After The Storm: Full Week Ahead Preview

Markets are coming off a stormy week characterized by extremely muddled Fed messaging and an unwelcome trade broadside that cast considerable doubt on the chances of a Sino-US pact being struck any time in the foreseeable future.

In the week ahead, America will mourn the 29 innocents killed in a pair of mass shootings over the weekend.

The twin tragedies will reignite the gun control debate and, perhaps just as importantly, are likely to raise serious questions about how top Republicans plan to address the president’s divisive rhetoric as the 2020 campaign heats up.

From a purely strategic perspective (i.e., without lapsing into partisanship), any GOP’ers who were already uncomfortable with Trump’s attacks on nearly a half-dozen lawmakers of color are likely to be even more so now, given that the El Paso shooting appears to have been motivated by anti-immigrant sentiment.

US: After the storm

While the gun debate and jitters about America’s “soul” will dominate domestic politics in the week ahead, the trade war and speculation about the Fed’s reaction function will occupy markets at a time when folks would much rather be on vacation.

Last week was the worst week for US stocks of the year, and the VIX rose the most since the week of the December Fed meeting.

Big cap tech took things especially hard, falling more than 4% to the S&P’s 3.1% drop. Yields plunged, oil saw its largest one-day drop since 2015, HYG had its worst week of the year, and on and on. You know the story.

Read more: A Nightmare On Wall Street

How it plays out from here depends on the evolution of trade tensions. Clearly, things are no longer “simmering”, but are back to a “boiling point” (as Jerome Powell put it on Wednesday) and that’s likely due in part to Trump’s desire to compel the Fed to commit to the onset of an actual easing cycle.

That’s a dangerous game. The Fed has already seen how slippery the slope is when monetary policymakers allow themselves to be co-opted into the trade war. Now, Trump knows he can force dovish turns simply be engineering extreme market pricing (especially in rates) with trade bombast.

Read more: Wall Street Is Worried About The Fed’s Role In Trump’s Trade War. You Should Be Too

Meanwhile, the Fed’s convoluted messaging pushed the dollar higher on Wednesday, and although it came off a bit amid Thursday and Friday’s turmoil, a greenback that remains stuck near 27-month highs (and all-time highs on the Fed’s trade-weighted measure), is a continual source of consternation for risk assets and for the White House.

Larry Kudlow’s protestations notwithstanding, intervention is surely on the table.

“We expect continued support for the USD versus EM and risk-sensitive currencies, following the abrupt escalation of trade tensions, and after the Fed delivered a hawkish-cut”, Barclays wrote Sunday, adding that “expectation of core central bank support and easing of trade tensions post-G20 had supported EM FX but both factors reversed last week”.

On the data front in the US, the docket is relatively light with PPI, ISM non-manufacturing, consumer credit and JOLTS on deck.

As far as Fed speakers go, markets will hear from Bullard and Evans. They “might” reinforce the “mid-cycle adjustment” message Barclays muses, before noting the obvious, which is that “the Fed now needs to take into account the latest trade escalation”. Indeed, whatever the messaging strategy was for August will need to be reconsidered.

There’s also some VIX seasonality to take account of. “The month of August marks ‘peak illiquidity’ after many funds effectively shut themselves with PMs in gross-down mode ahead- / into- their Summer holidays”, Nomura’s Charlie McElligott wrote last week. That’s “a large reason why over the past thirty years that we see August posts the highest average VIX return of any month”, he added.

(Nomura)

Europe: No respite

Across the pond, it’s the same story – the euro-area is staring down an exceptionally challenging economic backdrop. Last week’s growth and inflation data underscored the malaise, and this week will bring German factory orders and IP. Hopefully, the former will get a lift from an easy comp.

On the whole, the outlook is forlorn and more trade frictions don’t help, especially to the extent Trump’s latest balderdash towards China suggests the administration might adopt a similarly adversarial approach to the EU on auto tariffs. Trump joked about the Section 232 probe at an event convened to celebrate a US-EU beef agreement on Friday and nobody thought it was particularly funny. European stocks suffered their largest one-day drop since December to close the week.

“We continue to highlight Europe’s significant vulnerability to an escalation of US-China trade tensions given it’s open, export-oriented and trade-intensive”, Barclays notes.

In the UK, a no-deal Brexit is no longer some kind of “black swan”. Indeed, it’s not even clear that calling it a “tail risk” is accurate. Rather, it’s becoming increasingly base-case-ish, a state of affairs that has waylaid sterling.

“The prospects of no-deal Brexit weighed heavily on the pound last week and resulted in a further pick-up in volatility with the 1m2mf GBPUSD vol reaching new post-referendum highs”, Barclays cautions. The bank has also done some math, and determined that ‘a 10pp increase in the bookmaker-implied probability of no-deal Brexit results in c.1% depreciation in the GBP NEER, implying the potential for another c.6% downside in the NEER in case of a no-deal”.

Data in the UK this week include GDP, PMIs, trade balance and construction output.

China: War games

Chinese equities are coming off a miserable week and thanks to the trade war, talk of the yuan testing the dreaded 7-handle is back. This week brings a deluge of key data releases that will give markets a fresh take on the state of the world’s second largest economy. Credit data will be watched especially closely. Look for CPI, PPI, Caixin PMIs, foreign reserves, the trade balance, aggregate financing, new yuan loans, and the money supply.

Beijing continues to insist they will not be bullied or “blackmailed” by the Trump administration and traders (assuming any are around) will be watching for any signs that Xi is looking to move towards instituting more non-tariff retaliatory measures.

Miscellaneous: Safe haven problems and doves down under

Watch for more yen appreciation as risk-off sentiment predominates and the BoJ is widely seen as near the end of the road when it comes to monetary tricks. “The tariff news reinforces the case for USD/JPY downside”, Goldman wrote Friday. “The Yen remains one of the few undervalued safe-haven assets, and the structure of Japan’s balance of payments means that any drag from the trade war on cross-border FDI activity could be particularly important”, the bank said, bringing forward their 12-month 103 target to a three-month horizon.

We’ll also get policy meetings in Australia and New Zealand. Expect a hold from the RBA as the central bank takes a breather after two consecutive cuts. RNBZ will likely cut on Wednesday.

Event calendar via BofA

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