This Could Get Very, Very, Messy

Originally published by AxiTrader

Market Summary

Stocks in the US mostly recovered, bond rates were on the rise, and the US dollar came under renewed pressure again Friday as traders continued to process the short and longer term implications of the imposition by President Trump of tariffs on steel and aluminium imports.

I said “mostly” recovered because while the S&P 500 was 0.5% higher at 2,691 and the Nasdaq rose 0.9% the very narrow Dow Jones Industrial Average index of just 30 stocks fell 0.3% to 24358. That left the big 3 US indexes down 2, 1 and 3 percent respectively.

Europe had a very ordinary day Friday with the CAC, DAX, and FTSE FTSE MIB all off close to 2.5% while in London the FTSE fell 1.5%. Asia has also had a poor day but nowhere near that dire while the S&P/ASX 200 dropped around three-quarters of a percent Friday to close ay 5,929.

SPI traders, however, followed the S&P 500 a little higher and have added 12 points to Friday’s close. I’m not convinced they’ll be right though. At least not until we see what the US does tonight.

Uncertainty has lifted materially, as countries react to the tariffs and a trade war and retaliatory measures loom as a real possibility unless President Trump finds a way to step back. His anti-Europe tweets over the weekend (see below) suggest otherwise.

So much for the adults in the White House keeping the President in check. He is clearly his own man.

Anyway, to forex now and the US dollar has suffered as a result of the negative sentiment the tariffs have raised. Euro is back at 1.2330/40 this morning. The yen traded to a multi-year low Friday and though a little weaker USD/JPY is at 105.63 this morning. Sterling has been thrown a much-needed lifeline (if you are a GBP bull that is) by US dollar weakness as the UK government continues to grapple with the fact Europe is not accommodating it – GBP/USD is at 1.3808.

News that Germany has a government official now that the SPD has voted to join Angela Merkel is important as is the results of the Italian election which will be released in our time zone today.

Of the commodity bloc, the kiwi continues to do best at 0.7239 while the Canadian dollar touched 1.29 on Friday and is at 1.2879 in USD/CAD terms this morning. The Aussie made a fresh low for this run last week at 0.7712 but the tariffs have lifted the weight off the battler for the moment and it is trading at 0.7767 this morning.

As highlighted above US bonds are a little higher once again with the yield on the 10-year up at 2.86% from 2.8% on Friday morning my time. The 2-year note is at 2.23%.

On commodity markets, a weaker US dollar has been a positive for oil which was struggling Thursday. WTI and Brent found support late week and are at $61.25 and $64.37 respectively. Gold is higher on risk aversion and a weaker dollar but at $1322 looks cheap if things really kick off – as they might. Copper is at $3.10.

Turning to data and the day and week ahead is going to be big.

It’s services PMI day here in Australia and around the world today though I sense that this may be less important than usual. That said though in the current mood any weakness could be magnified more than its import. Likewise any misses in Australia’s job ads, building approvals, business inventories, and company profits data that are all due to be released this morning

And of course we have the RBA, GDP, and trade this week here at home. On top of that we have the central banks of Canada, Japan, and Europe all meeting as well as non-farm payrolls in the US, among othe things, this week.

It’s kind of long today but here's what I picked up (with a little more detail and a few charts)

International

• Tariffs, potential trade wars, and instability in geopolitics. These are the new fears traders have to face this week after President Trump’s announcement of steel and aluminium tariffs on Thursday set off a chain of events which have materially increased markets uncertainty.

