Opening Week Liquidity – We are heading into the first trading days of the new year
though it is not the first full trading week of 2020. That is an important distinction for those keeping tabs. Consider the throttling in activity and speculative appetite through the past week. The holiday conditions of the Western World drained market depth to effectively hobble any effort at establishing or extending trends – though there were a few notable sparks of volatility that were the result of the same illiquid backdrop. That is going to be even more pronounced in the week ahead. New Years is a bank holiday for virtually the entire financial system. That will make conviction even more difficult to muster. When trend development (momentum) and follow through on breakouts is difficult to muster, my default is typically to filter for opportunities that are more convincing range trades. However, the shallow markets will make volatility even more a complication to probability-based trading than normal. For anyone with less than a high level of risk tolerance, it may be better to sit on the sidelines until the follow week restores markets in earnest.
Though market conditions are unusual this week, that doesn’t mean that there is an equivalent lack of technical or fundamental event risk. Consider the Dollar for example. The benchmark currency is on the verge of a reversal to a more-than 18-month bullish trend channel that also sports the most remarkable restraint in terms of activity level (ATR) seen on record. At the other end of the spectrum, you have the US indices which have pushed to record highs both through periods of low and high liquidity. On the fundamental side, there are a number of scheduled events that should register. Proxy growth readings are on tap for the largest economies with the run of Chinese government PMIs and the ISM’s US manufacturing report both due. The former is an overview of a country being pushed on too many sides and the latter reflects an actual recession in factory activity (not an isolated malady for the US). Manufacturing reports for other countries, the FOMC minutes, US trade report and a range of auto sector reports will also register on my radar. However, a more systemic matter to keep in mind is China’s plan to lift a range of tariffs on a host of global counterparts starting on January 1st – though this list does not include the US. Is this a shift towards more growth-supporting open trade or does it end up adding to the provocation with the US?
Top Events for January
Looking further ahead to the first full month of 2020, there is the regular density of high-level event risk across global powerhouses in both the developed and emerging market worlds. That said, I will keep my attention more actively directed towards systemic themes whose threat has posed serious threat to the long-disputed stability of a ten-plus year bull market. The most representative matter seems to be trade-related concern. Beyond China’s plans to lift tariffs against a range of counterparts this week, we should keep a close tab on release of details on the Phase 1 trade deal. Both sides have hailed their compromise since October yet we are still critically lacking for the practical terms that will usher us to a full de-escalation of economic tensions between the two largest players on the board. According to US Treasury Secretary Mnuchin, the two may sign early January.
Trade issues aren’t unique to the US and China relationship. There are a number of active import taxes between the US and Europe at present. The US quickly slapped tariffs on certain provocative European imports (particular agricultural goods) after the WTO ruled this past year that the country could pursue over $7 billion in restitution for unfair subsidies afforded to Airbus. After a ruling earlier this month that the EU has still not lifted support for the airplane manufacturer, the US said it would consider escalating its effort. That decision could come in January. To add further complication, the WTO may deliver its decision on the US’s support of Boeing which could greenlight European tariffs which they would likely pursue wholeheartedly. Further, we are also waiting for the US to follow through on stated plans of retaliation for France’s digital tax that is raising cost to large US tech companies. Yet another front on trade to mind is the Senate’s decision to take up the USMCA agreement which could finally write off the replacement of NAFTA for a clear North American relationship – the first true resolution (for better or worse) of trade disputes. And of course, lest we forget, the extension of the Brexit decision expires on January 31st which is expected to see the previously struck withdrawal agreement push through after the conservative’s victory in the general election three weeks ago.
The two other prominent themes that I’ve been following through 2019 find far less top level event risk to trigger provocation – though they can hardly be written off. Recession fears have notably abated since the US and China revived their confidence on the Phase 1 deal. That said, the quality of growth-related data has not improved materially, rather the interpretation of the same data has taken a more notable optimism. That could quickly fade by seeing capital market performance stagger. The markets are indeed that fickle and superficial. As for the effectiveness of monetary policy, there is one particular rate decision that is on my board: the January 29th FOMC rate decision. After reviewing its objectives through this past year, the world’s largest central bank is due to offer its assessment of what may need to change in its targets and policies. Depending on the mood of the market, this could be readily interpreted as evidence that monetary policy has lost its potency – and perhaps even its ability to maintain calm and buoyant asset prices, which would be a disaster if ever realized.
Top Events for 2020
In the scope of an entire year, many fundamental developments will transpire that take control of both volatility and direction regionally and globally. Through that 12-month span, many of the most meaningful drivers are likely to be completely off the script that we have in scheduled events that we start off with in January. These developments that are related to generally known themes and carrying a significant level of impact can fit into the category of ‘grey swans’. Most are familiar with term ‘black swans’ which refers to extreme developments that were largely unexpected by the vast majority of market participants – and which are readily interpreted and retroactively explained to have been ’obvious’ after the fire is put out and the dust settles. We cannot reasonably speculate and trade around black swans because their extremely low probability makes for very bad trading statistics and worse timing. Grey swans on the other hand are far more reasonable.
Through all the open-ended matters, there are a few particular matters with rough scheduling that I will watch as inordinately influential on local currencies and capital markets. The first is the Brexit transition deadline. According to the original timeline for transitioning from member of the Union to independent country with trade relations aligned with EU members, the situation should be wrapped up by end of December 2020. After the delays in agreement to the exit, it would be expected that there also be an extension requested of the transition – a period for which the UK would still be beholden to some unfavorable European laws. However, Prime Minister Johnson suggested after the election that he would attempt to make a request for extension illegal. This is a decision that is far out, but its impact will be felt constantly with interpretations of remarks and negotiation updates, with sudden spells of volatility and proactive restraint in progress for the Sterling. Another matter that is well accounted for is the state of the US-China trade war. Taking the optimistic interpretation and say Phase 1 is finally signed off on by all those that hold sway, we still need to move to Phase 2 which is the real heavy lifting. A demand of full tariff roll back by China and the US requiring committed purchases along with intellectual property protections are difficult to come to terms on. Will they accelerate progress to ward off an unintended recession or will China wait until after the US election before it takes the cost-benefit seriously?
Speaking of the US election, this event will likely prove a global event with considerable build up in capital market performance. Generally speaking, the market is agnostic to party, however, the influence of protectionism amid populism that has taken hold in different regions of the world are difficult to miss at this point. Trade wars – at least in their present form – are a direct result of the ruling parties’ policy mix. What’s more in the US, the extreme bifurcation in political norms has created a familiar state of gridlock when it comes to pushing growth-supporting initiatives like the infrastructure investment fiscal stimulus that was part of the 2016 campaign trail while government shutdowns are a near constant threat as the deficit balloons to record highs. These are serious matters, but the market can decide to play the risks down as they have in the past. Yet, with a prominent election ahead, I suspect these matters will draw far more attention in 2020.