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Markets Morning - Tariffs, retaliation, and the threat of trade wars overhang markets

Market Analysis /
Greg McKenna / 01 Jun 2018

Welcome to my daily Markets Musings.

Feedback always welcome

Greg

Market Summary (7.44 am Friday June 1)

Welcome to the modern day Smoot Hawley folks.

Whereas earlier this week I characterised the Italian induced market turmoil as a result of the protagonists overplaying their hands the overnight news that the US is actually imposing tariffs on EU, Mexican, and EU goods AND that Canada and Mexico have already hit back is the result of pure calculation on behalf of the Trump Administration that the bully pulpit will work.  

And while markets overreacted to the Italian mess a couple of days back it strikes me they might be under-reacting to the real – distractive – negatives of this trade skirmish developing into a trade war. My guess is that many traders and investors see this as another negotiating tactic from the Trump Administration.

Wilbur Ross reckons this is just a family spat. But we are now genuinely faced with the type of tit-for-tat trade spat of which there will be few winners and which could materially impact global growth and relations.

That’s important for markets because it increases uncertainty. And uncertainty is poison for business, consumers, and ultimately markets.

But the washup is much more sanguine than it could have been.

The S&P 500 is down just 0.69%, 19 points, to 2,705. But it looks wobbly to me on the charts. The Dow is off 1%, 250 points, to 24,415 while the Nasdaq 100 fell just 0.15% to 6,965. In Europe, the target of the Administration’s ire, the DAX fell 1.4% to 12,604, the CAC dipped 0.5% and the FTSE did better with just a 0.15% loss.

That’s put the SPI under pressure with the June contract down at 6,009 again after a 7 point loss overnight.  Except for tech and utilities all sectors of the S&P 500 were down overnight. So the local selling could be broad-based. Watch the financials though some our big banks are right on support.

To forex now and even though EU inflation easily beat expectations with a 1.9% print the Euro has been unable to hold its highs around 1.1724. It’s back at 1.1690, up 0.25%. Sterling is largely unchanged at 1.3292 while the Yen has hardly moved as well – USDJPY is at 108.83.

The commodity bloc is mixed. The Canadian dollar is off 0.65% with USDCAD up at 1.2957 after the double whammy of the trade war and lowered chances of a BoC rate hike in July (Q1 GDP down to 1.3% annualised) hit the CAD. The Kiwi is up 0.15% to 0.6997 while the Aussie sits at 0.7563 after a high of 0.7593. Yesterday’s CapEx and the risk off tone that might (should) result from this escalation in trade tensions are likely to continue to see the Aussie capped below the range top.

On commodity markets it was again a tale of two markets as the Brent/WTI spread blew out again overnight. WTI fell 1.82% to $66.97 despite crude stocks drawing down more than expected. Brent on the other hand is up marginally at $77.59. Gold is still becalmed at $1298, Bitcoin is up 3% to $7551 – is it time for a big surge with all this messiness in “conventional” markets and economics? Copper is down marginally at $3.057 a pound.     

Also worth noting this morning, Italy looks like it has a new government and Italian bond rates have surged lower, President Trump downplayed the chance of a quick breakthrough at the North Korea summit, and US data was strong enough for the Atlanta Fed to upgrade their Q2 GDP NowCast to 4.7% annualised. NOT A TYPO.

And as we slide toward the weekend and non-farm payrolls in the US tonight (188k exp, UE 3.9%, Hrly Earn 0.2%) we also have a raft of global manufacturing PMI’s to kick off the month in Asia and Europe. Of note here at home is the AiGroup for Australia but of more import might be the Caixin Mfg PMI in China. As well as non-farms in the US the ISM PMI will be important as well.

Have a great day and weekend.  

Here's What I Picked Up (with a little more detail and a few charts)

