April Trading Insights from David Long
Let me start in a safe area, interest rates. The US Federal Reserve has met this week, and as priced in and widely expected, have raised interest rates by 0.25 basis points to 1.75%. It will bode you well if you remember that when the USA is in a rate hiking environment the US Dollar weakens. The market was looking to the FOMC for a potential 4 hikes this year and was slightly disappointed with the Committee’s guideline of 3 this year and 3 next year. Previous guidelines (The Dot Plot) showed 3 this year and 2 next, so we sort of got what we asked for but just delayed. However, the bond yields were weaker off this news and so the US dollar has not fallen as far as one would expect.
I also have to question whether or not interest rates should be on the path they are in the USA. Having moved off emergency levels (sub 1%) and well above the lows of 0.25% it was for 7 years, pushing rates much higher will have a major detrimental effect to their economy. Such large moves are usually only warranted when GDP growth is firing over 4 or 5%. The USA is far from those levels, last print was 2.5%. Inflation is hovering at 2% since late 2016, whilst the employment rate is OK, wage growth is stagnant. The rising rates on treasuries in the US has crunched credit markets, making it harder for business to grow, a push above 2.5% (3 more rises) would put the US on the brink of a recession. It would appear the US Fed is pre-empting or expecting “TrumpFlation” to have a bigger impact than it is actually proving to be.
The US Dollar Index has been range bound between 90.50 and 88.20 for 2018. March has an even tighter range of 140 pips, 90.34 and 88.94, so most majors have been choppy as dollar is range bound. Commodities too have mostly traded sideways although oil recently jumped out of wedge thanks to OPEC committing to dealing with supply glut. Gold is now running as well thanks to safe haven flows.
The exceptions have been Yen strength and CAD weakness, with both trending nicely for most of this year. The reason for Yen strength has been the uncertainty around stock valuations and recently due to political drama in the ruling party. Whilst the Loonie has been subjected to weakness thanks to some poor data recently but more to the negotiations around NAFTA and now Trump’s tariff tantrum. This segues me nicely to the most dominant theme this month and will most likely dominate headlines for months to come. Trade wars.
Trump had better tread carefully. He has instigated a trade war, directly aimed at China. Just today he signed further tariffs (US$50B worth) on Chinese products, beyond the steel and aluminium he signed on two weeks ago. The US Administration has declared that there is more to come. They have also declared that if China retaliate, they US will go even further. China retaliated today, with a minor slap of US$3B. This is hitting stocks hard and has only just begun. Turning back from this will be hard for even Donald.
Where it could get really nasty is that China holds US$1.2 trillion worth of US Treasuries. That is the single largest holding of the US$6.3 trillion treasury market. Japan is next with 1.08 trillion, so a third of US treasuries are held on the other side of the Pacific. China has been slowly reducing their exposure over recent months, if they were to accelerate this in retaliation to Trump’s tantrum, the US interest rates would skyrocket. That would be happening just as tax cuts and tariffs are feeding into the economy. These require funding, or increasing the deficit, which is done by issuing more Treasuries. The US Fed would be fighting an uphill battle and most likely lose it. The USA would then literally be, in the words of Paul Keating: a banana republic.
Sound messy? Yep. It is not out of the realms of possibilities though. Watch for China to ramp up the pressure with more tariffs back at the USA. Monitor bond news and prices. Be careful on buying stocks, in fact I would be looking for shorting opportunities. US dollar will be hard to trade so tread carefully against it. Safe haven assets such as gold and Yen would continue to appreciate. Aussie dollar and its exposure to Asia saw it being the darling early on this decade, that same exposure will see it punished through this period of tit-for-tat trade tariffs between our two major allies.
