Updated: Dec 2, 2019
Markets Grind Higher But Cracks Are Starting To Appear
Equity markets were slightly higher over the course of September. US markets briefly touched all time highs after the FOMC delivered it’s much anticipated 25bp rate cut, while European markets were also boosted by the ECB announcing a fresh stimulus package of a rate cut and a 20bn per month bond purchase programme beginning in November. This triggered an aggressive move lower in EURUSD which now sits near 1.09, a level not seen since summer 2017.
Unsurprisingly, the response from president Trump was to take a harsher stance with China over trade, which seems to be the weapon that the administration keeps using to strong-arm the FED into more monetary easing along with critical tweets such as “No guts, no sense, no vision!”. There seems to be a recurring cycle which goes as follows. The FED cuts rates, Trump criticises and wants more so kicks off the trade war, markets react badly and price in steeper rate cuts (stock market sells off), FED signals concerns over economy and willingness to cut rates more if needed, Trump walks back trade rhetoric, stock market recovers, FED cuts rates again, and so on. I suspect this cyclical dynamic could well continue into 2020, either until the US election, where there may be more incentive to strike a deal with China, or until US rates are back to zero and QE4 is the only available policy option.
Arguably the most significant event this month was the drone attack on a major Saudi oil processing facility which took out half of their oil production and caused an overnight spike in oil prices of around 15% (the largest ever). Geopolitical tensions have been reignited between the US and Iran, who are being blamed for the attack, which is unlikely to help in the trade talks with their allies China. The oil price has now come back down to pre-spike levels as the Saudi's have been using their reserves to meet demand and have promised to get production back to full capacity by the end of October.
Closer to home, the GBPUSD has had a volatile month with a short-lived drop below 1.20 and then a sharp relief rally to 1.25 after parliament was able to pass a law to block a no-deal exit from the EU. The supreme court also ruled against Boris Johnson, who may face a vote of no confidence, making a delay to Brexit and a UK general election highly likely. With such a huge amount of uncertainty continuing to linger on in the UK, we still think selling spikes in GBP makes sense as the investment climate will remain cloudy.
Another notable event was the spike in US repo rates from 2% to 10%, which signalled a shortage in liquidity for dollars and forced the FED to inject $200 Bn into the system to calm markets. Most market participants don’t really follow or understand the repo market and so officials have tried to blame this price dislocation on technical one-off factors such as the corporation tax calendar or a coincident treasury bill auction. I have mentioned previously that one of the last pillars holding this financial asset bubble together is liquidity and once the credit market cracks then it could all start to unravel fairly quickly. I see these events in the repo market as a warning shot that the credit channel may not be as healthy as absolute levels in corporate spreads would make you believe. WATCH THIS SPACE……if US banks and businesses really are that short of cash, this may be an early warning sign for the next recession and financial crisis.
Both precious metals and bonds have taken a breather this month after an amazing run. We would recommend taking this correction as an opportunity to build some exposure to these assets to prepare for any shocks we may get into year end. Given where we are in the Trump-FED cycle mentioned above, we expect risk assets to remain under pressure for the next few weeks despite market optimism on trade. The marginal buyer of equities continues to be corporate buybacks and these will be entering a blackout period ahead of earnings season.