International

  • I have wanted to write this for ages but have been uncomfortable with being misinterpreted. So let me be clear upfront, what I am about to write is about history not personalities. Here we go. Has president Trump, his Administration, and his operatives, learned nothing from the history of Napoleon and Hitler? If you open up too many battles on too many fronts you get stretched. Now, of course, like these leaders before him President Trump has supreme confidence in himself and his leadership – especially I’m betting Wilbur Ross. But right now he’s fighting with allies, he’s still arguing with China, he’s trying to get a deal with North Korea while at the same time having walked away from one with Iran. And of course he’s battling Robert Mueller’s probe and the Democrats as we head toward the mid-terms in November.
  • To reiterate, this is not to compare President Trump with those aforementioned leaders who spread themselves too thin. But to simply highlight that for some time I have been worried President Trump will open up too many fronts and end up causing a real trade battle which impacts global growth and the markets. Maybe he’ll end up being spectacularly successful but at some point folks don’t feel like they have a choice and stand up to a bully. Canadian prime minister Justin Trudeau may have just been the one to stick his head out the window and scream “I’m mad as hell and not going to take this anymore” (for the younger readers that’s from a movie called Network and the funny thing is if you watch this clip you will understand how the UK voted for Brexit, how Trump won the 2016 Presidential election, and how Italy ended up with these seemingly opposite parties forming government ).
  • Anyway, hopefully in that clip, and in my idea the President might be picking too many battles all at once you can see both why he is doing what he’s doing – he genuinely is trying to fulfil his campaign promises – and where it could all go awry. I’ll pose myself the usual question. Why does this matter in a daily note?  It matters because uncertainty is poison for business investment, for consumer spending, and ultimately for markets. We aren’t there yet. But the risks are rising.
  • The President clearly believes he’s on the right path though.
Source: Twitter Screenshot
Source: Twitter Screenshot
  • It’s non-farms night tonight. That means we get the release of the single most important data point released each month. The markets are expecting another strong number with a solid 188,000 print and an unemployment rate of 3.9%. If the forecasters are correct it could have a big impact on the recent market moves because it is likely to reinforce that the US economy stands as a bastion of strength and the Fed – as Lael Brainard said last night – is still on track to raise rates twice, perhaps 3 more times, this year. That would put some pressure on the Euro and US bond market rally. Something to watch this evening.  
  • Italy has now formed a government. Conte is the PM and the previously nominated finance minister is now the foreign minister. SO we’ll see how things progress from here. But it’s clear for the moment the coalition partners decided it as better to stick with the mandates they have than seek fresh elections and the potential wrath of voters. Equally, as I wote a couple of days back, they also simply realised they’d overplayed their hand and backtracked fairly promptly.

Australia

  • A down day and an inside day suggest the local stock market remains under a little pressure. In the past hour or so the SPI 200 has gained 8 or 9 points but it seems that the break up of the US market moves and some tenuously placed big cp individual stocks could see the ASX 200 under a little more pressure than the now down 7 points suggests.
Click on me, I'll expand
Click on me, I'll expand
  • The Australian dollar has done okay given the weakness in stocks and the disappointing CapEx data yesterday. In no small part that is because the US dollar is under a little pressure given it’s not obvious that it should necessarily benefit in a trade war. Certainly from a growth point of view it’s possible that the US stock market looks a little better if the global companies from offshore are impacted. But it’s equally true the S&P 500 is as much a global index as it is a domestic one given where a large number of the big companies trade. So far the fight is over steel, aluminium, and cars. If it deteriorates further perhaps that’s what might really hurt the Aussie and risk assets.
  • For the moment though it is still trading in the 0.7410/0.7610 range. The overnight high of 0.7593 was unsustainable after 12 hours of trying to break through while the 0.7550 region looks like impotant support if I look at the past days trade on the 4 hour charts. The daily candle is indecisive so a move below 50 would accelerate while a topside break likely needs a much weaker USD to push higher.  

Forex

  • Time for a rest? That’s the question now that the USD has essentially achieved the target I set ages ago of a move to 95.20. You can see the weekly chart here.  
Source: Investing.com
Source: Investing.com
  • It’s a reasonable question that many are asking, especially the Elliott Wave crowd who – like me – are looking for a reversal of the recent USD strength, Euro weakness, before the next leg higher for the dollar. Fundamentally,  the trade war complicates the outlook somewhat. On the face of it, given momentum, such a battle likely favours the dollar because of the momentum already built up in the US economy at a time Europe seems to be slipping a little. That then will inform the expected moves from the ECB and the Fed which in turn should again feedback into US dollar support.
  • Whether or not that’s how things play out in the short term is the question though. Sentiment is a difficult thing sometimes and as we’ve seen with periods when the North Korean issue has been top of traders mind the USD hasn’t necessarily been the beneficiary. Yen? Yes. USD, not necessarily.
  • So I need to cogitate on this. To try to see if the combination of a technical level achieved, a rise in uncertainty, and some very large moves recently means the turn is in for the USD. Or, alternatively, if the uncertainty we are seeing manifest in the 1.4% fall in the DAX last night is indicative of heightened concerns about the European growth and markets outlook. That would then suggest a higher USD. Interesting times.
  • For me the key is EURUSD 1.1730ish in the short term. You can see why in the chart below.
Click on me, I'll expand
Click on me, I'll expand

Commodities

  • The response function to higher prices is always expected to come first and fastest from Saudi Arabia. And there are certainly logistical issues getting some areas of US supply to market. But the EIA announced last night that US oil output jumped to a record 10.47 million bpd in March. It’s likely grown further from there. Indeed a recent paper from the St Louis Fed showed how the reaction function of US producers is influenced by price. So perhaps like last week we’ll see a bigger lift in Baker Hughes rigs than expected.
  • Al that is background on trying to explain why WTI fell but Brent was steady. In effect the issue is that supply keeps coming but transport and refining capacity may be lacking leading to a turn around in inventories – or at least that’s my short hand of an explanation. Anyway that’s driving WTI back toward important support. It has to hold the recent low around $65.75 or this might just be the latest pain trade to unwind.
Click on me, I'll expand
Click on me, I'll expand

Have a great day's trading.

Greg McKenna

Chief Market Strategist

gregmckenna.com.au

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