Trade War and More

Tariffs tend to dampen the economy at a snail’s pace although the micro effects are more immediate. The direct impact on US GDP will be small and impossible to measure over the near term.

Based on the last big four tariff announcements market capitulations presented buying opportunities, so in a similar fashion we think this current catharsis should not be interpreted as a time to sell USDJPY and US stocks.

Let us see what the market is telling us; as markets seldom if every lie.

With the US equity futures positions near the top of their historical range markets were always prone as US equities typically see modest selloffs quarterly. The uninterrupted 25% rally since late December is an  anomaly, not the norm, but it was the uptick in volatility last week that caused systematic strategies to pair risk as they were running at or near peak exposure. Indeed, this triggered large outflows from equity funds while robust inflows into bonds continued.

Damaging news flow aside, last weeks price action hardly suggests sentiment has fallen off a cliff. But in little over a week we have gone from trade news euphoria to total misery. But by all accounts and as we argued above, markets are less about the immediate economic fallout and more about just how much damage has been done to the trade process and whether a compromise can be reached.  Which now, unfortunately, raises the spectre that the US administration will push ahead with their threats to raise tariffs on the remaining Chinese imports.

Although the latest talks ended with a bit of a thud, negotiations have not broken down, but the great divide is and will always remain about bridging the trust gap. Vice Premier Liu said, “China’s opinion that the tariffs are the starting point of the trade friction and must be lifted if a deal is reached.”

The market consensus is still heavily biased towards a US-China trade deal, so if talks were to fall off the edge, then and only then would the market impact be tremendous. Markets have shrugged off the tariff announcement with little more than a stumble and investor optimism remain optimistic that the escalation will prove short-lived and be followed soon by a Trump-Xi agreement.

Overall Risk Premia Parity did not overreact to last week’s price action, as realized volatility in the cross-asset complex remains relatively meek.

Oil Market

Oil longs have pared back risk  over the last two weeks but remain near the top of their historical range, albeit below the peaks in Jan 2018;

Of course, the outcome of the trade war negotiations will have a binary effect on price action. But in anything but the most extreme trade war scenarios the risks to supply from Iran, Venezuela and Libya should be more of a driver for oil prices than the perceived threat to global demand growth from the current level of escalation on US-China situation.

Tanker tracking data compiled by Bloomberg shows that not a single ship has left Iran’s oil export terminals so far this month, reinforcing the message that US sanctions will be effective at removing Iranian oil from the global market.

Gold Market

Gold positioning is still very neutral and well below cycle levels where positioning was predominantly excessively  long.

This confirms our mixed bag view of Gold markets.

The fact that hedging demands were not more reactive to the trade war  headlines suggests the bears could still have the upper hand as the  US dollar continues to be the primary fulcrum for gold markets.

Unless growth data deteriorates significantly, we expect gold’s reaction function to be rangebound over the near term– whereby dollar strength on the back of ongoing trade negotiation uncertainties should continue to weigh on sentiment.