One way or another Trump will get his 100bp cut from the Fed, although, we are yet to see a strong deterioration in US inflation expectations to really get the Fed on board. That said, broad financial market volatility has ramped up, and financial conditions are tightening, and that is smack bang on the Fed’s radar. The markets are playing a key role in pushing central banks to get ahead of pricing and Trump feels he is in control of this dynamic.
Asia reacting to Friday’s news flow
It was a session of high drama on Friday and the timeline of events I have laid out here, where I have plotted the catalysts behind price moves, against the number of cuts priced (from the Fed) in through the year. The wash-up after today’s re-open is a market now pricing a 33% chance of a 50bp cut in September FOMC meeting - a debate St Louis Fed president, James Bullard, sees as a real possibility.
There is an ever-growing belief that Trump has no fear of risk assets declining and the market feels vulnerable. The fact that many are now seeing the division between Xi and Trump as something more sinister than just a trade war has seen calls for a global recession increase. With calls that what we are see unravelling is more of an economic war, and while the further 5ppt increase in tariffs will not help the perception of growth and US consumption, the concern traders have here is whether this even opens the top level of tariffs to over, say 50%.
The new news that has clearly resonated is the increased restriction on the corporate landscape and how corporations do business going forward. By that I mean, Trumps calls for US businesses to pull out of China, and how that could impact their sales and net interest margins. We are even hearing, at a worst-case-scenario, that the US could restrict China’s access to the financial markets and that is a genuinely scary proposition.
I’ve argued that Fed policy is about 50bp above the markets perceived long-term neutral rate, and the market knows that this is a Fed well behind market pricing and again this just adds to the vulnerabilities. The nine rate hikes and $730b in balance sheet normalisation has come to roost and traders are talking about liquidity issues this week, with a USD shortage adding to the concern.
A poor liquidity environment is adding to the worries and could be a headwind through markets this week.
Asia-based traders have had their chance to react this morning and it's not overly pretty. S&P 500 and Nasdaq 100 futures are lower by 0.5% apiece, although both have come well off the earlier lows. One chart I’ve got on the radar is the Russell 2000 (small cap index), where futures suggest the cash market opens just below strong horizontal support.
Asian equities have been hit hard, led by the Hang Seng, which has declined by 2.7%. That said the Nikkei 225 is not far behind with a decline of 2.2%, while the ASX 200 and CSI 300 are 1.3% and 1.4% lower respectively.
FX vols have pushed higher, with traders piling into the JPY as the default hedge against all the protectionism, with USDJPY getting a real working over. Here we saw the pair momentarily taking out the January flash-crash lows and into the weakest levels since November 2016, although buyers have seen the pair regain the 105-handle. The defence of these lows is interesting, but for how long?
Gold has also worked well, finding buyers in all G10 currencies, with a new record high in AUD terms (XAUAUD). The fact we are seeing bond markets finding even further love is key here, with the United States 10-Year Treasury -5bp on the re-open to 1.48% and the lowest since 2016. If we inflation-adjust the benchmark Treasury, we see the ‘real’ yield now at negative 5bp and again, gold will always work well in that environment. The trend is your friend here, but let’s see if the breakout can hold.
USD/CNH has seen limited client flow, but there’s a lot of focus on the pair, given the break to new highs. Importantly, the PBoC fixed the USD/CNY mid-point at 7.0570, 2 pips lower than Friday’s fix, but this was lower than the street's estimate of 7.0628 and we are seeing sellers of USD/CNH as a result and this seems to support to risk assets, such as S&P 500 futures. Once again, the PBoC have had the ability to weaken its currency to a far greater degree, but its restraint has limited intra-day volatility.
One would imagine that if USD/CNH really got a wriggle on then calls for USD intervention would just ramp up…which, means further gold and JPY upside, and…..currency wars!
It’s ironic that as USD/JPY traded through the earlier flash-crash lows, the JPY crosses had a mini-tantrum around 08:20aest, and of course, with our old friend liquidity at the root of the issue. If I overlap USD/JPY (yellow), USD/CNH (red - inverted), TRY/JPY (green), USD/TRY (yellow – inverted) and AUD/USD (purple), we can see how the moves unfolded. While USD/TRY and TRY/JPY had some incredible percentage changes, it was probably USD/JPY which cracked first, with algo’s following suit.
I’d imagine Japanese retail traders were busy unwinding carry structures. Where there has been huge position build up in long TRYJPY positions due to the extreme ‘carry’ and swap rate differential.
So capital preservation remains the name of the game, with Trump and Xi taken the trade tensions to a new paradigm. No longer should we react to calls that “talks are going well”, and it seems that in the near-term the only thing that is going to turn this boat around is the Fed, and to a lesser degree, the ECB, getting really ahead of the market. A positive Trump tweet would help of course, but it doesn’t feel like the markets haven’t fully played their role yet.