Fragile Equilibrium

Fragile Equilibrium

It seems that everyone is willing to offer up a comprehensive list of reason to be sceptical about global equity markets: tumbling macro fundamentals; central banks policy will be an ineffective and or heightened political risk. Be that as it may, equity markets continue to defy the sceptics as after each trade headline triggers a chaotic few hours of risk meltdown, investors come back for more.

Sure, I know we’re supposed to be on razor’s edge blah blah blah, and trading conditions are supposedly treacherous? Not really as the mean reversion trades are very well defined

Sure, the markets are always a negative trade headline away from a risk mini-meltdown, but the fact remains traders are more than happy to bargain hunt even after last weeks “Frantic Friday” as they become more desensitised to trade war headlines risk. Trade war escalation has gone well beyond not only investors worst nightmares but policymakers’ wildest expectations and screams out for a coordinated and all-embracing policy response in coming months.

Sure, markets are digging in for the long haul, but that doesn’t mean investors want to sell off equity positions as liquidity trade remains alive and well.

Oil markets

Crude stocks fell 10.0Mb, bullish vs consensus for a 2.1Mb draw and the 5-year average of -2.6Mb, and roughly in line with the 11.1Mb draw reported by the API yesterday. Declining imports and rising exports drove the draw and bullishly confirming that OPEC supply cuts are effectively working by depleting U.S. reserves.

The Drawdown comes at a very critical time for markets alleviating the fear of oversupplied conditions when gasoline demand typically wanes in September as peak US driving season ends.

However, the Oil rally gave way to demand and trade war concerns as oil traders remain less inclined to run too far ahead of the economic realities trade war has inflicted on the global economy. Moreover, they are certainly not in an overbullish frame of mind while the prospect of more U.S. tariffs is hanging over the markets head.

While the east-west trade war frictions grab most of the international headlines, the regions north and south escalation involving Korea and Japan could impair oil demand as their tit for tat political spat compounds the already export ruinous effect the US-Sino focus is having on both export juggernauts.

Risk-off remains in fashion as trade disputes continue to flare. Post DOE sell-off is typical price behaviour during trade war escalation when oil prices rally at the early part of the week when U.S. government data supports only to give ground to trade war and demand fear the rest of the week. Still, the DOE weekly draw is enormous, so in the absence of trade war escalating Trump tweets, I think even the bears should be more inclined to cool their jets a bit this week.

Gold Markets

Besides getting support from it’s two best friends, US President Trump and UK Prime Minister Johnson, the Gold market continues moving to the beat of the US bond markets.

Also, if US yields continue to fall, which is likely, particularly real US 10Y yields, this too will provide considerable headroom for Gold to climb higher. To a tee, gold traders are expecting the US duration rally to extend not only due to the scarcity of positive yielding paper but the fact the Fed has little option than to cut interest rates aggressively which is increasing the likelihood of 1-1.25 % yield on UST 10’s by year-end.

As well, Gold should continue to find the support from Chinese media signalling that no trade deal progress is forthcoming and President Trump tweeting criticism of the Fed.

The gold market continues to see participation from the macro side, and despite positioning being at the all-time highs, Gold as a percentage of USD and global funds’ total AUM remains off the highs reached during the previous bull-run. There should be ample room for strategic gold positions to continue to grow.

If trade tensions remain high, Gold can count on this issue as being outright supportive.

Dovish Fed expectations and concerns about the potential for FX intervention, which could sterilise the strong dollar negative effect into Gold markets, are likely also adding to its appeal.

The Yuan

We should see the market skew into an anticipated stronger Pboc fix, more at Yuan watch time.

G-10 Currency markets

Outside of the Boris Johnson regal request that knocked the Pound of its rally perch, trading has been remarkably muted as G-10 traders mojo has deflated after the reality of RBA Philip Lowe currency messaging from Jackson Hole sunk in.

“When easing monetary policy, all central banks know that part of the transmission mechanism is a depreciation of the exchange rate. However, if all central banks ease similarly at around the same time, there is no exchange rate channel: we trade with one another, not with Mars.”

The Malaysian Ringgit

The bearish skew remains intact as the Ringgit is being held hostage to a weaker Yuan as the stronger USD has its predictable wrecking ball effect in Asia capital market compounding the already negative trade war effect

This article was written by Stephen Innes, Managing Partner at VM markets LLC