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Talking Points:

  • US and China trigger their dramatic increase in economic volleys against each other, markets show little deference
  • A softening of last week's risk swell maintains resistance for a range of markets and the contrast to US indices intact
  • If you are placing a Dollar trade, it had better fully account for the uncertainty in anticipation and fallout from FOMC

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Trade Wars Balloon and the Markets Barely Show Recognition

The next leg of an unprecedented trade war has gone into effect at the start of this week. The United States and China have implemented the upgrades to their respective import taxes against each other, and any hope that we will turn back from the abyss before any permanent economic or financial damage is done has all but vanished. The United States added another $200 billion in Chinese imports to its list of goods to tax (10 percent now and 25 percent at the turn over the year) while China responded with duties on $60 billion in US goods entering its own economy. Normally, this would be cause for severe concern. Not only will it restrict collective economic growth, disrupt the flow of capital around the world and spillover to more sensitive bystanders (like emerging markets); but it is also a sign that the normal outlet for de-escalation (diplomacy) no longer works. Yet, as significant as this milestone is, the markets offered little concern for the occasion - much less, the response it deserved. The S&P 500 eased back and the Dow suffered its biggest bearish gap on the open in two weeks, but these moves occur from record highs. Other risk-leaning assets, however, offer a greater sense of appreciation to the risks. Other global indices have held at resistance levels far short of their own multi-year or record highs. The EEM Emerging Market ETF stalled at a particularly overt resistance to a large-scale descending trend channel. Not all assets are as overwrought and oblivious as the US stock market, but they will all suffer for its miscalculation nonetheless.

AUD/USD Chart (Daily)

S&P 500 Mere Slip Contrasts Trade War Upgrade, Beware Dollar Calls

Dollar's Longer-Term Risks Weighed by BIS but Markets Will Reserve Judgement for the FOMC

For the US Dollar, the restraint in speculative appetites translated into modest reprieve for the currency. If we were so inclined to make shallow interpretations of this connection to make our analysis easier, the Greenback's move could be labeled evidence that it is acting as a safe haven. I don't think that is the case however. With the government putting the US at the middle of the global trade wars, assuming capital will flee to a country the world has increasing reason to circumvent doesn't pass muster. Other, more systemic issues were highlighted by the Bank of International Settlements (BIS) - often referred to as 'the central bank of central banks' - this past session. In their quarterly update, the group that has found itself at the very far end of the pessimistic scale among supranational groups warned that the global markets were at risk of relapse with a particular addition to risk and credit. Particular binging on US funds - with loans to non-finance entities outside of the country at 14 percent of global GDP - added a unique twist to the threat. In particular, emerging market economies were feeling the pressure as the Federal Reserve steadily raised its benchmark rate. This is a systemic risk, but perhaps still an abstract one for the average market participant. There is far more tangible threat in play in mere anticipation of the next policy call from the US central bank. The Federal Open Market Committee (FOMC) is expected to hike rates yet again on Wednesday. Along with updated forecasts, this will certainly add pressure to the markets. However, expecting the Dollar to commit to a clear trend before this event is presumptuous. So, if you think the rebound for the Greenback Monday or even the EURUSD breakout last week is already set on cruise control, you may be in for a surprise.

EUR/USD Chart (Daily)

S&P 500 Mere Slip Contrasts Trade War Upgrade, Beware Dollar Calls

Brexit Troubles Deepen and EU Warnings Flash, Yet Neither Pound Nor Euro Commit

The Dollar isn't the only major off to a fundamentally disconnected start to the new week. The sting of the EU leader's Salzburg meeting last week that delivered a clear rejection of UK Prime Minister Theresa May's Chequers proposal represented an abrupt break in the progress towards a Brexit compromise. The unfavorable trajectory set after May doubled down on a 'no deal is better than a bad deal' approach in Friday's speech had not improved over the weekend, but the Sterling put in for a bounce Monday nevertheless. If anything, recent news would add to a tangible sense that the United Kingdom is on a head-long course to 'crash out' of the EU. While there is good reason to debate which side stands to lose the most, there is little doubt that no solution to this divorce will be a net detriment to the Sterling. The only-recent retreat from the currency does not accurately reflect the uncertainty that looms. Elsewhere, the Euro has its own exposure to a poor outcome from the Brexit - though a no deal will sufficiently support claims that other members shouldn't pursue such a course - but there are more intrinsic uncertainties weighing the second most liquid currency. Italy has announced a stringent anti-immigration policy Monday while a League economic adviser suggested a 2.5 percent deficit to GDP target would be credible and leave markets undisturbed. Italy remains the greatest risk to Euro-area stability, but monetary policy is still a crucial factor. ON cue, ECB President Draghi spoke Monday and issued another warning that the world should be prepared from a 'big hit from protectionism'.

GBP Index Chart

S&P 500 Mere Slip Contrasts Trade War Upgrade, Beware Dollar Calls

OPEC Meeting Pushes Brent Crude Oil Above 80 Though Trend Should Be Doubted

Outside of the majors, a more direct fundamental link was traced between the weekend OPEC meeting and crude oil's charge to start the week. While the US benchmark WTI contract managed a rally of its own with a break above 72, the technical implications don't stretch much further than setting a two month high and perhaps forming a right shoulder on a head-and-shoulders pattern. The European-preferred Brent contrast in contrast has earned a remarkable milestone. Breaking above 80 means overtaking a four-month range high and extending the market's highest reading since November 2014. The spark for this move was well founded in headlines. Despite US President Donald Trump's demands for OPEC+ to ramp up production in order to help lower prices for the commodity, the group reached no such agreement at its weekend meeting. That leaves a nearly 2 million barrel per day drawdown from Iran owing in large part to the onset of US sanctions in early November a prominent pressure on the supply and demand equation. In other commodities news, the Dow Jones Commodity Index has advanced strongly for four consecutive days as a risk-sensitive asset that seems to be running fully askew from its counterparts. And, as for gold, price action offer no meaningful backdrop towards trend development; but its unique safe haven status stands ready to fill in a very short list of acceptable safe havens should risk aversion trip liquidity and monetary policy factors. We discuss all of this and more in today's Trading Video.

ICE Brent Crude Oil Chart (Daily)

S&P 500 Mere Slip Contrasts Trade War Upgrade, Beware Dollar Calls

If you want to download my Manic-Crisis calendar, you can find the updated file here.

Written by John Kicklighter, Chief Currency Strategist for DailyFX.com