Trade War Risk: A Not So Subtle Reminder

Stephen Innes

Thu, Oct 31, 2019, 11:14 PM

The post FOMC price action has consisted of four moving parts. 1)The coming to terms that the Fed was dovish in that 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 market 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. Whatever your take is on 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 told reporters ( Oct 11, 2019) Whitehouse Briefings

The article proved a not too subtle reminder of how quickly trade war sentiment can pivot and highlighting 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 detente, the thorny H.K. protest bill.

Also, worth mentioning is China’s continued efforts to move away from the US dollar, something that is 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. As well, 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 absolute horrible category. In China, it was the slow, recovery in domestic demand 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 which 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 policy reasoning that is going to come back to bite them as the current run of U.S. economic data suggest. 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 it means more pressure on them to consider defensive measures but where the woodshed lies empty.

But when market headlines become over-politicised, the 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 trader continue stalking the most vulnerable links the chain.

Concerns about the US-China trade dispute have come home to roost which now calls into question, not on the timeline but if 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 as its the macro data, which might very well be the most significant obstacle to a recovery in oil.

And with trader 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

I think all the above in my morning note supports the idea that gold should always be a part of everyone’s portfolio.

Weak economic data in the U.S. and around the globe brings back golds glittering appeal as the borderline recessionary Chicago PMI prints give rise to the notion that the Feds 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. The waning Chinese economy 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 more than prepared to ride out this storm as China looks both regional and inwards to insulate itself from global risk.

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.