Trade War Risk: A Not So Subtle Reminder

Market Analysis /
Stephen Innes / 01 Nov 2019

U.S. stocks fell as weak manufacturing data and renewed concern on trade rattled markets.

S&P M5 Chart, Source: AxiTrader
S&P M5 Chart, Source: AxiTrader

The post FOMC price action has consisted of four moving parts:

  1. The coming to terms that the Fed was dovish in a sense of withdrawing any remaining market delusion about a conceivable path to interest rate normalization
  2. The China phase 2 of the trade deal will be hard
  3. Macroeconomic data continues to sour, and
  4. Pessimism that the Fed really knows much more than the hive-minded sagacity of the markets on the growth outlook. 

In actuality the market had not priced any Fed hikes, but the FOMC shift to inflation-based forward guidance all but guarantees the Fed's next move is a cut, suggesting the Fed is not straying too far away from the rate cut button. But it also indicates that traders are now in an asymmetrical mode as rates markets turn fearless of the robust data to a large degree while bearing down heavy on the weaker data prints.

Uncertainty about the state of the US-China trade deal has weighed on sentiment. An article by Bloomberg reports scepticism among Chinese officials about whether a comprehensive, long-term trade deal with the U.S. might be attainable. Take what you will from the Prasad says (Cornell academic)–Zhuo says (former Ministry of Commerce official) article which was dotted with dated Vice Premier Liu He quotes; "We very much agree that to get the China-U.S. economic relationship right, it's something that is good for China, for the United States, and the whole world and we are making much progress toward a positive direction," Liu had told reporters on October 11 (Whitehouse Briefings).

The article proved a not-too-subtle reminder of how quickly trade war sentiment can pivot and highlighted those fears that we all knew about but were perhaps was too wrapped up the phase one euphoria to recognise. Specifically, the trust gap is the bridge too far and what’s going on behind the shiny veneer of an apparent trade détente: the thorny H.K. protest bill. 

The real litmus test for risk sentiment was always going to be Phase 2, given the soft peddled nature of the Phase 1 deal. While bridging the trust gap has been a constant thorn, the real issue today is increased tension over developments in the U.S. Congress related to the H.K. bills, arguably the main downside risk to the phase 2 deal, and this has me worried.

Also worth mentioning is China's continued effort to move away from the US dollar, something that’s not getting enough airtime in the context of trade wars. China aims to raise EUR4bn in the first EUR denominated sovereign bond issuance in 15 years as it seeks to diversify away from U.S. markets as China continues to wean itself off a dependence on U.S. capital markets. The Chinese financial markets are opening to foreign capital to undercut the USD hegemony and perhaps undermine America's greatest strength in the trade war, the flow of money through U.S. financial markets. In addition, there have been efforts to promote futures trade in RMB as well as opening brokerage houses to foreign capital.

Two key macro prints overnight fit in the absolutely horrible category. In China it was the slow, recovery in domestic demand tha continued to weigh on the manufacturing sector. In the U.S. the Chicago PMI was weaker in October, down 3.9pts to 43.2 – the lowest reading since December 2015 where similar low watermarks in the past have coincided with recession. This data does not paint a very rosy picture and I feel sorry for anyone that bought into the Fed's rosy economic smokescreen. 

The Fed debate was a hawkish argument of a strong economy compared to the dovish view of what it thought it knew: likely economic damage from tariffs. And if it was merely the subtle shift in US-China trade war that caused them to sit on their hands, it’s this type of policy reasoning that’s going to come back to bite them as the current run of U.S. economic data suggests. Fortunately for the Fed, they still have a few logs to throw on the flaming out US economic fire, however the problem for other central banks such as the ECB and BoJ is increased pressure to consider defensive measures but the woodshed lies empty.

But when market headlines become over-politicised, risk becomes unquantifiable and therefore untradeable with any degree of accuracy.


Oil markets

I don't even know where to start as it's been a gruelling 24 hours across growth assets where oil markets are seemingly bearing the brunt of the market angst as cross-asset traders continue stalking the most vulnerable links the chain. 

WTI M5 Chart, Source: AxiTrader
WTI M5 Chart, Source: AxiTrader

Concerns about the US-China trade dispute have come home to roost which now calls into question not only the timeline but the phase 2 trade deal, which contains the macro meat of the matter. But will discussion even see the light of day?

Framing this doom and gloom view is the massive U.S. inventory build and the horrendous economic data released over the past 24 hours. It’s the macro data which might very well be the most significant obstacle to a recovery in oil.

And with traders possibly positioning for weekend headline risk it could be another taxing day for oil markets, although one would assume that the latest sell-off provides more incentive for OPEC and OPEC+ to cut production further. 


Gold Markets  

Weak economic data in the U.S. and around the globe brings back gold’s glittering appeal as the borderline recessionary Chicago PMI prints give rise to the notion of the Fed’s transition from a mid-cycle view to a full-cycle look. In other words, the Fed may need to cut interest rates more aggressively than the market currently has priced. 

And in China, where the economy continues to downshift and the risk remains tilted to the downside, it could trigger a more acute than expected global downturn. But the big issue is that, unlike the Fed who will ride into the rescue, the PBoC will be reticent to turn on the monetary taps and is more than prepared to ride out this storm as China looks both regionally and inwards to insulate itself from global risk. 

XAUUSD M5 Chart, Source: AxiTrader
XAUUSD M5 Chart, Source: AxiTrader

The China factor for gold (from my weekly gold market outlook Oct 29,2019)

While the FOMC is in focus this week, it's hard to ignore the Chinese economy is facing substantial downward pressure which is expected to continue in Q4 2019 and 2020. Third-quarter exports remained weak while imports weakened further and, when stripping out pork prices, CPI inflation is showing deflationary pressure while PPI is already there.

China's economic slowdown and their ongoing deleveraging campaign will create a monster downshift for the global economy, but more worrisome for Asia risk sentiment is the economic headwinds will put significant downside pressure on the RMB over the next 6-12 months. As we've seen so often in the past, the stronger USDCNH will act as a wrecking ball across Asia's capital markets.

There's a possible reason why central banks are backing the truck up on gold, and it's not because the Fed is about to cut interest rates, or the dollar is expected to weaken. It might be because they think the world is on the verge of an impending recession.


Currency Markets 

Outside of the risk-sensitive USDJPY which slipped 60+ pips overnight on the Bloomberg report on the US-China talks, there’s not a whole lot to go on.

USDJPY M15 Chart, Source: AxiTrader
USDJPY M15 Chart, Source: AxiTrader

Read more articles from Stephen Innes:

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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