Broader risk sentiment is wobbly amid yet another central bank regime shift where they have gone from supporting risk assets to now being forced to do so.
Trade tensions have been slowly escalating for over a year. The new tariff threat suggests the risk of more tensions in the near term. With trade concerns rising east, west, north and south global markets instability will manifest itself out of a modest equities markets downturn.
Indeed, owning equities in a trade war laced environment is proving to be a risky business yet again.
Tariff-related risk-off events tend to take on a life of their own and can linger for many weeks so fading the move too early could prove to be a costly exercise in frustration and hence the reason the markets are not backing the truck up on equity markets just yet.
A few positives that might encourage a bit of risk-taking early in the week
The tariff escalation will not derail the trade talks not to mention the door is still slightly ajar for China to make right on their G-20 agreed to concessions.
The sell-off will be more benign than after May 5 Trump’s Twitter Trade Tirade due to a possible diminishing risk impact from the tariff’s escalations.
Just like shooting wars: the buildup and each stage of campaigns have triggered risk-off events but with diminishing effect over time. Much the same could be right about trade wars in the context of escalating tariffs. So, with time, investors have managed to sidestep them (tariff increases) and returned to the familiarity of focusing on the data, which in the case of the US economy, things still look good.
The Fed dropped the ball, but they can tweak Fed speak to better guide the market after the Presidents latest twitter trade tirade.
It's unlikely the rest of the world's central banks are going to allow President Trump to snatch defeat from the jaws of victory Not yet, anyway. Not while there's still some monetary firepower left in their arsenal
The Fed's 'mid-cycle' response will likely morph into an aggressive out of necessity policy approach. While the threat of addition tariffs will make Beijing more accommodative to easing as policymakers have numerous avenues and a high degree for flexibility to respond. Suggesting that mainland’s accommodative policies including infrastructure, fiscal and monetary measures will be aggressively dialed up in coming months
Oil Markets
An eventful week for oil, with a positive oil price trajectory Monday-Wednesday ending on Thursday with the most significant intraday decline since February 2015.
But Most of the news last week was supportive for oil – the EIA reported a large U.S. inventory draw and a decline in U.S. production, a FED rate cut, a 300kb/d production stoppage in Libya, and further signs of escalating tensions in the Middle East.
But the tariff escalation has brought the trade dispute back into focus, and that is that will be the dominant driver of oil sentiment over the near term.
Gold Markets
Gold rallied close to $1450 on Friday as the markets had expected President Trump to apply tariffs on European autos, but instead, the trade announcement was about a U.S. and EU beef deal.
With NFP out of the way, the market is back focusing on trade turmoil with China. The trend for Gold remains higher as the stock market comes under pressure and as the market packs in future policy implications for the Fed.
Although gold prices are hitting all-time highs against fiat currencies dampening physical gold demand, prices remain supported by the official sector demand through diversification away from dollar reserves to Gold.
Investors continue to hedge and diversify into Gold supporting the uptrend as the yellow metal's appeal as an alternative asset gains widespread appeal. Falling real interest rates make Gold an inexpensive hedge amidst global economic uncertainty.
This trend is apparent in ETF demand and the extended positions in the COMEX, which is less than 10 million ounces away from all-time highs.
However, in USD terms and as a percentage of Global Funds assets under management (AUM), positions are not stretched at all. Suggesting there is ample room for asset managers to add gold positions as a percentage of AUM as investor seek out diversification amidst elevated uncertainty around trade and the U.S. debt ceiling.
Currency Markets
G-10
It was roller coaster ride in currency markets last week as the long-awaited start to the Fed cutting cycle failed to materialize. Instead, Powell punted his ‘put” while providing traders with an endless amount of confusion by categorizing Wednesday's quarter-point interest rate cut as a mid-cycle adjustment. But that was then an this is now as the markets are back focusing on trade wars where the Japanese yen is the primary beneficiary in the G10 FX.
When we think about the impact of tariffs on FX, there are two channels for distribution. One is the on the U.S. domestic whereby tariffs have negative implications for U.S. growth and should lead to lower U.S. rates, which in theory should weigh on the dollar.
However, the more compelling driver is via global trade and growth where the U.S. dollar tends to outperform when global trade weakens as the U.S.’s open economy remains relatively sturdy.
In the G10, beyond the immediate adverse reaction in commodity currencies, there remains a potential from more downside for the EUR as the threat of auto tariffs persists. Also, global growth is mushy, and it far too early in the easing cycle, the impact from the Fed and China's credit easing to feed into data. So, it’s unlikely the U.S. dollar is about to give up its king of the hill status anytime soon.
EM Asia
Traders exited the EM basket after the Fed and flows have an escalation in proportion to the tread of tariffs escalation as near term caution reign supreme in Asia FX with CNH seeing the most prominent move after Trump’s tweet with aggressive buying of topside USD risk in spot and across the forward curve. The sizeable right-hand side USD volumes were going through confirming that traders were blindsided by the trade escalation as everyone is looking to short CNH, China proxies and the favored short CNH expression if via the JPY.
The bottom line is that the market was far too complacent expecting the fragile state of trade war neutrality to extend as they significantly pared down long USDNCH position and now find then self scramming for the topside position as the markets are back knocking on “ sevens” door” ( USD/CNH 7.0)
Yuan
It's up the Pboc to act as the gatekeeper on this one as the theoretical value of USD-RMB under this latest tariff escalation is around 7.50-65 if China were to allow the exchange rate along to do the heavy lifting without any other offsetting policies. But for a plethora of reasons traders and analysts, I finally agree on something and that a test of USD/CNH 7.50 is unlikely to occur.
First, China's countercyclical FX policy would likely be in place to prevent messy movements and trigger capital outflows. Second, the escalation in tariffs all but assures a tremendous policy response from the Fed. Third, the Pboc doesn’t want to escalate trade war into the realm of a full out currency war with the U.S.