“To buy the dip or not to buy the dip?” – that will be the question in the week ahead.
Is it over?
Questions linger about whether Wednesday’s technical selloff and its less dramatic (but still disconcerting) sequel on Thursday have truly run their course. Consensus seems to be that most of the systematic de-risking is in the books, but some analysts expect aftershocks in the form of deleveraging from slower-moving, vol.-targeting funds.
The chaos on Wall Street spilled over into global equities on Thursday, denting already fragile sentiment abroad at a time when tensions between the U.S. and China are still running high. Chinese stocks had their worst day since 2016 on Thursday.
As has been the case all month, focus will be on Treasurys to see whether yields continue to rise following a pullback late last week. The equity selloff was generally seen as a kind of delayed reaction to the acute selloff in rates that dominated headlines earlier this month. Diversification desperation is top of mind for investors now that the equity-rates correlation has flipped.
“The correlation between global equities (MSCI World) and 10y USTs, on a three-month rolling basis, turned sharply negative”, Barclays noted over the weekend, adding that for now, the bank’s equity strategists “have recommended against buying this dip just yet and expect volatility to sustain in the near-term.”
Give me a minute
The selloff in bonds can generally be ascribed to ebullient U.S. economic data, the read-through of that data for the Fed and increasingly hawkish rhetoric from Jerome Powell. You can count Donald Trump in the camp that thinks the “loco” Fed should tone down the hawkishness.
It’s with that in mind that we’ll get the September Fed minutes this week.
“We will look for further discussion of why the accommodative language was dropped, the path of the policy rate relative to estimates of the neutral rate, and containing the labor market overshoot”, Goldman writes. BofAML echoes that assessment. “We expect they will elaborate on the removal of ‘accommodative’ [and] we also look for some debate around where neutral is, as well as an optimistic review of economic conditions supporting further gradual rate hikes”, the bank wrote Sunday.
Notably, specs pared the massive 10Y short in the week through last Tuesday, but it’s still very stretched.
Meanwhile, specs added to the net long in the dollar over the same period. That position is still stubbornly hanging out near the longest since January 2017.
The great manipulator
Also in focus is Treasury’s upcoming report to Congress that could find Steve Mnuchin slapping China with the “currency manipulator” label.
Both Treasury staff and the IMF have said China does meet the criteria for the deleterious “manipulator” label, but Trump is keen on keeping the pressure up on Beijing ahead of the midterms.
China has continually insisted that it won’t use the yuan as a weapon in the trade war, although Beijing has unquestionably countenanced depreciation this year by encouraging the monetary policy divergence between the Fed and the PBoC. The latter’s RRR cut probably didn’t do much to allay Trump’s concerns.
Compare and contrast the (color coded) rhetoric:
In August, Chinese authorities undertook a variety of measures to arrest the slide in the yuan, reinstating forwards rules (August 3), chiding onshore banks for selling RMB (August 7), moving to squeeze offshore liquidity (August 16), and reinstating the counter-cyclical adjustment factor (August 24). All of that argues against the “manipulator label.”
Of princes and autocrats
Tensions between Washington and Riyadh have escalated as more details surface about the disappearance of Saudi dissident and Washington Post columnist Jamal Khashoggi.
Trump is under enormous pressure to punish the Saudis for what certainly looks like murder, but the President has repeatedly insisted that canceling a $110 billion arms deal with the Kingdom is out of the question. In an interview with 60 Minutes, Trump hinted at “punishment” and Riyadh hit back, assuring Washington that any move against the Kingdom would be met with “strong” retaliation (the Saudis would later walk back those comments). Saudi stocks are riding a four-day losing streak and on Sunday plunged to their lowest levels since January amid the tension.
The evidence implicating the Saudis in the Khashoggi disappearance emanates from Turkish intelligence which obviously has the best read on this situation considering the (likely) murder occurred in the Saudi consulate in Istanbul.
There’s more than a little irony in Erdogan’s attempt to play “defender of the free press”, but apparently, murdering someone on his home turf without his permission was a bridge too far (or else he initially agreed to let it go down and then the Saudis irritated him somewhere along the way).
Whatever the case, his government is pushing the issue pretty hard and this comes at a time when Ankara is attempting to get back in Washington’s good graces following the release of Pastor Andrew Brunson on Friday. For market participants, the key concern going forward is whether Brunson’s release ends up being a “sell the news” type of deal for Turkish financials (think: Halkbank) and, more importantly, for the lira.
“Over the next few weeks, we expect markets to increasingly focus on Turkey’s deteriorating inflation trajectory and the risk of the central bank staying behind the curve as the next CBT meeting approaches”, Barclays wrote over the weekend, adding that “the risk of a delay of further monetary policy tightening was somewhat heightened, after Finance Minister Albayrak unveiled a national campaign encouraging the private sector to cut prices by up to 10%, and promised that the government would tighten controls and introduce fines on companies posting large price increases.”
The Borsa Istanbul Banks Index has staged a nice bounce off the September lows, but the losses this year are still truly horrific.
In any event, it will be highly interesting to see how things pan out going forward re: the Trump-Erdogan-MbS autocrat nexus.
Pass the Chianti
In Europe, the focus is squarely on the Italian budget debacle. The domestic appeal of populism appears strong despite (and perhaps because of), renewed widening in the BTP-bund spread. According to a survey by Ixe pollster, support for League rose to 31.8% this month from 31.2%, while support for Five Star ticked up to 28.2% from 27.6%.
Italy will submit its draft budget to the European Commission on Monday and needless to say, the stage is set for a showdown between Brussels and Rome. Italian assets are under enormous pressure with yields on the rise and equities now mired in a bear market. On Thursday, reports indicated that the ECB will not step in to assist in the absence of a formal E.U. bailout request from the populists.
“We think medium-term concerns about Italian fiscal slippage will likely continue to exert downward pressure on the EUR in the coming months, restricting the single currency’s ability to post meaningful gains”, Barclays says.
All eyes are on October 26, when S&P and Moody’s will review Italy’s ratings. Italian financials are an absolute train wreck after falling some 35% from the 2018 highs.
Brexit talks over the weekend predictably went nowhere, and sterling fell to a one-week low in early Sidney trading. They might as well call off Wednesday’s summit.
We met today @DominicRaab and UK negotiating team. Despite intense efforts, some key issues are still open, including the backstop for IE/NI to avoid a hard border. I will debrief the EU27 and @Europarl_EN on the #Brexit negotiations.
— Michel Barnier (@MichelBarnier) October 14, 2018
On the data from, we’ll get retail sales in the U.S. and a raft of releases from China, including GDP, PPI, CPI, and the closely watched retail sales-IP-FAI trio.