Trade War Talking Points:
- The Sterling and FTSE 100 rallied after the UK election results but a week-end retreat suggests unwanted scrutiny
- Risk trends are most at-risk from a trade war 'breakthrough' failing to gain traction while the market is watching
- Growth will be a concentrated fundamental theme this week but liquidity will certainly play the largest overall role in activity
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Risk Trends That Rise on Hope and Stall on Headlines?
Though there can always be just a little more fundamental support to rouse for the markets, the mix of developments we were met with to close out this past week was about as good as we have seen in some months. Between the Fed sticking its policy landing, Europe seemingly back on course for its divorce from the UK and the US-China trade spat finally finding some relief; there was finally some tangible support for a long-intangible risk run. We have seen an impressive optimism in broad sentiment through the past month with a particular enthusiasm for some benchmarks like the S&P 500 which has steadily climbed through the year. The foundation of this bullishness has conveniently shifted from green shoots to trade hopes to monetary policy support to suit an underlying bias. That said, the progress always seemed to hold more traction in anticipation than actual development; so it was a theoretically ideal scenario to translate last week's headlines into fuel to an already impressive fire.
Chart of S&P 500 with 20-Day and 200-Day Moving Average (Daily)
Chart Created with IG Charts
What we ultimately ended up with on Friday, however, was not a ringing endorsement for a robust systemic trend - much less the charge necessary to overcome the fade in liquidity we are facing over these final weeks of dimmed liquidity ahead. The S&P 500 and Dow managed to tag record intraday highs Friday, but there was very little of the follow through that would be expected from such a fundamental run. Implied (expected) fear would drop according to measures like the VIX, but the lowered hurdle didn't seem to inspire a rapid build up in exposure. Further, the qualitative valuation of 'risk appetite' that would see speculative assets running at a relative discount to the high-flying US indices came up short as well. There were gaps lower in the ratios of the S&P 500-to-VEU (rest of world equities) and S&P 500-to-EEM (emerging market ETF) but certainly none of the follow through. Perhaps that comes in the week ahead, but the lack of momentum from all corners is concerning.
Chart of the Ratio of S&P 500 to EEM Overlaid with the EEM in Blue (Daily)
Chart Created with TradingView Platform
The Trouble with the Trade War Breakthrough
When evaluating the biggest headline for global risk trends, most will point to the US-China trade war news. However, I would say that it is important to appreciate the implications of the UK election and the Fed decision. The former is not a preference from the international market for a party or candidate over the others but rather an exhaustion of the uncertainty around the Brexit and the threat it poses to Europe. The Fed decision is perhaps even more remarkable. That may seem an unusual assessment, but consider: the Fed cut three consecutive meetings to show that it was prepared to act and had more room than its major counterparts, while it left us December with an evaluation that its assessment of the outlook was smooth as glass (never mind the repo market). When forward guidance is the most often used tool, this is 'sticking the landing'.
Chart of DXY Dollar Index and Expected Range Change Between Dec 2019 and 2020 (Daily)
Chart Created with TradingView Platform
As for the trade war headline, this is where the bulk of the interest rested while also managing to draw the greatest number of troubling details. One point that is a definitive improvement of our circumstances was the avoidance of the scheduled December 15 escalation in the United States tariff list on Chinese imports. That would have been a painful escalation of the trade war for a market that is increasingly aware of the economic tab. Averting an escalation on a theme like trade wars is not the same thing as reversing course on the steadily building risk. On that front, US officials reported that the two sides agreed to reduce the tariff rate on the $120 billion in new products under import tax from September from 15 to 7.5 percent. That is a tangible improvement. Yet, is it enough? The 25 percent tax on the previous $250 billion in goods was still in place as an incentive for Phase 2, which President Trump suggested could wait until after the election. Furthermore, the amount of agricultural purchases by China, enforcement procedures, FX monitoring and whether China views the agreement as expectable remain unclear. With USDCNH's reversal, it seems this issue was not being conveniently overlooked.
Chart of USDCNH and 1-Day Rate of Change (Daily)
Chart Created with IG Charts
Sterling's Brexit Honeymoon After UK Election Already Over?
Though not as severe as the Yuan or AUDUSD's course reversal, there was a similar swing in conviction from the British Pound. The Thursday evening polls from the UK election made clear early in the exit polls that Prime Minister Boris Johnson's Conservatives had secured a large majority in Parliament. The PM's party won 365 seats for their best showing since Thatcher while Labour dropped back to a more than 80-year low 203 seats. That clears the way for a Brexit policy from the UK after years of Parliament acting as a foil to the Government. The Sterling in turn rallied on the news, not because there is a preference for a party but because there was finally a clear negotiation stance from the UK from the more than three-year year divorce proceedings. The Pound rallied sharply after the move, but notably backed off its Friday highs. Further, there was little outperformance for the FTSE 100 relative to other global indices.
Chart of GBPUSD (Daily)
Chart Created with IG Charts
| Change in | Longs | Shorts | OI |
| Daily | -3% | 7% | 3% |
| Weekly | -15% | 34% | 10% |
There is perhaps further Sterling discount that could be worked off moving forward so long as a clear plan is laid out with steps towards the separation from the EU. That said, the general lack of enthusiasm for regional - much less global - capital market enthusiasm raises some worry. There is a long path of negotiation and uncertainly still ahead for the Brexit without much time to hammer out the kind of trade deal that normally takes many years to reach. The market could have chosen to defer those details and just run with the week's developments, but that doesn't seem to have been the case. Again, is that a reflection on the weight of Brexit or wearing of risk trends?
Growth May Prove a Better Catalyst for FX Than Broader Risk Trends
In the week ahead, we are very clearly wading through the final week of full liquidity of the year (and decade). That comes with very clear expectations. While there are rumbles in speculative conviction, living out a full bullish or bearish actualization will prove very difficult to achieve with the knowledge that we are very unlikely to muster follow through in the subsequent two weeks. That defining feature of our landscape should be the first thing we consider in our analysis through the rest of December.
As for themes, the influence of the trade war progress will be at the front of my mind. If there is heavy financial media coverage of the deal struck and the lack of details, it will inevitably draw greater attention to any lack of speculative conviction in the news' wake. Outside of this bias evaluation, growth will play a meaningful role in fundamental evaluation early this week. The flash December PMIs for Australia, Japan, Eurozone, UK and US are all due Monday. It is possible that these figures could collectively move the global sentiment needle, but that would require a significant measure of confluence between the figure either towards easing or improving - a lot to ask. Instead I will be watching the relative health figures as a possible motivation for more liquid FX markets and pairs like EURUSD which have exhibited more deference for this theme in the recent past.
Chart of EURUSD (Daily)
Chart Created with IG Charts
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