S&P 500 Third Biggest Bullish Gap This Year Doesn't Resolve Key Themes or Fear
Volatility Talking Points:
- Risk trends bounced to start the week with the S&P 500 posting its third biggest bullish opening gap of the year
- Seasonal liquidity is converging with a deferred fundamental attention with the Jackson Hole Symposium at the end of the week
- Meanhile, headlines are keeping the stakes elevated for trade wars, recession fears and the faltering of global monetary policy
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In the Quiet, Speculative Appetite Returns to Its Old Tricks
The pressing fundamental risks facing the global financial markets these past weeks, months and years weren't suddenly resolved over the weekend; but we nevertheless opened the new open period with a favorable risk bearing. There was a jump for most of those assets with a speculative bearing on them Monday, but follow through was spotty to say the least. The favorite exception - the benchmark used to seemingly set the mood of the entire financial system - the S&P 500 posted its third largest bullish gap open of the year and coasted modestly higher through the day. This isn't an accelerating move at the cusp of a new bullish leg nor the dramatic reversal from a low, and that is telling of the intent we should draw from its occurrence. I would also suggest the fundamental developments have little to do with this bounce as the headlines were far from the course correction for which markets have been waiting. It is not unusual to see headlines used to explain what is more likely a speculative rebalance. Nevertheless, it is important to qualify the weight behind the move as it will factor in heavily as to whether there is follow through.
Chart of S&P 500 and Size of Opening Gaps (Daily)
Chart Created Using TradingView Platform
A definitive reversal in the balance of fundamental outlook could certainly bolster the likes of US and global equities, emerging market assets, carry trade and more. Yet, on a day where headlines carried more warning than reassurance where their topic was of real importance, it is more reasonable to assume the move we have opened to is more a result of a speculative opportunism in complacency. If the established systemic risks are not escalating to greater proportion, then the anticipation of key event risk later in the week and the general observance of seasonal liquidity pressure naturally benefits short-term speculators. In other words, if your horizon is within a few days and the outlook for risk outweighs its present development, the drive to rebalance stretched risk positions is stronger than any reiteration of well-established risks already being priced into the markets. In short: speculative interests are taking conditions for granted but they have limited capacity to develop any new trends.
Evaluating the State of Trade Wars on the Post-Facto Market Activity
One of the three dominant fundamental themes constantly blipping on traders' radars, trade wars was deemed a support for market sentiment to open the week. Yet, I believe that is undue optimism afforded to the theme after the market earned its own balance. If we were to evaluate the headlines on this front Monday, there was little to latch onto. Supposedly, US President Donald Trump's remarks that "we are doing very well with China, and talking!" that earned so much market enthusiasm. That isn't particularly inspiring or informative. In the meantime, the Huawei situation is being strung along with some of the Chinese telecom's affiliates facing US ban. Further, Vice President Mike Pence's warning to China to respect the Hong Kong laws agreed to in the Sino-British joint declaration seemed to tie this critical diplomatic situation to trade relationships, creating an even more difficult situation to navigate.
Chart of USDCNH (Daily)
Chart Created Using TradingView Platform
The impact that trade wars are having on the global economy is a popular topic as it filters through traditional sentiment surveys and the market itself. This past session, a Bloomberg assessment assessed the uncertainty around this standoff could shave as much as 0.6 percentage points off of global GDP, equivalent to more than half a trillion dollars. It is also important to keep tabs on the status of the US-European relationship with France's digital tax encouraging large tech companies to essentially plea to the heavy-handed US government to interview - an opportunity for the White House to spread its trade fight to other regions. Expect this to be top topic at the Jackson Hole Symposium and G-7 leader summit at the end of the week.
Recession Fears Persist, Raising Expectations for Central Banks and Governments
If there is a single theme that we can assure will come up in the weekend gathering of monetary policy, business and investment leaders, it is the state of monetary policy and the economy with which it is attempting to influence. Over the weekend and into Monday, there was a swell in anticipation (I think more appropriately deemed 'hope') that global authorities are looking to answer growing fears of a global recession. It was reported that China was offering stealth stimulus by shifting more loans on a fixed rate to a Loan Prime Rate (LPR) which would supposedly ramp up lending. In Europe, the anticipation of another ECB stimulus wave was reinforced by speculation that Germany's Finance Ministry is ready to respond to a recession with a 50 billion euro stimulus.
The United States preparation is proving far less conventional and even outright confrontational. There was suggestion through the session that the White House was considering payroll tax cuts, but that was rejected by spokespeople. Meanwhile, the Trump administration recognizing the broad fears of an economic downturn is worrying about the election cycle. In turn, the pressure the President and his staff are leveraging on Chairman Powell and the FOMC is proving relentless. Trump would strain credulity when he suggested the economy was "very strong" but the central bank should cut rates 100 basis points and perhaps restart QE.
How Far Can You Discount Dollar, Euro and Pound Fundamentals?
There are a range of incredible risks/opportunities for the majors looking out over the horizon - developments which if realized could systemically change the course of currencies, capital markets and risk trends themselves. With that kind of extreme influence, can we truly expect the market to price in partially an outcome whereby its realization would translate into a move that would send us charging in the opposite direction to our current path? That is what I'm considering with the majors. The pressure between the White House and Federal Reserve is extreme with the credibility with one of the institutions on the line depending on what policies are enacted and what shape the economy takes. With that said, a 6-day rally for the DXY looks more than at-risk.
DXY Dollar Index and Consecutive Candle Count (Daily)
Chart Created Using TradingView Platform
Meanwhile, the Euro is facing an incredible amount of conviction from policy officials and market participants that another wave of policy support is coming. The reports of Germany's government ready to beat back a technical recession gave the DAX a jump but it does not exactly fully compensate for the unknown. For the Euro, the expectations for the ECB to restart stimulus and perhaps cut rates further into negative territory as soon as the next meeting in September carries serious weight - though its promise for the economy faces serious scrutiny.
And, then there is the Pound. We have seen a significant drop over the past three to five months which has put a pair like GBPUSD within reach of a more-than-three decade low and EURGBP at a multi-year high of its own. And yet, there is likely significant further depreciation that the Sterling would face if a 'no-deal' Brexit scenario were realized and financial cracks started to fan out in the UK markets. Over the weekend, a worst-case scenario paper was released from the previous administration's assessment that spoke to severe fallout for the country in the event that no solution was met. Michael Gove suggested that assessment was dated, but admitted the risk is still significant. Also headline news were reports that Prime Minister Boris Johnson was pushing the backstop issue which was not meet with much enthusiasm from EU President Tusk nor Taoiseach's Vardkar. We discuss all of this and more in today's Trading Video.
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