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August ends on positive note, but volatility could persist into September

The US-Sino trade-war, though de-escalating in a very small way in the last few days, took a turn for the worst, with fears mounting that the conflict has now come too far to be truly resolved.

The trade-war remains the core concern

Sentiment managed to turn in global markets towards the end of last week. But overall, it’s difficult to argue that the month of August was anything but a tough one for investors. The US-Sino trade-war, though de-escalating in a very small way in the last few days, took a turn for the worst, with fears mounting that the conflict has now come too far to be truly resolved. Every thread tying the overall narrative in the financial markets now can be followed back to the trade-war – be that the global growth outlook, the likely actions of central bankers, or the strength of corporate earnings growth.

The fear of fear itself

From estimating its impacts, to guessing its likely outcome, market participants and policy makers alike are fumbling around in the dark for answers. It’s not necessarily the consequences themselves, but the uncertainty of what those consequences might be that is generating fear and volatility in financial markets. To rephrase a late U.S. President: the only thing being feared is fear itself. And this is where the danger lies: global financial markets hang-on to a precipice in which the fear brought about by trade-war uncertainty could be self-fulfilling and self-perpetuating. The emergence of such a vicious cycle could mark the most damaging phase of the trade-war to date.

The risk of a vicious cycle

There appears to be the knowledge within financial markets that this is becoming the case. Policymakers and leaders of high-finance alike are chiming-in with suggestions that it is investors becoming sucked-in to the doom-and-gloom cycle that presents the greatest risk to the market outlook of all. It would be one thing that would certainly be keeping a few central bankers up at night, as they grapple with the impacts of the trade-war, and their ability to address it. What happens if a tidal wave of monetary stimulus is released into the global economy, but consumers prove too fearful to consume, and business prove too fearful to invest?

How does this cycle end?

The answer: it probably means that this business cycle ends with a bang rather than a mere whimper. And this is why, as it stands, more than deteriorating fundamental data, and more than what central banks-do, the circumstances driving the trade-war are most relevant to financial markets presently. Afterall, the global economy was probably already slowing down – the data, from the US, Europe, China and many lands beyond had peaked a while ago. On top of that, conventional wisdom implies that central bankers were always going to respond to this slowdown by turning on the money taps.

Uncertainty and the fear-of-missing out

The problem is, with the outlook for the trade-war and its effects so unclear, imagining the extent of the global economic slow-down, and therefore the appropriate policy responses to it, is highly uncertain, and therefore difficult to price-in by market participants. These big one, two and three per cent intraday moves – up or down – in global stock markets speaks of a dynamic whereby investors are rushing to price-in any bit of good-or-bad news, lest it be the turning point in which a trade-war narrative is clearly formed. Indeed, this behaviour seems irrational. But in an increasingly high-risk, low-return world, this fear-of-missing-out is the most powerful driver of market-behaviour.

What are the core trends driving this market?

This behaviour also creates a lot of noise and distraction in the market. So out of all this, what truths and trends can be relied upon? Right-here-right-now: the latest round of US tariffs were implemented on the weekend, the economic data keeps softening, and earnings downgrades are still happening. Hence: stock market volatility will likely stay high. Government bond yields look set to keep falling. Gold looks poised for sustained upside. The USD remains almighty, and the JPY looks well supported. The AUD looks destined for further downside. And oil, copper and other growth sensitive commodity prices are trending almost categorically lower.

A week full of risk – and possible volatility

With this as its backdrop, the week ahead presents as a massive one. Event risk is quite high, both domestically and abroad. Locally, investors will be digesting a reasonably lacklustre reporting season, an RBA meeting on Tuesday, and a GDP release on Wednesday that’s expected to show growth in the Australian economy last quarter was at its weakest since 2011. Abroad, trade-war headlines could still keep a-flowing, and US and Chinese PMI numbers will be closely monitored. While an eye will also be kept on a loaded economic calendar, that will be highlighted by US Non-Farm Payrolls data on Friday.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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