Trump … Trump … Trump! He had the final punch to market last week.
The week started with the benign condition as China manufacturing PMI was slightly better than expected. Fed cut 25bps as expected, and by itself, it didn’t disappoint the market too much. The problem started when Powell mentioned in his statement that the cut was expected to be a ‘mid-cycle’ adjustment – this particular phrase really sent stock markets lower and higher US dollar, with market interpreted it as an indication that Fed only takes this cut as one time off and is not too worried on the economy projection.
In the currency market space, the US dollar index DXY breached a 2-year high at 98.8, and Trump immediately showed his displeasure with the Fed’s decision that sent the US dollar higher. Ironically, the market positioning indicator showed that leveraged funds had been long dollar (in the developed market space), and use this opportunity to take-profit and sell the dollar the next day, and it’s actually Donald Trump himself that dropped the news bomb by announcing 10% tariff on 300B trade from China.
This immediately sent a massive jitter across the board, in stock, rates and EM market. AUDUSD breached its effective 5-year low (before it reversed slightly, again due to positioning), and the rate (Eurodollar) futures jumped more than 20bps. After the dust settled, S&P500 is down 3.1% (biggest weekly drop in the year), oil futures is down 1.8%, and US10yr yield scarily dropped to 1.85% breaching 2-year low.
All this negative development on the US-China trade deal eclipsed the US Non-farm payroll data which is in line with expectation (slightly missed the headline number at 164K, but strong unemployment number at 3.7% nevertheless).
So what we should expect from here? It’s still 1 month from the tentative new tariff from Trump, on which China will definitely retaliate. If this happens, then the market can still drop a lot from here, even if the Fed is going to cut another 25bps in September.
But the problem as we are all aware, Trump can simply change his tone and give his sweet talk to Xi Jinping, he also can pressure US Treasury to intervene FX market. Basically, there is no bound that we can anchor historically from here. Also, in particular, the VIX index which jumped immediately to 17.61, still has room to go higher on a relative basis historically.
In summary, it’s probably better to sit tight and light on positioning given the extreme randomness that can happen in the coming weeks related to the US-China trade deal. Buying volatility option, and as we mentioned previously, buying gold, is probably a reasonable hedge for the potential massive risk-off conditions.
Next week economic headlines are rather light, with RBA and RBNZ rate policy is coming up. We should anticipate some trade comments from Trump against China and the EU, which can easily stir the market sentiment.
