Hollywood can make a horror movie out of last week’s bloodbath in the financial markets titled “Revenge of the Tariff Man”. A day after the Powell Fed dissed him with no real promise of an aggressive monetary easing, President Trump tweeted his intent to impose a 10% tariff on $300 billion in Chinese exports to the US on September 1st. This tweet had a seismic impact on global markets. The two-year US Treasury note plunged an epic 17 basis points to 1.72% as the capital markets priced in global recession and four Fed rate cuts.
Crude oil plunged an incredible 8% and Dr. Copper, whose alleged doctorate in economics is an advanced recession indicator, fell 3%. The US stock market had its worst week in 2019 led by a 900-point fall in the Dow, with the S&P 500 index down 3% and NASDAQ down almost 4% to the critical 8000 level. The Volatility Index almost doubled last week to 18. Something is dangerously unsettling in a world where a Presidential tweet alone can wipe out $1.2 trillion in Wall Street equities alone. Sadly, my call for financial fireworks in August was vindicated with a vengeance.
The 10 year US Treasury note had its worst weekly decline this decade, down 22 basis points to 1.86%, the lowest since Trump’s election in November 2016. The Chicago Fed Funds futures markets now prices a 99% – I repeat: 99% – probability of a 25 basis point Fed rate cut to 1.75% at the September FOMC. The only reason the US dollar did not plunge is due to the macro woes of the Euro, sterling and the Chinese yuan, whose offshore NDF hit the critical 7 renminbi level against the greenback.
Trump’s latest tariff threat is a game changer in international financial relations. The Osaka truce is kaput. China will be forced to retaliate against US exports to the People’s Republic. US consumer goods prices will rise, led by a $100 potential rise in Apple’s iPhone. If enacted on September 1st, the tariffs will negate the impact of the tax cut on the US consumer and business sectors.
The 10% tariff could be a Trumpian negotiating tactic to kick start stalled trade talks in Shanghai. Yet the escalation in the trade war forces Beijing to take “counter-measures to resolutely defend the core interests of the country” as the PRC Commerce Minister promises. Chinese retaliation could exact a heavy price from Washington. Beijing could boycott US imports, from Boeing jets to soybeans to Silicon Valley smart chips.
The Politburo could order the PBOC to devalue the Chinese yuan to nullify the tariffs – and trigger a 1930’s style currency war. China could ban rare earth metals exports and thus disrupt global tech supply chains. For both Washington and Beijing, this spat is no longer about trade but national security, the Thucydides trap enacted two and a half millennia ago in the Peloponnesian War – though President Xi should never forget that Athens won and Sparta (his side) lost. A rising power challenges the global superpower only at its own peril.
President Xi Jinping faces an economic shock even as he faces a crisis of political legitimacy with the revolt in Hong Kong. The world’s two largest economies are engaged in a titanic, zero sum economic struggle. The Chimerica model of the pre-2008 decade is dead. There are no winners in this tragic Sophoclean game of global economic chicken. The revenge of the Tariff Man is lethal.
Mario Draghi made it clear at the last ECB Governing Council meeting on July 25 that he has abandoned the Maastricht Treaty mandate of price stability and committed his successor to a quest for a 1.9% inflation target with a symmetrical response to deviations above and below this target rate. This deliberate sophistry about Maastricht is the ECB President’s response to the free fall in German factory orders amid a deflation big chill across the Old World.
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The choice of Christine Lagarde, a French politician and not Dr. Jens Weidmann, the hard money Bundesbank chief, as the next ECB President now makes perfect sense. The Frankfurt central bank is on the verge of the mother of all asset purchases to nudge down its negative bank deposit rate. Draghi’s swan song to the financial markets is “the outlook is getting worse and worse” – a manufacturing recession in Europe is an ugly existential reality now, despite seven years of Draghi’s monetary stimulus, a true “mamma mia” moment for the Eurozone.
It is a cruel irony of fate that Madame Lagarde takes over as ECB President on October 31st, D-Day for no deal Brexit. She will accelerate Draghi’s promised monetary stimulus even though the 10-year German Bund yield is minus 50 basis points, a post Bismarck low, while using her clout at the Élysée Palace to pressure the Frau Reichskanzler in Berlin to green light fiscal stimulus. This sets the stage for a softer for longer Euro, whose depreciation could well exceed my 1.08 target level.
I had written a column recommending a buy on the Canadian dollar at 1.3450 in May and booking profits at 1.3050 in July as I thought the strong loonie trend was exhausted amid King Dollar’s rampage. Now that the loonie is at 1.3240, I am not willing to buy it at these levels as I was unsettled by the 8% plunge in the West Texas Intermediate crude in a single trading session and must study the Bank of Canada’s smoke signals on its global growth outlook.
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Ottawa could well opt for a preemptive rate cut this autumn while lower crude oil, a US-China trade war and lower global growth are all bearish for the Canadian dollar. The plunge in US Treasury note yields reprice expectations of Fed monetary easing far more than is the case with the Ottawa central bank. I would not be surprised to see a Fibonacci retracement of the May/June trading range to 1.33. There are also new, weak loonie long as the latest CFTC trader positioning report attests. This means a tangible risk of weak long loonie liquidation. The spike in implied volatility is in the FX option markets and seasonals will also pressure loonie. I can well envisage the Canadian dollar to depreciate to 1.3360 as risk aversion sweeps Bay Street, with its heavy metal exposure.
The election of Boris Johnson, the one vote Tory majority in the House of Commons after the Lib Dems won the Wales by election and the refusal of the EU to concede on the Northern Ireland border as a prelude to negotiations have shredded all global investor confidence in sterling. Sterling now trades at 1.21, its lowest level since the 2008 global financial crisis (apart from a flash crash fall to 1.18 in October 2016). Even the Bank of England has warned about panic selling in sterling if no deal Brexit happens on October 31st and Sir Richard Branson predicts sterling will fall to parity against the US dollar, crashing below its 1.05 lows in 1985.
Sterling’s ghastly plunge last week was reminiscent of a free fall in an emerging markets FX crisis, not the price action of a major G-10 currency. Emperor Nero fiddled while Rome burnt and Prime Minister Johnson pledges a “do or die” Brexit on October 31st as the hedge fund herds gang up on sterling, an eerie replay of Black Wednesday on September 15, 1992. The risk of wild sterling moves in either direction has never been higher, though no deal Brexit equates to much lower cable, as low as 1.02-1.10, as J.P. Morgan and Nomura currency strategists predict. A potential US trade deal, a Johnson U-turn on his hardline stance and the return of Parliament from the summer recess are all sources of a sharp sterling short covering rally. I miss Theresa May and so does sterling – “ain’t no sunshine when she’s gone”!
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