Risk Trends Holding Up

Originally published by IG Markets

Risk trends were holding up rather well heading into the US session – even though the European and Asian hours were trading softer before New York was online. However, by the afternoon, Dow and company put in for a tumble that would rival what their international peers had closed out.

There was a range of possible sparks for the speculative swell with the docket padded with event risk and Fed officials weighing in on monetary policy. Yet, what ultimately seized the yoke was the simmering concern surrounding protectionism. It was rumoured late last week that US President Donald Trump, who was considering the recommendations from the Commerce Department on how to respond to perceived trade inequities, was favouring the harshest proposal. This past session, we learned that the President intends to announce his decision next week and headlines reiterated he was leaning towards a 25 percent tariff on imported steel and 10 percent on aluminium. History says this effort will unlikely have a net positive impact on the US economy and it is extremely unlikely that there will be no retaliation in kind by trade partners.

Wall Street: What started out as a quiet session for US shares market on Thursday quickly turned toxic, with headlines purporting faster Fed rate hikes and the US heading towards some of the most aggressive tariffs on trade partners in years. From the Dow, we now have a third consecutive decline – the first such series of this duration since a four-day drop that ran through September 27. Of greater concern is the fact that the already troubled recovery effort from February’s losses has lost its motivation and fundamentals look disinclined to strong arm a recovery. What’s more, the decline the Dow and S&P 500 find themselves in is accelerating. Long-term bulls don’t need to become too worried until we return to 24,000 and 2,550 respectively, but that may be in the cards for the near future.

Fed Member Says 4 Hikes Still ‘Gradual’: There were a few Fed speakers on the wires Thursday evening, but most were watching what new Fed Chair Jerome Powell would say before the Senate. Yet, this was his second day in Washington; so his prepared remarks were already imprinted on the market and the provocative questions aimed at trying to elicit a political or market response were largely already attempted the previous day in the House. Instead, a much more remarkable statement was made by New York Fed President Dudley who said four rate hikes in 2018 would still count as ‘gradual’. While that is not an endorsement, it is the translation for notoriously vague Fedspeak. And, this translation is much more hawkish than what had been afforded for by market participants.

UK PM May to Present Brexit Counter: On Wednesday, the European Union’s 27 issued a Brexit draft that was well over 100 pages meant to spell out the terms for which the group believed the divorce with the United Kingdom would go. When UK Prime Minister Theresa May summarily rejected the assessment owing to a number of points – but centered on the issue of a ‘hard’ North Irish border – the pound tumbled in response. Coming up Friday, the Prime Minister is set to deliver her rebuttal, but there are concerns that she will once again be vague about what the country is pushing for given the constant infighting that has been reported on nearly a daily basis. An unclear agenda and negotiating points would not likely draw an agreeable EU response, making Friday another risk of sterling pressure.

Run of Central Bank Decisions Next Week: March’s first full week of trading will showcase a Central Bank Bonanza. The local focus will be on the Reserve Bank of Australia with Philips' testimony later in the week. Specifically, markets will weigh their words to see how they will approach five straight months of housing price declines and dropping Capex; the market is not pricing in much either on Tuesday or down the road for the RBA.

Globally, the focus will almost entirely be on the ECB that meets on Thursday morning. Recent minutes showed that multiple members were concerned about the US’s focus on the benefits of the falling US exchange rate to support trade. They failed to mention their mirror-imaged focus in 2014 when concerned about deflation and exacerbated sovereign crisis at euro 1.40. Either way, a report surfaced this on Thursday night from Reuters that the ECB could drop its easing bias at the upcoming policy meeting, which if done, would surely help the US’s weak FX case and keep the euro supported above 1.20.

The other central bank within the G8 to announce their cash rate is the Bank of Canada who is also dealing with an aggressively falling currency. The Canadian dollar fell more than 7% against the yen in February, and Trump’s Tariff talks look to hurt Canada more than most.

ASX200: The second straight drop to the S&P/ASX 200 below 6,000 again to open March on a sour note. The ASX was not alone as the MSCI Asia Pacific Index also dropped 0.9%. The drop of 42.62 points to 5,973.34 was led by Orocobre (AX:ORE) falling 6.1%.

The drop in the index took it below the 50-day moving average, which aligns with the 1.5% a YTD loss. BHP Billiton (LON:BLT) ADRs are currently lower by 2.4% at an A$29.98 equivalent or a 1.7% discount to the close. Rio Tinto (LON:RIO) implieds are down 2.7% to an A$67.89 equivalent, a 2.8% discount to Sydney’s close.

Commodities: Thursday’s market focus was expected to be on Jerome Powell’s second appearance as the new chairman of the Fed delivered the Semi-Annual Monetary Report to the Senate. However, the thunder (as is often the case) was quickly shifted to US President Donald Trump who said the US would impose harsh tariffs to the tune of 25% on steel and 10% on aluminium. The irony will likely be that the pain would be delivered to the Americans as a protectionist policy would increase inflation and hurt major trade partners like Canada, who is the single largest supplier of steel to the US. Currently, China (the perceived target) falls out of the top 10 steel exporters.

Other focal points on commodities were the continued slide in crude oil, which fell to a three week low. The drop was pared as the US dollar pared gains on a perceptively dovish Powell testimony. Alongside the drop in crude has been a flow report showing six-consecutive weeks of withdraws from the main US OIL ETF, USO (NYSE:USO), that amounted to $1b in the outflow. WTI was down by 1.5% late in the US session as risk assets took another dive late in the session. The oil market is not absent positives as US oil Inventories in Cushing, OK were at a 3-year low while OPEC production hit a 10-month low.

Australian Dollar: The Australian dollar fell 0.3% on the session to the US dollar to trade at $A 0.7736. The biggest hit in the session came after poor capital expenditure data took AUD/USD to a two-month low while AUD/JPY flirts with the lows of 2017 some 70 bps from the spot at the time of writing. In addition to the initial drop, options volatility bets jumped suggesting aggressive swings and possibly to the downside are in store.

The key drivers for the Aussie will be the RBA next Tuesday and the disappointing local data. Regarding the RBA, the market is only pricing in less than a 1% chance of a hike per Overnight Index Swaps and does not see a greater than 10% chance of a hike, with 50% considered as priced in, until July. The Aussie has been following the pulse of both risk-sentiment and weakening local data trends. Thursday saw a disappointment in 4Q capital expenditures for February followed by AU home pricing data showing the fifth straight monthly decline. Should the RBA mention these points, the statement will likely read dovish to the delight of Australian dollar bears.