A funny thing happened on the way to the Jackson Hole forum.
Stephen Innes
While the markets are accustomed to his scathing attacks on Jay Powell, but similarly painting President Xi an enemy of the U.S. with the same brushstroke sent shockwaves through global capital markets. It was Trump’s heightened aggression that sent the dollar toppling as it threw more fuel on the currency war debate.
With President Trump’s latest tweets sounding like things are about to re-escalate considerably, no one wanted to be caught short USD, Fixed Income or Gold heading into a weekend fraught with the potential G-7 headline risk.
No G-7 Reprieve
For those looking for a G-7 reprieve well keep looking. The summit of world leader event devolved into a bemusing tableau when at breakfast meeting Sunday, the US President suggested he had “second thoughts” about those tariffs, noting he had “second thoughts about everything”. The White House press secretary later clarified: those second thoughts stemmed from regret about not “raising the tariffs higher”, indeed the Nash equilibrium in a repeated game. All of which suggests not only is further escalation likely, it’s the base case outcome.
Jackson Hole
The FOMC minutes painted a visible split on the committee, so the markets had already cooled the 50 bp view which was priced out, and likewise, currency event volatility had all but evaporated. Thus, the bar was low for a Jackson Hole surprise, but after Chair Powell’s July FOMC “mid-cycle ” crisis, there was a concern for another communication mishap.
Thankfully Chair Powell avoided setting the Snake River on fire. Instead, he used the Jackson Hole symposium to clarify matters. Overall the speech sounded slightly dovish at least relative to the markets low bar expectations, and mostly because it allows the market to continue debating a 50bp cut in September. However, whether it’s a 25 or 50 bp cut, there’s a growing chorus more now than at any time in this testy period of trade war escalation the destination of US rates is zero.
Oil Markets
The thud heard around oil markets on Friday was the result of a timely but not unexpended tit for tat trade war escalation by China.
The tit-for-tat tariff dispute between the U.S. and China has already sent oil prices tumbling in large part because of worries about a severe global economic slowdown and potentially even a U.S. recession.
However, to the degree, these added tariffs will hurt U.S. production is questionable as other than the preferred exporter of last resort for the excess Cushing barrels, U.S. crude imports into Beijing plummeted almost immediately after the tariff war escalated and were expected to grind to a halt after the US levied the next wave of tariffs.
The 5% China tariffs on US oil imports are less significant for oil flows between the two countries than they are for what they say about the likelihood of a near-term resolution to the trade dispute.
Markets are very tight in Cushing, and with Baker Hughes rig posting a most significant weekly decline since late April “prompt” WTI supplies, may not get much easier anytime soon.
However, with the delicate balance in oil markets precariously perched one negative trade headline away from a significant sell-off, with oil markets now ” officially ” caught in the trade war tussle, the trap door opened on oil’s fragile recovery sending a tsunami of negativity sweeping through the oil patch on Friday.
Oil markets remain in a trade war funk, and with constant trade war overhang, the markets are prone to turn even sourer if there is no definitive evidence of progress on the US-China trade talks. Given that thawing in US-China tensions is all but a pipe dream at this stage, as it appears both sides are happy to move forward with their scorched earth policy, no winner everyone burn. So, the path of least resistance for Oil markets does appear lower.
Gold Markets
Gold was the beneficiary of President Trump’s tweetstorm on Friday as Gold provides the ultimate haven for any dollar intervention threats. Escalating Trade War and the weakening Yuan increase the odds of a currency war but when framed by dovish central bank policy, Gold sits at the top of the mountain or reasons to stay hedged against a possible equity market rout.
Currency Markets
FX strength or weakness mostly depends on what side of the currency war debates you’re on. In the meantime, risk-off is the safest direction; USDJPY lower.
As for currency war, it was hard not to get involved on Friday as the markets aggressively sold dollar fearing President Trump was going to unleash the currency war bazooka. However, I think the market reaction was very telling. Specifically, that currency war is not even close to being the markets base case scenario. The EURUSD rally fizzled at 1.1150 hardly the volatility one expects from a market pre-positioning for a full out currency war.
However, the mere threat alone should keep the dollar on the defensive over the near term.
Currency War
Besides a triple shot of Fed easing which is starting to look more like a lock, the most effective way to weaken the USD, particularly vs the Yuan in a currency war scenario is for the US Treasury to buy Chinese Government Debt. Of course, funding President Xi’s BnR ambition will leave a sour taste in Trump’s mouth, but it is the logical action to both sterilises the effect of China potentially selling UST’s while effectively strengthening the Yuan.
Reading the Yuan tea leaves.
Trading the Yuan for any currency trader I know is a substantial occupational hazard,
USDCNY will very likely be fixing higher this week (Monday and after) – dragging USD-Asia higher with it.
CNY deprecation during the previous trading sessions has mostly gone unnoticed. However, Fridays slightly stronger Fix than expected had market commentator suggesting the strong Fix was a signal that the PBOC wants to temper the CNY depreciation at least.
Of course, we’re not buying any of that with 300 billion in tariffs hanging over China’s head, and neither were other Yuan traders who bid the offshore USDCNH above 7.10 on Friday.
History tells us that the Pboc is very calculated with this messaging and its something never trivialised by traders.
For the rest of Asia, currency markets took notice of the Yuan weakness on Friday, but for any unfortunate traders that held on to their USDASIA shorts over the weekend, they’re sure to pay the piper this morning.
More on ASEAN markets and Hong Kong after the China Fix
Trump Put Strike
I suspect the latest market meltdown will continue to turn President Trump to turn increasingly anxious about an economic slowdown that is manifesting on the cusp of the U.S. elections run.
Trump will not capitulate on the trade war. Instead, he will likely toggle other dials. However, as far as a Payroll tax cut, it’s improbable as it pays for social security and no way this passes in the House of Representatives, but we should expect more fiscal trial balloons to float in the weeks ahead. Ultimately, signals are increasing that the Trump put strike is little more than a hop skip and a jump away from at-the-money position.
This article was written by Stephen Innes, Managing Partner at VM markets LLC
