FX manipulation, procedures for dispute resolution or even a clear statement from Chinese officials (through state media) that they are in fact satisfied with the terms. 
    We shouldn’t view the situation with complete skepticism though as there was very real avoidance of a painful acceleration in their standoff. The US backed off of a planned December 15th increase in the list of taxed imports from China to encompass virtually all of the country’s goods – and China deferred tariffs on US autos. That would have been another severe escalation in the trade war. Further, the White House’s decision to halve the 15 percent tariff rate on the $120 billion in Chinese imports announced back in September is the first meaningful step to actually ease tensions. While this is largely the avoidance of a further step to intensify a painful economic trade war, that may just be enough to stir speculative interest that traders have held on their sleeves. 
    Risk Trends Now that Our Wishes Have Been Met 
    Speaking of speculative interest, we should theoretically have all the necessary ingredients to push ahead with a strong close in global capital markets through the year’s end. On a structural basis, we have seen the capital markets climb with little regard to the troubling questions over traditional value for the better part of a decade – perhaps driven by the very generous policies of the world’s largest central banks – and 2019 has been particularly liberal with the buoyancy. Another layer to add to this favorable backdrop is the seasonal expectations associated to the month of December. Historically, ‘risk’ benchmarks like the S&P 500 climb through the final month of the year as much through habituation as anything tangible like tax harvesting. There is a reason it is called the ‘Santa Claus Rally’. And, rounding it all out, we were given a few very high-level, reassuring events to spur a sense of tangible optimism. The Phase 1 trade war agreement and a clear path for the Brexit negotiations between the UK and EU after the former’s general election are a measurable relief to global risk. 
    With the market’s seeming default optimism, all of this should make for an easy response to extend the bid over November and the first half of December. And yet, this past Friday’s market activity did little to reassure that we were going on cruise control. While measures of implied (expected) volatility dropped in the aftermath of this dual update, the underlying speculative markets would not match with a charge higher. US indices, the best performing of the major assets I follow, marked a technical high with no  meaningful progress. Where we could have mustered some conviction through associated risk measures playing catchup to the SPX, there two we were met with hesitation. That doesn’t mean that market has completely blown its opportunity to rouse conviction; but it draws serious, negative attention. A market that rises despite trouble in backing fundamentals and underlying value suggests a speculative default. That same backdrop failing to progress when concrete support is presented is troubled. 
    The Last Liquid Week of the Trading Year
    Liquidity is exceptionally important when you are trading the markets. A good example of what happens at the opposite ends of the spectrum is the day-to-day activity by one of the top shares in the world (say Apple) and those that are on the ‘pink sheets’. The former can build on its gravity to progress a bullish run further than smaller counterparts from sheer size while also curbing panic selling that may otherwise afflict counterparts as its scale can be interpreted as safety. Alternatively, the smallest shares move in often erratic day-to-day swings and frequently see their value wiped out when risk aversion hits the broader financial system. Fundamental and technical analysis counts of course, but market depth and fluidity is a principal influence. 
    Consider this for what we face over the next two weeks. We are heading into the final thrust of the trading year. Ahead, we face the last full week of the trading year. We’ve seen a clear deference for a risk-on bearing and predisposition towards keeping exposure fairly steady (no profit taking or meaningful hedge build up). Anything other than a slow volume trade of consolidation should be observed closely. A significant climb in capital markets would reflect an ‘all-in’ mentality that would register as quite extreme. Such a climb could be a cue for investors to launch a strong 2020 start, but it could also readily turn into a blow off top when it comes time to reassess value. Alternatively, any meaningful retreat given the prevailing winds, seasonal backing and sliding liquidity could signal risk aversion that is ready to override all the typical hurdles. Be mindful of the market’s next move and the quick assumptions that will be drawn from it. 
  24. JohnDFX
    Will the White House Pick a Fight with Europe? 
    The long-awaited first step towards de-escalating the most taxing trade war in modern financial history – between the US and China – took place this past week. Representatives for both countries, US President Trump and Chinese Premier Liu He (notably not President Xi) participated in a very long signing ceremony. The contents of this first stage for finding a long-term and full compromise is important as is stands as the symbolic doorway with which these two superpowers can continue to work towards a true compromise that sees all the steep tariffs (largely put on by the US) rolled back and China take on the role of a norms abiding ‘developed economy’. That said, we are still critically lacking a path towards reversing the tariffs on $360 billion in goods already in place as well as acceptable monitoring for technology transfers and intellectual property protections. For now, we may find ourselves in a sort of purgatory for relationship between the two. 
