One day after the Federal Reserve completely confused markets by following up a dovish policy statement with a hawkish press conference, the environment provided for investors evolved further -- and not in a good way. What becomes apparent is that President Trump must have felt lied to. Reportedly, against the advice of some of his closest advisers, the president took to Twitter, and in a series of posts, informed the world of his plan to impose a 10% tariff on virtually all of the remaining Chinese imports (about $300 billion worth), not already facing tariffs of 25% (roughly $250 billion worth).
Just like that, equity markets turned on a dime. Levels just regained from an FOMC-induced decline were now re-lost, capital flowed into the long end of the Treasury curve, badly mangling the most focused-upon of all spreads -- the 3-month /10-year. After coming this close >< to un-inverting earlier this week, that spread stands at -24 basis points as we pass through the zero-dark hours of Friday morning. In addition, commodity prices with the acute exception of gold as a safe-haven, tumbled as prospects for improved global growth not only dimmed, but allowed U.S. dollar valuation to find support at elevated levels.
The new tariffs go into effect, if nothing changes, by September 1, and cover everything from smart phones, computers, toys and clothing, to household products. I think the insult that the president likely felt is expressed by Trump's Tweet: "China agreed to buy agricultural products from the U.S. in large quantities, but did not do so." The president also complained that China had done nothing toward stopping sales of Fentanyl into the U.S.
What do I often tell readers and listeners? If it makes you nervous, reduce it until it does not. Seems simple enough, right? Not really. I know it's hard.
I have felt that an easier monetary policy would lead equities to higher valuation multiples. That is still true. Certainly, the ECB can be expected to be aggressive. Perhaps very aggressive at this point. The Bank of England and the Bank of Japan will likely look toward easier paths, as well. Keep in mind that Japan has now removed South Korea from its list of preferential trading partners. The world is in a tougher environment. Understand. As global growth weakens to the point where global contraction becomes a threat, the reality of trade wars will, in my opinion, devolve into more overt, less covert currency wars.
Catastrophe has a way of not happening. That has been said, and for the most part, it's true. However, most of the horses are still in the barn. Market indices are close enough to their apex where profits can be taken and cash be raised intelligently. It's already happening. Trading volume has increased at both of New York's major equity exchanges for a second straight day. I don't think you have to wonder if the funds are participating. They are.
Earnings season now reaches its latter stages. The numbers have been better than expected. That fact just became much less important to equity prices than is the guidance on trade -- given that for all firms, but especially those most exposed globally, that now must be questioned.
President Trump's deadline for these new tariffs is September 1. The European Central Bank (ECB) likely eases policy in aggressive fashion on September 12. The Federal Reserve and the Bank of Japan (BOJ) step to the plate together on September 18. Then, the Bank of England decides the next day, on September 19. All four-to-six-weeks out.
Sleepy summer? You better be mentally ready for this. Identify. You know what's right for you. Fear? Never. Adapt. It keeps getting harder? Overcome. We can do this, gang. We were born for a desperate battle against overwhelming odds. This is what we live for.
Sick of hearing me opine on what the Fed should be doing? The policy moves made this week were correct. I'll give them that. (How'd you like to be one of the two clowns that dissented? Talk about a lack of situational awareness. Gee whiz.)
Facts are facts, and the central bank is certainly going to have to play an increased role in managing the nation around elevated levels of risk should this next shoe in the trade war actually drop.
My guess? China retaliates. These additional tariffs are implemented and 10% is a starting point. The Chinese economy continues to rapidly slow down. The global economy slows further. The U.S. economy is adversely impacted. If you see canned beans on sale at the grocer, load up. Then again... that's just a guess.
We already know that purchasing managers are holding back. That will at some point impact labor market development. We know that consumer credit is growing annually above gross wage growth, but not necessarily above after tax wage growth since the tax cuts. Thank goodness. That consumer, who is walking this tightrope formed the backbone of Q2 GDP that surprised to the upside. The yield curve must be defended. Aggressively if necessary. The U.S. banks must remain healthy.
This morning, German 10-year bunds yield -49 basis points. U.S. 10-year notes yield 1.85%. That spread is still intact. This international demand is why the Fed has been unable to provoke higher interest rates at the longer end of the curve. Got it.
That spread normally spans a range of 2.33% to a little over 2.4%. Almost never varies. This game is not hard. This is one big reason why the dollar is valued the way it is. You need the dollar to buy American sovereign paper. Simple enough. Everyone still here?
Command and Control
The U.S. Treasury Department is projected to issue at least $200 billion more than previously thought over the next few months. It is expected that Treasury will borrow most of this dough at the short end... 30 day, 90 day, 180 day, and 1 year T-Bills. Through this issuance, supply at the short end will be greatly expanded. That potentially exacerbates the inversion of the curve. Unless foreign investors who can't believe they can get 2%+ for short-term debt snatch up everything they can get. That makes sense. It also further increases demand for dollars.
The Fed, if they are on their game (this is asking a lot), would be smart to compete with these foreign buyers on the short end in order to decrease available supply, thus suppressing yields for paper maturing in under two years. The Fed could create the currency out of thin air to do so, a strategy we know as "quantitative easing."
That at least expands the monetary base amid increased demand. Better I think that the central bank sells 2-year through 10-year paper out of inventory in order to realize the funds required. This also puts upward pressure on yields further out on the curve. Treasury could assist in this effort by borrowing less on the short end than planned, and instead put product out at 20, 30, 40 and 50 years. Yes, that means getting creative. These problems don't fix themselves. Hope, my friends is not a plan. You can lead. You can follow. Do not stand in the way.
In what might now be the least focused-upon monthly jobs report of the recent era, the BLS will go to the tape on Friday morning with their numbers. What to watch? More than any other item, wage growth remains key to this release from a macroeconomic perspective.
Average hourly earnings are expected to rebound to 3.2% y/y this month, coming off of June's 3.1%. Bear in mind that this growth stood at 3.4% as recently as February, and ending this erosion is important to the success of the report while maintaining recently improving levels of participation.
Pay no mind to the headline unemployment rate. More important will be the U-6 rate -- the underemployment rate. Yes, job creation rebounded last month. However, this measure of demand for labor actually went the wrong way in June, from 7.1% to 7.2%. Remove the seasonal adjustment, the real change was from 6.7% to 7.5%. Ouch.
Sample Portfolio Allocation (Just an Idea)
Equities: 55% (downward bias versus multinationals)
Debt securities: 17.5%
Cash: 20% (upward bias)
Gold: 7.5% (maintained), 2/3 of which would preferably be in the physical.
July Employment Situation - 08:30 ET
Non-Farm Payrolls: Expecting 161K, Last 224K.
Average Hourly Earnings: Expecting 3.2 % y/y, Last 3.1% y/y.
Average Workweek: Expecting 34.4, Last 34.4 hours.
Participation Rate: Expecting 62.9%, Last 62.9%.
Unemployment Rate: Expecting 3.6%, Last 3.7%.
Underemployment Rate: Last 7.2%.
Other Economics (All Times Eastern)
08:30 - Balance of Trade (June): Expecting -$54.5B, Last -$55.5B. Flashed 98.4.
10:00 - Factory Orders (June): Expecting 0.7% m/m, Last -0.7% m/m.
10:00 - ex-Transportation (February): Expecting 1.0% m/m, Last 0.1% m/m.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 776.
The Fed (All Times Eastern)
No Events Scheduled.