Nobody Knows What’s Next As Trump’s ‘Crazy Like A Fox’ Strategy Keeps Markets Guessing

If you were wondering what sane trade policy looks like, just know that it doesn’t look like August.

Although the month closed on a positive note with US stocks snapping a four-week losing streak thanks to a string of stronger-than-expected yuan fixes (which conveyed Beijing’s desire for stability even as the currency gradually depreciates) and indications that planned September talks will go ahead despite recent escalations, the month was a mess.

As reflected in the worst consumer sentiment print of the Trump era and disconcerting poll data which shows Americans becoming increasingly worried about the economy, confusion now reigns.

Little wonder, given that rather disconcerting visual, that “uncertainty” is Fed officials’ new favorite word.

And that’s just fine with Trump, who deliberately engineered some of what you see in the top pane of the chart in an effort to compel Fed cuts.

Where things go from here will in part depend on how successful he is in that effort, but given the rather overt nature of the president’s attempts to politicize US monetary policy, officials will almost surely be more reluctant than they otherwise might to cut rates aggressively for fear of falling into the various traps described by Bill Dudley in a high-profile Op-Ed published earlier this week.

Bill Dudley Has Some Advice For The Fed: Tell President Trump He’s On His Own

One thing we do know is that lackluster liquidity isn’t helping. Trump is tossing live grenades into a market devoid of depth. The right pane below shows that market depth never truly recovered after the February 2018 VIX event.

(Goldman)  

That’s conducive to exaggerated price action, as the lack of depth magnifies shocks, and the dreaded flows-vol-liquidity feedback loop is activated.

“Low S&P 500 futures liquidity has likely contributed to higher vol of vol”, Goldman writes, in a new presentation, warning that this “suggests risk of larger and faster vol spikes”.

For the time being, the bank says we’re “stuck” between a low and high volatility regime.

(Goldman)

To assess the likelihood of being in one of the two regimes, Goldman looks at more than two-dozen indicators. On the macro side, the bank uses ISM, their own current activity gauge, PCE, unemployment, NFP, the funds rate, NFP volatility, inflation volatility, T-Bill dispersion, GDP dispersion, and the EPU indices, among other variables. On the markets side, Goldman looks at the BAA-AAA spread, high yield spreads, the TED spread, MBS spreads, the Shiller P/E, cross-asset vol., rates vol., commodities vol., and the 12-month change in the yield curve.

The bottom line, for Goldman anyway, is that a return to a low vol regime “is unlikely without better growth”.

(Goldman)

Of course, better growth is unlikely in the absence of a resolution to the trade war. Indeed, the color that accompanied the latest University of Michigan sentiment report and the poll data mentioned above both underscore the extent to which trade uncertainty may be set to undercut the previously ebullient US consumer.

San Francisco Fed chief Mary Daly alluded to the same dynamic earlier this month. “One thing I’m looking closely at is whether the mood gets so out of sync with the data that the fear of recession becomes a self-fulfilling prophecy”, she said.

The risk is always the same for the president in his bid to engineer rate cuts by acting, for lack of a better word, crazy – he may end up talking the economy into a recession in the course of trying to talk the Fed into cutting rates to avert that same recession.

If you’re inclined to believe the president is smarter than he looks, that outcome would amount to being too smart for his own good.

In the end, there may indeed be a “method to the madness”. But it’s still madness. And as we saw in August, people are at wits’ end with it.