    Looking out over the week ahead, however, trade will remain top of mind. For one thing, the World Economic Forum in Davos is likely to address the scourge of trade war just as it did last year. As confrontational as the members were the last go around, the tensions did not actually boil over into actions that the market would have to account for in price. That said, we do have a particular possible flashpoint staged by officials. The US and France set a deadline of January 21st (Tuesday) for negotiations over the controversial digital tax that the latter announced for large tech companies last year. The White House considers this a burden disproportionately applied to US companies and has threatened to retaliate against France if it is not lifted. A $2.4 billion tariff has been threatened if an agreement could not be struck. In turn, France and the EU’s trade chief have remarked that they are prepared to retaliate should the US act to retaliate.
    Let’s also not forget that there is another front to this battle already underway. The US has pushed forward with import tax on $7.5 billion in European good in response to the WTO’s ruling that the EU had unfairly subsidized Airbus and that the US could pursue recompense. Turning the screws further, the US has threatened to pursue further tariffs after a follow up evaluation by the World Trade Organization’s report that Airbus aid was still not fully curbed. European officials will have their day though as a ruling by the same organization is due on Boeing and the United States’ support soon – likely this month. Will the US ease off?
    Monetary Policy Will Gain Traction When Questions Over Reach are Asked 
    Monetary policy has been relegated to the backdrop as a systemic fundamental theme these past months, but its influence has not actually ebbed. The collective global yield (benchmarks set by the largest central banks) and additional stimulus infused into the system is still historically unprecedented. That reality seems to have simply become a natural part of our environment. Yet, a dependency on what was previously considered extraordinary monetary support – emergency stimulus – should not be viewed as a healthy foundation. For one thing, it leaves the world’s largest policymakers with very little in the way of ammunition to fight any future economic or financial fires that arise. Furthermore, the external support seems to have encouraged investors to bolster their exposure to ‘risk’ rather than seek value and help find balance in the system.
    In the schedule of large central bank meetings ahead, we will see this stretched situation for authorities and markets raised between the Bank of Japan (BOJ) and European Central Bank (ECB). The former will announce its policy mix Tuesday morning after the liquidity lull caused by the United States market holiday the previous day. This group is unlikely to change focus on the 10-year JGB yield target and its essentially-zero benchmark rate, but their reiteration of having room to do more if necessary and seemingly indefatigable optimism for a recovery in the future is drawing more and more skepticism from the market given the constant shortfall on objectives. They are perhaps the most over-extended of the major banks as a percentage of GDP. The ECB isn’t as exposed as its Japanese counterpart, but the changes this past year stand out more prominently. The return to QE and drop further into negative rates has more members of their board questioning what are the costs of this extreme policy. The group is due to announce the results to its review of framework which could either bring serious change to modern monetary policy or act as a foothold to skepticism over the old guard. 
    Another central bank worth watching this week will be the Bank of Canada (BOC), which is not expected to alter its rate and struggles to stand as a model for global policy – whether the average or extremes. Instead, this group’s dovish or hawkish lean could offer influence to the Canadian currency. And, given their general perspective of balance, moderate shifts could give charge to pairs like USDCAD. 
    Range, Breakout or Trend Conditions? 
    This is a topic that I have raised before, but it deserves to be revisited at regular intervals as it can significantly influence your ability to navigate the markets. I think most would agree that conditions change, and it should thereby stand to reason that we should adapt to the evolution in order to reasonably pursue profitability. In general, I believe there are three types of market environment that we progress through depending on liquidity conditions, volatility and prevailing fundamental themes. Range or congestion, breakout and trend are three distinct environments that cycle progressively almost regardless of the time frame we consult. Naturally, if you have tuned your analysis to one of the three and/or established a trading strategy that is optimized for one, a systemic shift in the market will leave you adrift. It is absolutely possible to appreciate your conditions and adapt; but those that think they can create a one-size-fits-all approach are deluding themselves.
    So what kind of market conditions are we dealing with? This is something I ask myself at least at the start of every week. There are some very interesting cases to be made by a few key assets out there. US indices for example have been climbing fairly steadily these past three months. On that alone, we can call a trend. However, the pace of the Dow’s advance is extraordinarily restrained; and there are not many markets that reflect the same intent. Recently, a bid for risk-based catch up from the likes of the FTSE 100, the EEM emerging market ETF and debatably some of the Yen crosses  look like they are just recently clearing prominent resistance levels. That may be true, but breakout is defined not by a laser-accurate level but the measure of follow through when it is cleared. There seems limited backing for follow through. That leaves congestion. There are plenty of false starts and large ranges to point out. Furthermore, remarkably low volatility levels doesn’t support the immediacy of breakout. FX Volatility measured by JPMorgan’s global measure has dropped to a record low this month. As a mean-reverting condition, activity will normalize; but it doesn’t have to do so immediately. 
  25. 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.

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