It seems that August is about to end as volatile as it started. The market seems to ignore the variety of economic data this week on the heightening of negative risk sentiment. The latest escalation in US-Sino trade tension, the Brexit clock counting down, the Italian government’s crisis, and tensions in Hong Kong and between Japan-Korea are heating up once again and it seems that markets behaviour turned on these events and on September’s developments.
It is not that economic data are not important, however we need to look afar and focus on the big picture.
The global slowdown has been additionally confirmed by US and UK curve inversions, the Japanese consumption tax hike is on October, Central Banks are primed for more stimulus in September driven mainly by trade war, while the implementation of 10% tariffs on a further $75 bln of US goods from China is on Sunday (September 1st), along with the first tranche of US tax on Chinese products which will go into effect the same day!
China’s announcement on Friday for retaliatory measures to go into effect September 1 and December 15, countered the United States’ planned actions. Meanwhile, the PBoC set the Yuan’s reference rate at a new 11-year-plus low. As a response, President Trump applied an additional 5% approximately $550 bln to Chinese imports. Given his history on the trade front, more retaliation would appear to be in the cards; at least this is how markets have interpreted things.
The big question is whether the existing state of affairs is the new standard from now onwards !
So far, this is what it seems to be happening, as everything points out that economy might be in a significant turning point, with the latest proof seen in the selling of Germany’s first 30-year Bund with a zero coupon, which coincides with a period of further Fiscal Expansion possibility.
Today’s latest poor data in EU and I am referring of course to the German Ifo, disappointed once again, with the headline number at the lowest level since November 2012. The report was expected to add to warnings from the Bundesbank that the economy may continue to contract in the third quarter, which would leave the overall economy in technical recession after the decline in Q2.
Geopolitical trade developments and Brexit uncertainty are largely to blame, with the weakness in manufacturing now starting to impact the overall labour market and other sectors. So far, the sector breakdown of the Ifo still shows that optimists outnumber pessimists in both services and construction, but with the trade reading now also in negative territory and especially services confidence falling sharply in August, the balance of risks is clearly tilted to the downside.
Apart from the trade war affecting Eurozone’s economy and adding pressure on ECB to prepare another package of easing measures in September, the US trade policy also drives the Fed policy expectations as well. These market actions and reactions we have seen the past 3 days will up the ante for the September FOMC meeting. Hence, despite Powell’s efforts last week to pullback any aggressive scenario, expectations for an aggressive 50 bp easing will rise measurably if the trade rhetoric remains heated. A close eye will be kept on the next potential shoe to drop, which would be another breakdown in US-China talks, currently slated for September.
Brexit jitters also remain on the agenda as UK parliament returns from summer recess on September 3. UK PM Johnson repeated that the UK is prepared for a no-deal scenario, however, the most recent Reuters poll on Brexit, which was published earlier in the month, found that while the odds for a disorderly no-deal, no-transition period Brexit had risen to a median probability of 35%, the most probable outcome was still for a deal being struck.
It is in this context that last week’s upbeat remarks from Germany’s Merkel triggered a buying reaction to Pound, although her comments were little more than platitudes; a stage-managed show of reasonableness. What’s clear is that there isn’t any sign that “alternative arrangements” proposals to the Irish border backstop guarantee would be satisfactory to Ireland and the EU as a means of ensuring that the Good Friday Peace Agreement isn’t broken. The possibility for a general election hangs in the air, which would, even if it is held after October 31, boil down to a straight contest between an alliance of pro-EU parties and pro-Brexit parties. That may be the point at which Brexit is once and for all decided on.
Hence as we will soon enter September, August and more precisely the current week is critical as it might provide a reflection of the upcoming month’s outlook. August has been challenging even though it isn’t over yet. Nearly all the major global indices have dropped over 4.5% this month, with even larger declines in the NASDAQ (-5.2%), Hang Seng (-5.8%) and FTSE (-6.5%). This might continue especially amid an increasing turbulent geopolitical backdrop and extended growth slowdown.
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Andria Pichidi
Market Analyst
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