Dow hits record high amid trade wars; dollar ‘weak’ ahead of Fed
Sterling pound slides with Brexit
There are few overt reasons to be relentlessly bullish in the markets, but that doesn’t seem to be holding speculators back. Risk trends soared through this past week, stretching beyond the bounds of the habitual single-direction benchmarks in the US indices. Though more nuanced, it is remarkable to note this past week that where the blue-chip Dow Jones Industrial Average charged to a record high, the speculative-favorite Nasdaq did not. Meanwhile, other global equity indices (DAX, FTSE100, Nikkei 225) may not be at records but their pace is far more impressive. Where is this enthusiasm originating? That may not matter for pure technicians but it certainly matters to those weighing markets for motivation though fundamentals. ‘Animal spirits’ can be a powerful catch all, but its use should be more thoroughly vetted when the laundry list of threats is as long as it is now: trade wars, emerging market instability, monetary policy shifting etc. It would be foolish to right off the potential for further stretch, but we should choose vehicles wisely. A record high cost limits risk-reward for US indices, but discount in Emerging Markets (EEM), commodities as risk assets and Yenbased carry trades have value. That said, the contrast between US equities versus practically everything else should raise suspicions over the appeal of chasing risky gains.
This past week, the Dollar suffered a critical technical breakdown. The DXY Dollar Index broke a rough ‘neckline’ on a head-and-shoulders pattern and the EURUSD registered the same progress just in reverse. It is difficult to dispute the appeal of the charts, but that doesn’t make it certain opportunity. What was the spark for the benchmark’s tumble this past session? To assume its safe haven role has conveniently kicked back in despite its jostling for carry trade position or the suggesting trade war blow back is now an issue while sentiment seems to be casting the threat aside seems disingenuous. I personally don’t see a particularly compelling reason for this critical break to transition into a prevailing trend. Instead, we should be more critical of the technical cues that would bait us in with no questions asked. Where EURUSD has marked its break relatively cleanly, other breaks are loaded. GBPUSD’s break was a function of Brexit and that them has changed course. NZDUSD’s impressive channel reversal was prompted by the New Zealand GDP and the RBNZ is ahead. Meanwhile, we are still standing on the boarders of bearish Dollar moves from the likes of AUDUSD, USDCAD and USDJPY. That will make the event risk and themes for the week ahead even more important to signaling trades. The Fed rate decision is higher profile with an expected hike (near certainty in swaps of a 25bp move to 2.00 - 2.25 percent) and updated forecasts. Yet, I will also keep tabs on President Trump’s discussions with international counterparts at the UN, updates on trade war retaliations and political risk headlines heading into the mid-term election.
The US-Chinese trade negotiations aren’t the only mediations that are moving headlong in the wrong direction for economic and financial health - yet they are the largest. The status of this degrading relationship is awaiting any indication that China will add to its rather meager $60 billion retaliation to the United States’ $200 billion upgrade in its tariffs against China, and whether President Trump will follow through on its threat to go all in (tack on another $267 billion in duties) for any retaliation China sought. Meanwhile, the US has kept the pressure up against Canada in their discussions to replace the NAFTA agreement. A White House advisor suggested we would soon reach the cliff where the US would go it alone in a bilateral agreement with Mexico and without Canada if a compromise wasn’t met. The Canadian Dollar still reflects rather little worry despite this situation being stretched out for weeks. As for the Brexit negotiations between the United Kingdom (UK) and European Union (EU), the state of play is materially worse. After the EU leaders rejected the Chequers Proposal outright after its Salzburg summit, Prime Minister May delivered a speech suggesting the ‘no deal’ outcome is perhaps now more likely than actual compromise. The Sterling took a vicious hit for the news, and it has further room to retreat if officials don’t do some triage.
While we should keep close tabs on the dominant themes and most liquid players in the system, we should also not presume absolute clarity in their bearing. That will mean trading these considerations and markets will require thorough analysis and certain finesse. However, if you want your trades to be more straightforward though perhaps holding out less potential - there are more discrete options to follow across the markets. In the FX market, the New Zealand Dollar posted an important, bullish technical break last week with the 2Q New Zealand GDP beat. To turn the break into anything resembling a trend, the upcoming Reserve Bank of New Zealand (RBNZ) rate decision is crucial. This is a carry currency that has lost all its carry appeal. Over the weekend, a two-day OPEC meeting will weigh on supply figures under the glare of headlines that quote President Trump demanding price relief for the oligarchy. I remain dubious that the event can supply a clear bearing, but it can generate volatility. And, an unusual glance into the more restrained cryptocurrency arena, this past week registered a massive rally from Ripple. Up nearly 200 percent in a week’s time at Friday’s high, volatility is not unusual in speculative assets. But don’t presume we are having a redux of the Bitcoin boom of late 2017.
In a week where US household wealth gapped up to $123 trillion, investors continued to pour money into exchange traded funds that track US indices. The three main markets shrugged off trade war fears and pressed higher, with the exception of the NASDAQ. Still, demand for the tech-heavy index was similarly robust.
Increased exposure comes at a time when the indexes approach record levels and confidence in the economy is equally high. Last week, small business confidence hit a 35-year high and then ISM manufacturing boasted the highest levels since 2004. Further, a leading indicator in consumer confidence also hit an 18-year high in August.
Next week will also mark the end of the third quarter as we look to enter the fourth with record confidence and equity valuations. With that in mind, the data above left out Friday’s fund flows. Index overseers conducted ‘Quad witching’ on Friday, rebalancing indexes and modifying some sector compositions. The rebalancing often results in unusual volatility and volume, potentially distorting conclusions drawn from the above. In next week’s report, the data will be included and accounted for.
The week ahead boasts a couple of notable event risk starting with the Reserve Bank of New Zealand interest rate announcement.
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