• Key takeaways:
• Europe has threatened US exports of Bourbon, Blue Jeans, and Harley Davidson’s in a symbolic retaliation that also targets about $3.5 billion in trade.
• President Trump tweeted trade wars are “good and easy to win” when “a country (USA) is losing many billions of dollars on trade with virtually every country it does business with”.
• President Trump doubled down on Europe subsequent to the above tweeting, “If the E.U. wants to further increase their already massive tariffs and barriers on U.S. companies doing business there, we will simply apply a Tax on their Cars which freely pour into the U.S. They make it impossible for our cars (and more) to sell there. Big trade imbalance!”
• Ben Hunt from EpsilonTheory tweeted that this could escalate in a tit-for-tat war of words and tariffs because it will play well to the electorate both in Europe and the US. Not good, but dead right.
• The WTO chief has warned a trade war could actually happen because of the US tariffs. YUP, what Mr Watson used to say to Sherlock! The IMF has sounded a warning as well.
• Some folks reckon the US dollar outlook is darker now because of the threat of a trade war. As I highlighted Friday, “there is absolutely no reason why the US dollar should benefit from the sort of policies President Trump is now following”. But this is a potential paradigm shift so nothing is certain – either way.
• It’s apparently about China, even though they are a small net importer of steel into the US, officials said Friday. But China says it doesn’t want a trade war with the US – however it will wage one if they have to. The Chinese vice-foreign minister said “we absolutely will not sit by and watch as China’s interests are damaged”.
• The FT has a story highlighting Fed concerns about the Tariffs. They rehash comments from Jerome Powell and Bill Dudley that were made last week. But they do have some fresh thoughts from Minneapolis Fed president Neel Kashkari. The FT reports he told the paper, “he could understand why US protectionists were seeking to respond to unfair trade practices by other powers including China, adding that decades of efforts to convince Beijing that fair trade was in its interests had led to nothing”. THAT IS THE BIG ISSUE UNDERLYING ALL OF THIS. But Kashkari added, “if you raise steel tariffs, are the steel jobs in the US going to more than make up for the economic effect [on] everybody who is a steel consumer? If you look narrowly at that, the answer is going to be a resounding no”. Note he said “if you look narrowly”.
• Could Treasury’s, and the selling of same, be a strategic weapon in a trade war? Some say yes, others no because the holders would lose money on their holdings. But if you want to make the US and President Trump pay why wouldn’t you flog Treasuries up toward 4% in the 10’s and really put pressure on US stocks? If negotiations fail it could become a weapon of choice.
• France and Germany are going to harmonise tax rates after the big cut in US corporate taxes.

• WASHUP? This could get very, very, messy.

• Writing in his weekly column, Thoughts from the Frontline, John Mauldin summed up neatly where President Trump is coming from. Mauldin wrote, “there are no easy answers, as one man’s lower prices are another man’s lost job. I understand the frustration of those who feel that “our jobs” have been taken, because they can look around and see factories closed. It is easy to blame China, but China sends us less than 2% of our steel imports. And the Chinese are trying to shed 1.5 million jobs from their own steel industry. Think about that figure in the context of 140,000 total jobs in the US steel industry. That’s 140,000 US steel jobs versus the 6 million jobs in companies that actually buy and process steel and aluminum, which will now cost more, with the price increases passed straight through to consumers’.

• He then added in brackets the key point, “(The single most important problem we need to solve with China – if we really want to do something significant – is to deal with the massive theft of US and European intellectual property. But that is a much more difficult issue than can addressed by simply imposing tariffs.)”. He’s right on both counts and you can see why this is such a complex and potentially explosive situation. Trump's tariffs can easily be the thin end of the wedge, or the Trojan Horse that destroys the edifice of a system thath has wrought the crisis in global democracy – something I highlighted with Martin Wolf’s excellent article last week.

• We need to talk about stocks folks. Even though the latest Reuters surveys show a still bullish consensus for year-end with an average forecast for the S&P 500 of 2,900 at years end and a mean of 3,000 the risks to those forecasts are rising. And it’s not just the tariffs. Leaving aside the fact that the tariff announcement spooked investors there was more to last week’s sell off than just that. As Ben Levishon pointed out in Barron’s over the weekend, “whenever the market drops, everyone looks for a reason. This week had many—which means maybe it didn’t actually need one to fall this week”. He says it was the tariffs, but it was also Jerome Powell’s testimony Tuesday, rumours Wednesday that infrastructure wouldn’t pass Congress this year. Not to mention “higher bond yields or rising wages, the two factors said to be responsible for the market correction that occurred last month”

• Uncertainty folks, that’s what that shopping list of reasons and catalysts speaks to. And as it rises so then does volatility. And with that comes an increase in traders and investors stress levels. So we get risk aversion. Stocks, and thus markets are at risk right now from the growing uncertainty that central bank emergency stimulus unwind, Fed balance sheet reduction, higher short and long rates, risk of a trade war, President for life in China, Russian belligerence over nuclear weapons and gas moves in Ukraine, and of course Trump tariffs all have wrought. Of that I am certain. But it is not certain we are about to see a big fall in stocks or other markets right now. Just that the risks have risen. Yes, certainly, last week’s candle on the S&P 500 was a big outside week. But’ we’d have to see Friday’s low give way to get too worried. And then off course we have the double bottom from a couple of week’s back.

