Volatility Talking Points:
- A dive into the closing hours of the week/month/season sent EURUSD below 1.1000 which made President Trump's Dollar lament predictable
- The US President would also call out automaker GM and businesses warning of a tariff impact 'weak', showing a commitment to trade wars
- With September comes a seasonal shift for risk asset performance and volatility - a troubling norm with such systemic fundamental risks
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Bring the Volatility: Seasonality Can Help and Hurt
With Friday's close, we have brought to close week, month and season. It is that seasonal traditional that most interests me as a trader, as historically there is a statistically relevant probability that we can expect a substantial change in market activity over the coming weeks. Referring back to the seasonality charts I've reflected upon often recently, the month of August is one of the most 'quiet' trading periods of the year on average while September is the polar contrast. From the VIX volatility index, since its inception in 1990, we find the activity measure typically crests through the months of September and October (the latter is slightly higher in its average). From my favorite (flawed) measure of sentiment, the S&P 500, we find its trading-day adjusted volume is at its lowest point in the year through August and starts to turn higher in September. Far more interesting though is the average performance for the index through the year as it is the only calendar month that has averaged a loss back to 1980. In short, we are in for a shift.
With that big picture sufficiently impressed in our minds, let's consider in practical terms. The change in activity levels will not flip to inactive to extreme swings as if a switch has been flipped when the markets reopen. It will likely still take some time as liquidity slowly filters back online for the 'fall trading' norms. That can certainly be hastened by unexpected and systemically-important fundamental developments however. Monday in particular will be reticent to extreme market movements as the US will be offline for the Labor Day holiday. While only one country, the speculative clout of the US tends to break the continuity in building pressure. Yet, inevitably, liquidity will deepen and complacency will be more difficult to afford. With such extraordinary and recognizable fundamental risk pressuring the markets, adding fuel and drawing attention to the inequities can more readily break the fragile calm we've depended upon for months.
Recession Fears Continue to Gain Traction and its Measures, Prominence
As we head into September trade, the fundamental risks that have until-now been played down will engender a closer scrutiny. One of the most systemic discrepancies is the wide divergence between the performance of capital market benchmarks and the very tepid pace of growth for the global economy. The world and its largest members continue to register a progressive throttle of expansion that threatens to tip us into stall speed. That alone is problematic, but the situation is compounded by the recognition that these misaligned measures of health have been driven far beyond their traditional measures of value with considerable dependency placed upon extraordinary, external support measures that are usually reserved for fighting economic and financial crises. As such, the markets are starting from leveraged heights and the safety net looks like it is only painted on the ground. A recession, in this case, will be more than a recession.
There are a range of economic measures from which we can assess actual health over the coming week. The top line figures are more likely to register but if recession fears are acute, even secondary figures will be interpreted for their GDP impact. This past week ended with Indian and Canadian 2Q updates while Italy revised lower its own reading. Over the coming week, we are due China PMI figures for August (Government reading), the US ISM service sector activity report (responsible for three-quarters of the country's output), Australia and Switzerland GDP. None of these indicators would be considered systemically important individually, but it is the context that matters most. It is in this uncertainty but heightened attention that we have seen measures like the Yield curve inversion take greater prominence. The 2-10 (year Treasury Yield) and 3-10 (month to year) closed this past week in negative territory. In fact, the 10-year yield posted one of its largest monthly declines on record through the just-closed August.
Chart of US 10-Year Treasury Yield and Rate of Change (Monthly)
Chart creating using the TradingView Platform
President Trump Playing Down Trade War Pains and Leveraging Critique of Fed, American Businesses
As recession concerns deepen, the pressures pushing the world towards an economic stall earn a closer focus. There are 'natural' influences at work - the maturation of a decade-long market run and similar economic expansion. Then there are the unnatural influences. The trade wars are registering as a deeper pain to for investors and businesses around the world. Consumers it seemed, particularly in the US, have proven one of the remaining holdouts to trouble. The downward revision of the University of Michigan's sentiment survey this past Friday though to a six-year low and significant drop in favorable reference to government economic policies shows something is amiss.
A policy that is throttling the global contribution that trade pays to expansion is not something the White House seems willing to give up on however. Recall President Trump suggested that a 'brief' recession should perhaps be tolerated in the US in order to fore change in an uncompetitive China. There are no short recessions in the scale that the President has suggested (a few months) as the technical definition is two consecutive quarters. To end this past week, we saw Trump again call out a major US company (GM) for not supporting his trade war and moving his operations out of China. He went even further by suggesting companies that have reported in their earnings and guidance that tariffs would be a burden on performance are "weak" and "badly run".
And, of course, the most frequent accusation for economic trouble that is redirected from trade wars of late is levied at the Federal Reserve. The President has accused the Fed of creating economic problems on an almost literal, daily basis. His interests to prod the central bank to cut rates seem less interested to generate expansion through the availability of cheaper funds - the traditional outlet - and moreso a means to devalue the currency - notably a development that would benefit the projection of trade wars. Far too much dependency is placed at the feet of the US and global central banks, not just political leaders but the market and economy at large. What happens when their efforts are deemed insufficient to keep up the market's pace?
The Importance of Dollar and Euro Versus Volatility of 'Aussie' and 'Loonie'
Looking ahead to the forthcoming week, the FX market will be tracking out systemic influences as well as targeted volatility issues. On the former matter, there are few more important currencies than the Dollar and Euro. Though much of the attention via trade wars has fixated on USDCNH (and for good reason), the truly exceptional upheaval in financial stability will likely be found in the world's most liquid currency pair: EURUSD. There is not yet an outright trade fight between these two regions, but the risk of manipulation of the first and second most liquid currency in the world is occasion for serious concern. Some (including Trump) may consider ECB preparation for another wave of stimulus an artificial measure to drive its currency lower. Outright calls for the Fed to lower rates in order to affect a Dollar slide from the President however are far more explicit. If he takes matters into his own hands, it would be far more provocative.
Chart of EURUSD (Daily)
Chart creating using the TradingView Platform
For concentrated event risk, there are a host of key events on tap that can generate serious reaction from very certain areas of the market and particular currencies. I am particularly interested in the two key central bank rate decisions on tap for the coming week: the Reserve Bank of Australia (RBA) and Bank of Canada (BOC) meetings. There is a significant level of speculation of cuts for both. The impact of easing for both would be severe, but temperance from the former will be met with a more significant rebalancing of a depressed currency.
Chart of AUDUSD (Daily)
Chart creating using the TradingView Platform
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