‘Barely Legal’

Not surprisingly, US equities are starting to feel the heat from Sino-US tensions which are most assuredly on the boil.

Wall Street stumbled to a second day of steep declines, after Jerome Powell warned on long-term damage to the economy and Donald Trump berated China in a shrill tweet.

“As I have said for a long time, dealing with China is a very expensive thing to do”, the president said Wednesday, before floating a modified version of the “China virus” label he promised to stop using – now it’s “the Plague from China”. Here’s Trump:

We just made a great Trade Deal, the ink was barely dry, and the World was hit by the Plague from China. 100 Trade Deals wouldn’t make up the difference – and all those innocent lives lost!

The president previously agreed to stop referring to COVID-19 in country-specific terms after criticism from the media and a pseudo-rebuke from Anthony Fauci, who told Science Magazine in March that he would “never” refer to the pathogen in a way that suggests any single country is at “fault” for the pandemic.

That Trump is digitally shouting about “plagues from China” does not bode well, and speaks to all of the points discussed at some length in “‘Cold War 2.0’ Is Still A Thing.”

Xi’s media man Hu Xijin threatened reprisals in a tweet of his own. “To counteract the abuse of anti-China litigation over COVID-19, Beijing is already preparing to take the necessary punishment measures against some members of the US Congress, the state of Missouri, and relevant individuals and entities”, Hu warned. (Watch out Missouri.)

The Federal Retirement Thrift Investment Board confirmed it will comply with the White House’s wishes regarding a planned shift that would have seen a $50 billion international fund invest some retirement savings in Chinese equities. “Due to a meaningfully different economic environment related in large part to the impact of the global COVID-19 pandemic, as well as the nomination of three new FRTIB board members, pending further study, the FRTIB board is delaying the implementation of the I Fund benchmark change to the MSCI ACWI ex-US Investible Market index from the MSCI EAFE index”, a statement from the board reads.

The decision comes less than 48 hours after Larry Kudlow instructed Labor Secretary Eugene Scalia to convey Trump’s orders to the board’s chairman, Michael Kennedy.

Between all of that and Powell’s downbeat assessment of the economy, small wonder that risk assets were under pressure again. It didn’t help that David Tepper went on national television to declare the market the second-most overvalued in history (i.e., outside of the tech bubble).

This is on track to be the worst week for the S&P since mid-March, when the crisis was spiraling and the VIX was at 80.

Treasurys bull-flattened, and the dollar rose, both consistent with rising geopolitical tension and possible trade frictions.

As I’ve been at pains to emphasize, this isn’t going away anytime soon. Here’s TD’s head of global FX strategy Mark McCormick with some useful color:

It’s important to note that the US/China barbs will likely persist into the election, suggesting it’s a wildcard that won’t go away this year. COVID-19 has now shocked the economy that Trump angled to sell on his re-election bid. It’s also negatively impacted his approval rating. It was unthinkable a few months ago that the Senate was up for grabs this year. However, Predictit now shows a 50% chance of the Democrat seeding back control. There’s a long runway until November, but there’s one thing the Dems and Reps agree on: China. That means global growth will have to deal with 2019-style geopolitical uncertainty alongside the navigation of a global pandemic.

There isn’t much that’s bullish about most of the above for risk assets. In addition to presenting first-order effects on sentiment, the read-through for the dollar (stronger) could work at cross-purposes with the Fed’s efforts to ease financial conditions. That, in turn, could squeeze emerging markets.

Remember, a stronger dollar tends to throw sawdust in the wheels of global trade and commerce. We don’t need any more sawdust right now – we need grease. The Fed is doing its best on that front with expanded and enhanced swap lines, which have eased dollar funding pressure, but not everyone has access to the facilities. Some emerging markets could be left to twist in the wind.

Ostensibly worrisome budget dynamics and the easiest Fed policy in history likely won’t catch up to the dollar until such a time as other countries aren’t similarly inclined to fiscal and monetary largesse. In fact, more than a few analysts have suggested dollar strength will persist and exacerbate the disinflationary impulse unless the Fed either cuts rates below zero or buys enough assets to create the equivalent of a negative policy rate.

There’s also the simple fact that lower rates means the cost of servicing the debt is commensurately miniscule. Here’s former Lehman trader Mark Cudmore:

Several traders have asked how the dollar can remain so resilient amid such a shortfall and the exploding debt burden it implies. The answer lies in an analysis of cost of servicing the US debt burden — which has fallen significantly over the last two months as the decline on US yields dominates the debt increase seen so far. Those last two words are important — the fiscal stimulus promised and the issuance schedule indicated by the Treasury will result in the debt pile sustaining a rapid growth rate. Meanwhile, yields are not only running out of room to fall, but there’s a risk they instead rocket higher at some point. In such an environment, we’d quickly enter a world where rising US yields are a net negative for the dollar, rather than a pillar of support, as the cost of servicing the debt enters a self-feeding spiral. But such a world is several months away at least.

Yes – “at least”. That’s probably an understatement. We could be years away from “such a world”.

In any event, the news flow is skewed negative for equities at the current juncture, and with stocks still some 26% off the March lows, there’s certainly scope for a pullback.

Of course, if you ask Donald Trump, this is mostly a conspiracy orchestrated by scheming Debbie downers.

“When the so-called ‘rich guys’ speak negatively about the market, you must always remember that some are betting big against it, and make a lot of money if it goes down”, the president said Wednesday, in an irritated tweet.

“Then they go positive, get big publicity, and make it going up”, he added. “They get you both ways. Barely legal?”

Perhaps David Tepper, Stanley Druckenmiller, and Jeff Gundlach should keep their opinions to themselves, lest they should wind up on William Barr’s bad side.