Trader thoughts - Markets dip as one risk event is replaced by another

A relief rally, now onto the next risk:

Traders are being inundated by information, much of it speculative. Against this backdrop, volatility reigns: while off its highs still, the VIX is up 2.7 per cent on the day. To be clear, the Fed’s dovishness and Mr. Powell’s-famous-Put is underwriting the potential for future bullishness. But market participants can’t afford to let their guard down in this environment. We have the world’s most powerful politicians converging on Argentina, and with so many fissures running-through global political economy, the number of issues threatening market stability is considerable. One assumes that every generation thinks of themselves as existing at the end of history – reference: we can thank Fukuyama for that notion, perhaps – but it does sometimes feel that with the world-order trembling, we are living through a historical juncture of some description.

Markets want what’s familiar:

Markets don’t like this. They desire support and stability and a protection of the status quo. It’s why, in part, seeing the Fed ostensibly step in to support financial markets is so emboldening, and sparks all sorts of bullish impulses. This is especially so within equity markets, which being able to gorge on cheap credit for years, became spoilt and fattened. The fundamentals of the system itself are shaky. Although this ought to be an inherent virtue when it comes to the nature of capitalism – the notion of creative destruction, as economist Joseph Schumpeter expressed it, whereby viable investments prosper, and wasteful inefficiencies are purged – for the better part of a decade, policy makers (rightly or wrongly) have sought to resist this process to maintain a semblance of economic constancy and social confidence.

Withdrawal symptoms:

The problem is weening the macroeconomy and financial markets off the opiate. This is what the Fed is ultimately attempting to do, but with capital having allocated itself to places it ought not to have, removing the support from the system, along with the perverse incentives it produced, is proving no simple task. The Fed yesterday morning – articulated in Powell’s speech – almost certainly backed down in the face of the implicit pressure applied by markets. The message was clear from marker participants: we don’t like the risks of macroeconomic and geopolitical instability, we think growth will slow, we need support, otherwise we’ll melt-down. And so, in the tradition of Fed board’s gone by, Powell did. The message was only affirmed in this morning’s FOMC Minutes: the idea of “further hikes” passed December is debatable, because economic forecasts are softer, and there exists too many risks that could undermine the Fed’s objectives.

Inflation waning?

One of these objectives, when looking at the Fed’s strict mandate, is inflation targeting, and it appears that fundamental inflation is petering out once again. Market participants have cooled on the idea of that inflation risk is high, primarily due to a downgrade in growth forecasts and the recent dumping in oil prices. The Fed’s chosen inflation measure, the PCE Index, printed overnight, and revealed inflation slipped below the Fed’s target level of 2 per cent by more than forecast. The number came in at 1.8%. It’s not to say the risk of inflation has disappeared: wages growth is on the up in the US, which could conceivably feed into higher prices – not to mention the effect tariffs or (an unlikely) turnaround in oil prices could have on future inflation. However, as the markets understand things for now, inflation isn’t a bug bear, and that gives an assurance that the Fed will stay steady.

The G20:

In the bigger picture: it’s about this weekend’s G20 Summit. The trade war, Brexit, oil prices and global economic prospects are the big talking points; but underneath those we also have new tensions between Russia and the Ukraine, Italy and its fiscal situation, the Saudi’s and the controversy surrounding the Khashoggi murder, along with a myriad of regional issues faced around the globe. It’s a true tinderbox, that unsurprisingly would have world leaders, and thus market participants, very anxious. The core dynamic appears to be that those with the power to influence the direction of the political-economic world order have no interest in preserving it. Trump’s America is descending into paranoid isolationism, China wishes to reshape the neoliberal system to serve its long term national interest, the Russians are apparently trying to consolidate their regional interests, while the Europeans are busy naval gazing and questioning how to keep a unified Europe together at all.

Trade War:

Presumably, traders will do their best to ignore the structural power struggles and all the comparatively smaller issues dampening market sentiment and just focus on what will come out of the Trump-Xi dinner date. One would have to be utterly naïve to believe a breakthrough is upon us here. It’s unimaginable – granted, maybe only for those who lack a rich enough imagination – that either side will compromise its strategic interests. President Trump will want concessions from the Chinese before doing a “deal”, the likelihood of which seems very low. China possesses a long-term strategy for its nation and economy – one that extends passed the speedbump that is the Trump Presidency. Compromising the future to appease a bombastic American populist leader in the present is counterproductive. Both sides must know this, and that they are not on the same page right now, whatever the benefits may be. The likely outcome from the weekend will surely be a piecemeal statement committing to ongoing talks, as always seems to emerge from the talk-fests.

Price activity overnight:

The price action overnight reflecting the underlying market dynamic described so far has been quite subdued. European indices caught up with their North American and (some) Asian counterparts to put in its own post-Powell relief rally. US equities lost steam however, but in late trade look poised to close 0.3 per cent higher for the day. US Treasuries whipsawed on shifting sentiment relating to interest rates, with the yield on the 2 Year Note is currently at 2.81 per cent and the yield on the 10 Year note is 3.03 per cent. In currencies, the US Dollar is effectively flat, the EUR is slightly higher, the Yen has experienced a haven bid along with Gold, the Pound fell on Brexit fears, and the risk off tone sent the A-Dollar below 0.7300. Finally, commodities are slightly up: oil benefitted from news that Russia was prepared to cooperate with Saudi Arabia on production cuts, but copper is slightly lower.

ASX today:

Promisingly for Australian equity market bulls, SPI futures are indicating a 12-point jump at the open for the ASX 200, in line with the late run on Wall Street. The ASX experienced an immediate pop-higher at yesterday’s open, but the price action was dull and middling throughout the day. Overall, volume was strong, breadth was healthy, and the large-cap heavy weights in the materials and financials sectors added 13 and 10 points to the index, respectively. Growth stocks were big higher as expected, while defensive sectors were somewhat ignored. Private Capex figures were released and didn’t rock markets too much: it came in below expectations, but there were signs non-mining investment is turning around. The day ahead from a technical perspective should be assessed on whether the ASX200 can clear the small resistance hurdle at 5780 or so. But given what’s on for the weekend though, one shouldn’t be surprised or disheartened if that doesn’t happen today.