Recession Talking Points:
- Despite the build up of enthusiasm around US-Chinese relations on a 'phase one' deal in their trade war, there was no follow through Monday
- While trade conflicts' influence on economic activity will remain a key theme, top scheduled theme ahead is growth (recession?) fears
- The IMF's WEO is likely to lower its forecast for global growth, but has that been priced in or will it dim the market's bias further?
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The US-China Trade War 'Breakthrough' Draws Ambiguity, Loses Market Momentum
Traders were left with a cliff hanger to chew on over the weekend: would the swell in risk appetite that charged enthusiasm through the final 48 hours of the past week carry over into the new period? At least this time the uncertainty was between speculative coasting or outright optimism. The rise in confidence among investors was founded on anticipation for an overdue breakthrough in the ever-escalating trading war between the United States and China - the two largest economies. There was indeed a 'phase one' deal announced, but the terms were not black and white. China committed to $40-50 billion in annual farm product purchases and the US deferred the tariff rate increase on $250 billion in Chinese imports from 25 to 30 percent that was due to go into effect Tuesday. After that, the conditions were more amorphous: review of entities list, review of FX manipulator status, consideration of enforcement on Chinese competition. This was as much officials' enthusiasm as inked treaties. And, the last-minute announcement Friday evening didn't make the situation any clearer. I polled traders over the weekend to see how they believed the markets would open this week, and the mixed view was indicative of what we actually experienced.
Speculative bias can be a fickle thing. If the markets were already genuinely enthusiastic, the news early Friday evening New York could have leveraged considerable speculative momentum. Yet, that has not been the general setting of the markets these past months. Skepticism has reigned - whether that is resistance to fully giving over to another run towards record highs or finally collapsing under the weight of misaligned value. It is therefore not surprising that we opened this new trading week with little of the drive that we had enjoyed late last week. In fact, the S&P 500 carved out one of the least committed technical pictures possible with a doji, an inside day (range within the previous day's range) and one of the smallest daily ranges we've seen this year. Lest we believe this is just an affliction of this particular index or US equities in general, we see the same reticence and even modest pullback across most risk leaning assets. I believe this is more a reflection of the market's lack of conviction; but for the trade situation, there is good reason to remain skeptical with the US keeping the December 15 tariff upgrade threats in place, China voicing concerns and recollection of the June agreement and collapse.
Chart of S&P 500 and 1-Day True Range (Daily)
Chart Created on Tradingview Platform
A Focus on Growth and the Bias it Can Create
Moving forward into the week, trade conditions will maintain a critical fundamental status as systemic market moving theme. Yet, we will likely struggle for the critical insight that can offer the definitive outlook that the market is seeking to establish conviction one way or the other. We should keep tabs on the headlines as US officials are due to continue negotiations in Beijing to evaluate the mood (particularly if there is movement on the December 15th tariff plans) and there will be some relevant data to monitor in the meantime. This past session, the Chinese August trade balance for example showed an increase in the surplus ($34.75 billion to $39.65 billion) that was deemed detrimental as it was the product of a -3.2 percent drop in exports and -8.5 percent decline in imports. Yet, this lacks the heft that the market is looking for. We are more likely to get that on another key theme: growth. In fact, the Chinese trade report reflects poorly on the economic assessment of the world's second largest economy and adds to worry over the 3Q GDP the country is due to issue Friday. Other growth-centric data of note this past session included Eurozone industrial production (-2.8 percent) and a series of Bloomberg-based economist surveys (Germany 3Q growth forecast slipped from 0.0 to -0.1 percent) which continues to add to EU recession fears. This is absorbing into the collective evaluation for now, but full market impact awaits a shift in bias and commitment.
We will see that full evaluation of economic health and its speculative implications put to the test through the upcoming session. We are due a global overview of economic health from the IMF's World Economic Outlook (WEO). This semi-annual report is uneven in its market impact historically, but the level of aloofness is directly proportional to the general state of complacency in the system. At present, the markets may be unwilling to commit wholeheartedly to risk on or risk off, but they are certainly taking in the critical updates as they are coming across the wires. And, if anything, their reticence to run on the trade wars news suggests there is some bias against following risk appetite. Given the new IMF director's warning recently, it is very likely that the update is towards weaker growth. Director Georgieva said the outlook was for the worst pace of growth in a decade. The question is how much has the market discounted? Are the warnings issued by this institution and others to this point baked into the market's current bearings or is there a critical mass that will see this ship capsize?
Chart of the US 10-Year to 3-Month Treasury Yield Curve (Monthly)
Chart Created on Tradingview Platform
Monetary Policy, Brexit and Targeted Event Risk to Watch
Outside of the top two themes dominating the headlines, we can't afford to lose sight of other critical matters in this otherwise fragile environment for speculative appetite. Monetary policy for example grows in importance as the risk to growth and market performance will raise the need for alternative sources of stability. The most ubiquitous of those sources these past few years has been monetary policy. BOE Deputy Governor Cunliffe touched upon the big-picture of monetary policy as an unreliable rudder for growth this past session when he remarked that the persistent low rate environment risks making economic downturns more severe. I will be looking for more of this big-picture insight versus the more targeted regional implications from the BOJ Governor's bank branch managers talk, the RBA minutes, the BOE Governor's testimony to Parliament and Fed member Bullard’s remarks ahead.
For more concentrated fundamental influence, another political-economic relationship on the fritz is the UK's divorce negotiations with the European Union. Reflecting a similar enthusiasm for breakthrough potential to the US-China situation, we ended this past week with an enormous swell in hope for a genuine Brexit deal. Yet, where the US-China situation was confirmed to some extent by officials recounting the 'phase one' deal, we are still running on anticipation when it comes to the United Kingdom's negotiations. After the biggest two-day rally in GBPUSD in over a decade, the bar is set exceptionally high to earn follow through. It is therefore no surprise that the Sterling throttled its pace Monday without a definitive mile marker on trade.
Chart of GBPUSD with 2-Day Rate of Change (Daily)
Chart Created on Tradingview Platform
There are a few other events that I think are worth watching for their local economic implications - and potential volatility. The Euro's actions recently suggest it is more a counterpart to more troubled benchmarks like the Dollar, Pound and Yen (as risk); but I will be watching its response to the Eurozone and German investor sentiment data on the docket for Tuesday. Perhaps the most local but loaded listings on tap is the New Zealand 3Q CPI update. If inflation is particularly weak, it would push the RBNZ to ease more quickly and further undermine the currency's general role amongst the global majors. Alternatively, inflation pressures could give the Kiwi some balance specifically with crosses like AUDNZD and NZDCAD where 'risk' and trade are not as complicating.
Chart of AUDNZD (Daily)
Chart Created on Tradingview Platform
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