It is safe to say that Trade Wars are now in full throttle. Summer holidays are over before they even started. Last week, as the Fed delivered only 25 basis points of rate cuts, much to Trump's detriment, it compelled him to react and hash out a new 10% tariff on the last $300 billion worth of Chinese goods. The Red Dragon has now risen and is flexing its muscles. After China made several goodwill gestures to the U.S. by agreeing to buy U.S. agricultural products, to continue "calm talks" and to not indulge in hurtful commentary, Trump then slapped another round of tariffs.
Monday morning, the Chinese yuan fell over the key psychological level 7 vs. the dollar for the first time ever -- a record low. After all, U.S. tariffs can easily be offset by a weaker yuan. This will anger Trump even more, and now he will turn his duel towards Fed Chair Powell to lower rates even more. How long can this vicious circle continue? Ouch is all I can say.
Chinese markets are down 2% on Monday. U.S. 10-year bond yields are trading 1.77% with the 3-month/10-year curve at extreme inversion. S&P 500 Sep futures have broken below the 2900. Oil is down 2% and copper broke the support of $5800/tonne, the low of December 2018 during the market collapse. All key technical levels are being broken during August, when most had shut their screens off after the Fed FOMC meeting, holding longs and invested in the market as they held onto their strong faith in the Fed's unlimited money printing press, cheering the mantra "the trend is my friend."
Truth be told, Trump secretly does not want a trade deal until next year, only to magically agree right before November 2020 elections to show the American people how "great" he is. Also, he wants (rather needs) the Fed to keep cutting rates down to 0, how else can he achieve that than rattle the world cage and start a Trade War with every nation to make sure economic data is in turmoil. This will all be perfectly aligned for next year, when monetary accommodation is at maximum heights and then a snap deal announcement (even a fake one) will get the market to rally to even new levels. But first we must deal with the shock and awe.
Chinese market is built on a delicate house of cards. Even after years of deleveraging and reducing shadow banking products, there have been several bank closures, some of which have been sucked up by the state, but some allowed to fail. The Chinese market can be manipulated by the PBOC/CCP but it is still quite delicate. The global bond market has been signalling collapse for some time and as all asset classes are linked to each other (aka the "carry trade" argument, whereby investors buy all risk assets as central banks around the world continue easing monetary policy). The same unwind can cause a massive selloff in similar risky asset classes -- remember December 2018?
This market is not about fundamentals. It is about the expected blow-out in risk management and investors de-leveraging. The algorithms that had been chasing this market higher will now be getting flashing red signals and start chasing the market lower. Too bad hedge funds and all are long as they feared missing out on market rally. Emerging markets and China have been weak for some time. It is the U.S. that has been outperforming the rest of the world. The U.S. needs China to import much more than the Chinese need the U.S. to import from them. China is easily able to source its goods from other countries and has already been planning for this via Brazil, Australia and Middle East nations. The U.S. economic data will get worse and worse and its equity market is at risk of being sold down now.
The technical setup of the S&P 500 broke through the key wedge pattern and it can get ugly very fast as there is a lot of room down to 2850 first, and then potentially down to 2400 even. The Volatility index ($VIX) has been in a downward trading pattern -- and just recently broke out of its resistance to shoot higher, trading up 8% today to $18.78, with a lot of room to move to $25.
Quiet, illiquid markets mixed with big technical trend breaks, muddled up with an even more uncertain economic growth picture as the U.S./China go head to head, makes for a toxic cocktail of collapse in markets. Growth and cyclically geared assets like copper, oil and iron-ore will all get hit despite supply/demand dynamics in the short-term, taking their equities even lower.
The yuan is worth monitoring as China has warned speculative traders that they risk shorting the yuan as the government can take measures to starve off liquidity. One thing is certain, the markets will be weak going into the fall, forcing the Fed to likely cut in September on to try and support the market. It is too little too late, especially with a mad man at the helm of the U.S. market bent on getting his way and going all-in. Anyone remember the Fall of 2008?
