The Big Short

The Big Short – Is It Coming Now?

It’s been a particularly interesting few weeks that culminated in some particularly newsworthy events over the last week with the choppy waters being the beginnings of a storm that has been brewing since Trump’s November 2016 Presidential Election victory.

For the market, analysts looking for key drivers over the near-term that will ultimately decide the fate of a number of currencies, economies and ultimately whether a new crisis dawns.

Looking at current market conditions:

  • 10-year Treasury yields have hit their highest level since 2011, largely thanks to FED Chair Powell who talked up the U.S economy, supporting the FED’s projected rate path, with yields holding in spite of slightly softer September inflation numbers, as the annual core rate of inflation holds above the FED’s 2% objective in September.
  • Economic indicators out of China had suggested that the ongoing trade war with the U.S had begun to bite. September’s trade figures released on Friday showed a record trade surplus, a perplexing set of figures when considering the downward trend in manufacturing PMI numbers that will have Trump scratching his head.
  • Corporate earnings season is kicking in. Rumblings from corporate America, over the effects of the U.S tariffs on Chinese goods and China tariffs on U.S goods, has already begun and could rile the markets further. The effects of the trade war may well be reflected in a number of earnings figures in the coming weeks.
  • President Trump’s decision to add the FED to his ‘Blacklist’ is another cause for concern as the influence from the Oval Office reflective of just how bad things could get as the cost of borrowing rises and profit margins shrink. It’s not surprising that the U.S President wants the FED to hit the brakes, the effect of Trump’s tariffs on margins and rising borrowing costs a bad combination all around.
  • All things considered, the IMF bided its time in throwing in downward revisions to growth forecasts. Last week’s revisions for this year and the next are another reason for the markets to be edgy going a week full of possibility.
  • Moving over to Europe, the Italian coalition government’s budget plans have got the European markets up in arms, contributing to a jump in Italian government bond yields and a material widening in the spread between Italian and German yields that has caught the attention of many, with 400 the line in the sand.
  • Over in the UK, it’s been a rollercoaster of a ride for the British Government as the EU’s stance on Britain and its departure from the EU took a turn for the better from a UK perspective. The shift comes in spite of some harsh words from pro-EU French Prime Minister Macron and talks of blocking Le Tunnel and more should no deal be reached. How events unfold will have a material impact on, not just for the UK, but the EU and the global economy. In spite of some rather bizarre views that a collapse in the UK economy would have little to no effect on the EU and beyond, let’s just consider the fact that the UK economy is the world’s 5th largest, sitting below Germany and above France.

So, what could possibly go wrong?

The Establishment could flex its muscles on Monday and reject Italy’s budget, spreads between Italian and German government bond yields would certainly breach 400 and we can wave goodbye to the FTSE MIB, with contagion risk likely to weigh on European assets, driving demand for U.S Treasuries and German government bonds.

An Italian Referendum on membership with the EU? Now that would be interesting when considering the result of the last election…

In the UK, make or break talks between the UK Government and the EU could end in tears, reigniting the possibility of a no-deal that would see the Pound take a tumble.

And of course, the U.S President could ramp it up against China with the allegations of China spying on the U.S through computer chips making China enemy #1, a stark contrast to Trump’s early days in office and his decision to meet the Chinese Premier before any other.

Corporate America delivers early on what many expect to be an eventual shift in earnings, reflective of the effects of trade tariffs and rising borrowing costs, the combination of which is certainly not going to help wage growth.

If that’s not enough, then there’s Iran simmering away in the background and Russia riled by fresh sanctions. Argentina, Turkey, and other emerging markets’ currencies weigh on the global economic stability. If there was ever a time for a great divide, it seems as though it would be now, China, Russia, Iran and Turkey on one side and the U.S on the other, everyone else in the middle and needs to pick a side.

Trump wants to go it alone and if he manages to hold on to both houses in November, could be the U.S against the rest?

Taking a deep breath, the stars will really need to be aligned for the markets to get through unscathed.

Looking at the asset classes…

With the global equity markets in retreat and forecasts for corporate earnings less rosy than the previous quarter, it may well be time for some cream to come off the top, which could finally topple the S&P500, the Dow and in particular the NASDAQ that has outperformed the pair through the year. Expect the broader market to follow…

The EUR, European equities, and the FTSE MIB, in particular, are in the hands of Italy and Brussels… Greece and the Syriza caught the markets’ attention back in 2015. Was that the warm-up act for the main event?

Make or break for the Pound this week, as Theresa May and the team look to resolve the Irish border issue and close out a deal that would need to include a favorable trade deal. Will it be $1.40 or $1.20? The last time there was a bet on the Pound, it was a bloodbath…

Gold has finally found some support in spite of the current yield environment, a 2.2% gain for the current month an indication in itself of just how much of a knife’s edge the market is on.

It’s looking like a big short, it feels like a big short and the street is talking about a big short…