BRAZEN CAPITAL — GLOBAL MACRO/MARKETS WEEKLY UPDATES
Week #34 (08/18/19–08/24/19)
Updates from the Belvedere
On Top of the Radar
Rates market share center stage as volatility of risky assets picks up
The inversion of the 2yr/10yr portion of the US yield curve (in other words, the yield on the 10-yr UST fell below of the yield on the 2yr UST) added to investors’ concerns that the U.S.-China trade war was taking a toll on global economic growth; plus, weaker economic data from Germany and China helped fuel the “risk-off” attitude. As global equities (MXWD) started to decline during last week, “risk-off” sentiment engulfed the markets; as such, defensive and interest-rate sensitive “bond proxy” performed better.
Interestingly, the US options markets appears to be focusing more on rates than tariffs, as the divergence between the implied volatility of the ratio of US Treasuries to S&P500 and Chinese LC EQ to S&P500 suggests more uncertainty on the future path of US rates than the trade war impact on China.
We think there is an opportunity to own volatility ahead of the upcoming annual Fed conference in Jackson Hole, Wyoming from August 22–24.
Under the Radar
US-China Trade War, Continued
The White House’s decision to delay proposed tariffs on roughly half of the targeted incremental China imports provides positive information on how the Administration is approaching trade policy. But a 10% tariff is still going into effect on some China goods on Sep 1st.
The decision to delay implementation of tariffs on some goods was driven by concerns over the political risks associated with imposing tariffs on consumer goods before the holiday season as well as the recent deterioration in the US equity market; this suggests that there is a limit to how far, or at least how quickly, the White House might escalate trade restrictions. However, the announcement nevertheless finalizes tariffs on nearly all remaining imports from China that have not yet been affected by additional tariffs. The formal release of the notice substantially reduces the probability that the planned tariffs due to be implemented September 1 will be called off before then.
Global Capital Markets Conditions
Until the last two weeks, the summer season in the US was fairly typical: lower volume and subdue volatility. But August arrived to shake things up! During the first two weeks of the month, the broad US market already had two days with close to 3% declines (most of the losses were recovered on the following days, but that could be due to short coverage rallies).
Furthermore, last week, the 2yr-10yr portion of the US yield curve, which gets a lot of attention from Wall Street, finally inverted (the 3mo-10yr portion, which has been inverted for over 5 months, is closely watched by the Fed). This event triggered an upgrade to “Defcon 3” by TV talking heads…, even President Trump got to his preferred method of communication to “Tweet out” his opinion.
We continue to expect a steepening of the US yield curve beyond the 2-year maturities.
Weekly Highlights
Week #34 Preview
Europe CPI; Italian Drama; CB Minutes (Fed/ECB); Jackson Hole, WY
On Monday, Euro-area core inflation likely remained at 0.9% YoY, according to economists’ estimates gathered by Bloomberg. Headline inflation for the region likely fell to 1.1% in July from 1.3% in June. This reflected lower price gains for energy and reduced services inflation, which fell to 1.2% from 1.6%. An expected large decline in services inflation in Germany suggest more widespread weakness in underlying price pressures in the region’s largest economy.
On Tuesday, Prime Minister Giuseppe Conte is scheduled to address the Senate at 14:00 (London time) about the political situation in Italy after Matteo Salvini, head of the anti-immigrant League, recently called for early elections. The speech may lead to a no-confidence vote in the Senate that could take place the same day. Alternatively, Conte could skip the vote and go straight to the Quirinale Palace to submit his resignation to Italian President Sergio Mattarella. Or neither may happen.
On Wednesday, we can read the Fed’s July policy meeting minutes as they are released at 2 p.m. in Washington. The minutes will give insight on the decision to cut rates for the first time since the economic crisis (10 yrs ago). Two regional presidents, Boston’s Eric Rosengren and Kansas City’s Esther George, opposed the decision because U.S. economic data remains solid. Norway’s sovereign wealth fund, the world’s largest, releases its second-quarter report, and discusses the latest market developments.
On Thursday, we will be monitoring what fed fund futures imply for rate cuts during the Kansas City Federal Reserve Bank’s annual central banking symposium in Jackson Hole, Wyoming. Fed Chair Jerome Powell will speak. Prices indicated a hike a year ago and now suggest trades expect at least one 25bps cut in rates at the September meeting. The ECB will publish the details of its July policy meeting.
On Friday, US housing starts and new home sales data are released at 08:30 am. Lower rates helped propel new mortgage applications higher in July and push up the U.S. Housing Market Index, a measure of confidence among homebuilders.
Week #33 Review (JPMC)
Volatility has picked up in August, and with reasonable cause. Last week, markets sold off on further evidence of a global slowdown. Chinese industrial production in July slowed to +4.8% y/y from 6.3% last month, the weakest since 2002. Similarly, Chinese retail sales slowed to +7.6% y/y from 9.8% in June, with a sharp decline in autos. The German economy, a manufacturing powerhouse, contracted 0.1% q/q in 2Q19, without much sign for improvement in the short term. Even with the U.S. delaying some of the September tariff implementations to December, trade continues to be a source of confusion and uncertainty.
Reflecting global economic stress, the most popular measure of the slope of the U.S. yield curve, the difference between the yields on the 10-year U.S. Treasury and the 2-year U.S. Treasury, inverted briefly. While recession risks are rising, it is important to keep in mind that consumption, the bedrock of the U.S. economy, still shows signs of resilience. Consumption accounts for two-thirds of U.S. GDP, and of that, retail sales comprise 43% of consumption. Retail sales have been healthy throughout this lengthy expansion. July retail sales rose an impressive 0.7% m/m and are still up a respectable 3.1% y/y on average this year, despite the diminishing boost from the tax cuts. Despite growing risks, consumer spending remains strong this year, and should offset other pressures on U.S. GDP growth in the third quarter.
Prior Publications
08/11/19 — Trade Tension Back on Centerstage
05/12/19 — Trade War Redux
05/05/19 — Fear of Missing Out (#FOMO)
04/28/19 — Micro Data (US CQ1 Earnings Monitor)
04/20/19 — Keep Calm, White Waters Ahead
03/07/19 — Policy Shift Creates Opportunity in EM debt and equity
02/27/19 — Expect the Unexpected
02/10/19 — US Equity Macro Narrative
02/01/19 — Sustainability: The future of investing
Asset Class/Subclass Positioning and Outlook (Available to Subscribers and Clients only)
Asset Class/Subclass Actual and Forecasted Returns (Available to Subscribers and Clients only)
August 2019: Monthly Analysis, Outlook and Commentaries of Asset Classes/Subclasses (Available to Subscribers and Clients only)
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Sources
Bloomberg/BlackRock/GS/JPM/MS/CWS/IG-WM