• I’m at risk of sounding like I am gibbering this morning. But all of the above sets up the key point right here and right now. As I mentioned to Sam Jacobs of Business Insider last Friday, Trump's tariffs, Xi’s lifetime leadership, and Russia’s belligerence on nuclear weapons potentially signaled a regime shift for markets. It’s not me just making it up though. My hypothesis is supported by Andrew W Lo’s notion of Adaptive Markets as I tweeted over the weekend. Andrew Lo liked the tweet by the way!!!

Source: Twitter Screenshot

• The key here is just when the global macro economic backdrop has sweetened all these other factors have reared their head to increase uncertainty and threaten the accepted stability and paradigm of the post GFC, perhaps even WWII era.

Australia

• The AFR reports this morning, that Deloitte Access Economics have done some modelling and reckons the trade war shouldn’t hurt Australia too much. 20,000 jobs lost and about $5 billion washed off GDP annually would result from a “tit-for-tat” trade war between the US and China, Deloitte said. “That's not the end of the world – and it's not a recession. But it's nonetheless nasty: a self-inflicted wound that the world and Australian economies could do without,” Deloitte said.

• But even with all the uncertainty SPI traders are betting that it is going to be a better day for the ASX today following Friday’s 0.74%, 44 point, fall. At the close of play Saturday morning the SPI was up 12 points. That’s a continuation of a very neat bounce off the lows of Friday morning which were then eclipsed when the SPI fell to 5963 during trade Friday afternoon before Asia markets started to recover from their lows. At 5,924 the SPI has had a very solid bounce. The reality though is that where the ASX goes today, even if it moves higher, is prone to be magnified or unwound by what happens in the US tonight. And on that front I have a lot less certainty than usual. An up Friday on a down week is nothing but position squaring. So I am wary as we start the week today that the SPI’s close Friday could be a mis-lead

• The Australian dollar lifted off its lows late last week as the US dollar once again fell out of bed. That recovery continued on Saturday morning as US stocks closed the day higher though the week lower. Last week’s low at 0.7714 was a neat Fibonacci extension (138.2%) of the fall to 0.7758, recovery and then break lower once again. So it’s also a good place to bounce from. The RBA and GDP are going to be very important for the Aussie, so too the overall risk aversion/appetite situation this week. But for now the Aussie looks biased back toward at least 0.7815/20 initially.

Forex

• The US dollar is back below 90 in US Dollar Index terms as both the euro and the yen caught a bid at week’s end. The euro was a clear beneficiary of concerns over the tariffs and trade war while the yen gained on that and comments from BoJ governor Kuroda Friday which talked of an end to QE in Japan. Not till 2019 mind you, but an end nonetheless.

Source: Investing.com

• The touch, and reversal, almost perfectly off the 38.2% retracement level of the recent sell off in the DXY last Thursday in the wake of the tariffs and then Friday’s fall back below the trendline of the little W pattern I’d highlighted last week is an ominous sign for the US dollar. The chances of a move back to the lows have grown once more.

• That, in turn, sees the euro back testing the top of the old trend channel it broke back down and into last week. There is a cluster of resistance in terms of the 15 and 30 ema along with the mid-Bollinger band ma here in the 1.2325/40 region. A break could see a retest toward the highs above 1.25. That’s a chance now that Germany has a government and as long as the Italian election does not deliver either chaos or an outcome that might pull them out of Europe.

Commodities

• The big CERAWeek oil industry conference is on in Houston this week. So expect plenty of chat about what OPEC is trying to learn about shale oil and its productive capacity and intentions. This time last year we had OPEC leaders making injudicious comments about US producers joining their production cuts. Such comment were clearly misplaced and misunderstood US law. But that hasn’t stopped OPEC members still hoping US production might slow with Iraqi oil minister Ali Nazar saying, “We all should look with responsibility to the market in order to keep the balance in the market as much as we can so as not to harm investors”.

• That’s neatly put and perfectly pitched because what’s clear between last years CERAWeek and this week is that shale oil investors are now seeking a better return on their investment. That’s something that hasn’t restrained production yet, as EIA data last week showed. But as costs rise - $100,000 or more a year to drive sand trucks is apparently the going rate at the moment – production may slow. But for now US oil is producing strongly with no real signs of deceleration or a move back below 10 million barrels a day where OPEC would seemingly prefer it to be.

• That’s a risk for prices. But for the moment though, Oil found a base on Thursday and Friday as the US dollar weakened. $63.15 in Brent and $60.10 in WTI are now the downside levels to watch. Here’s the Brent chart.