"A currency war fought by one country through competitive devaluations of its currency against others, is one of the most destructive and feared outcomes in international economics. It revives ghosts of the Great Depression, when nations engaged in beggar they neighbor devaluations and imposed tariffs that collapsed world trade."
- From "Currency Wars: The Making of the Next Global Crisis" by James Rickards (2011)
Maybe you thought equity markets were being tested. Perhaps we were surprised by just how severely mangled the U.S. Treasury yield curve became late last week in response to President Trump's plan to impose a 10% tariff on just about all remaining Chinese imports to the U.S. in response to China having reneged on past agreements to purchase large quantities of agricultural goods while the two nations tried to negotiate a lasting trade deal. Kids, you ain't seen nothing yet.
While most of you rested that greasy thing that exists between your shoulders, or at least tried to, the Chinese currency, the yuan, was permitted on Monday to smash through what has been considered to be the important psychological level of 7 to 1. The significance here is that this level had been defended in the past by the People's Bank of China (PBOC), that nation's central bank. The PBOC, by the way, is not independent of the government. One must keep in mind just how important it is to that Chinese government to be seen as in power, and in control. Especially as the city of Hong Kong falls into a state of increased civil unrest that on Monday morning leaves the city stricken by a protester led strike that has disrupted public transportation. Especially as that nation experiences an economic slow down that has impacted most of the rest of the planet to some degree or another.
What this move does, besides the obvious short-term advantage in cross border trade, is pressure US dollar valuations to the upside, and increase the rapid collapse of yields on the long-end of the US Treasury curve. The US 10 year gives up a rough 1.74% as I work my way through the wee hours. The focus upon the 3 Month/10 Year spread now stands at a grotesque -31 basis points. In fact, the 3 Month/30 Year spread currently would be less than 24 basis points away from an inversion of it's own. Nasty. In addition, Bloomberg reports that Chinese state buyers have now been asked to halt the import of U.S. agricultural goods.
When the planet's two largest economies take steps to "retaliate" and that condition spreads impact liberally around the globe, at what point do we start calling a trade war, what it is becoming... a currency war? Then, when will this currency war be recognized for what it probably also was all along? A cold war. I will happily be wrong about this. Just in case I'm not, folks better start getting used to facing multiple uncertainties simultaneously.
Does the weaponization of the currency by China pose any risks to China? Sure, it does. They're just out of ammo on the trade front. That quite probably does not mean the U.S. is any closer to winning anything. Watch for signs of capital flight. It is not just U.S. sovereign debt currently in demand. These yields are under pressure across Europe as well as in Japan. Haven seeking has now forced Gold in dollar terms to levels not seen since early 2013. By the way, Bitcoin may not present as a traditional vehicle for a "flight to quality" type move. That said, Bitcoin surely does present though as a way for citizens to get wealth out of troubled nations with damaged currencies. Bitcoin is up more than 7% on Monday, either as wealthy Chinese look for an exit, or speculators expect them to.
We have discussed at length in this space what the FOMC can or can't do in order to not just prevent the next recession, but to extend the current cycle. Should President Trump move forward with these new tariffs on September 1st (Remember, the president has merely proposed new tariffs, the Chinese have actually taken action), not just the Fed, but the ECB, the BOJ and the BOE will all be forced to get more aggressive with easier policy as well as easier signalling as perhaps they were ready for.
Obviously long-term yields for sovereign debt are already negative for Europe and for Japan. We talk about "pushing on a string" here in the U.S. These central banks are out of string. How much does it help to push negative rates more negative. Once the zero-boundary had been violated, savers had been destroyed, banking as a business became possibly permanently handicapped, and what was meant to provoke risk taking simply provoked the exact opposite, as the very idea forced consumers to hoard resources in preparation for what might be lurking ahead. Why do you think that both Europe and Japan have been unable to rescue themselves?
The only move of significance that might create at least short-term positive impact for Europe might be equity asset purchases. Japan has already gone this route, perverting forever the purity of price discovery, and very likely exhausting lasting benefit by becoming too large a player in these markets. A player that can never dare exit.
Oh, the U.S. president will almost certainly get his lower interest rates. I see really no alternative other than defending the U.S. currency and the U.S. economy should all nations follow each other down Alice's rabbit hole. An awful lot will happen, and it will not be good before anyone hits the reset button.
In The Mean Time
Equity markets suffered through their worst week of 2019 last week. Monday shapes up as pretty rough as well. Yet earnings have been printing far better than expected. According to FactSet, with 77% of the S&P 500 already in the books, the blended rate (results for those reported & expectations for those yet to report) for earnings growth is up dramatically from a week ago... to -1.0%. The blended rate for revenue growth for the index has improved also, to 4.1%. About the only basic stat for the index broadly that has not improved are forward looking PE ratios. As of Friday's closing prices, the S&P 500 is now valued at 16.8 times next 12 months' expected earnings. That's versus a five year average of 16.5 times. Overvalued? Only if earnings fall off of a cliff. Only if the badly inverted yield curve really does foretell a period of economic contraction.
Should investors become more comfortable in this more protectionist world, engrossed in both irresponsible monetary and fiscal policy at the same time, TINA will reintroduce herself. Equity valuations will rise, as debt securities can't go past face value. Right? Besides, wouldn't higher valuations for equities and higher costs placed on cross-border commerce be considered inflationary? Sarge, inflation is nowhere to be found. Got ya. What if... as global economies work themselves into contraction... central banks are forced against their will... to raise benchmark interest rates when they should be easing. Asking for a friend.
Coal For Christmas
A deal might be struck. Not today. Maybe tomorrow. Maybe never. Understand. Identify. Adapt. Overcome. Fear? Only for the wicked. August will be volatile. September will offer a monetary mosaic of economic thought offered up by people we probably shouldn't be listening to. October is well... going to be October. Tape on the foil, and fight the way you were meant to. Glory might be found in both victory and defeat, but the heart must be pure, the effort valiant. Santa? You're coming this year, aren't you. It was the year without a....
That said, we'll get through this. We'll get through anything. Together. Why? Because we are team. We help each other. We move only as fast the slowest among us, and we watch each other's back. Now go, and win.
Economics (All Times Eastern)
09:45 - Markit Services PMI (July-F): Flashed 52.2.
10:00 - ISM Non-Manufacturing Index (July): Expecting 55.5, Last 55.1.
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