Rethinking It

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by: Dean Popplewell

Risk sentiment stabilised primarily on the back of reports that the Treasury Department will not recommend China be labelled a currency manipulator, along with headlines that Trump and Xi will meet on trade seem to be enough reason for the equity sell-off to cool. But indeed never has so much been riding on the contributions of so few.

Once again market sentiment is being driven by rhetoric from US administration and Trump himself who has been quick to point fingers at just about anyone and everyone - whether it is the Fed has gone crazy, OPEC is causing an oil spike, China at fault for trade tension and declaring his policies are hurting China. But from my chair, the message is loud and clear, all designed to stir his support base into a frenzy ahead of the November midterms.

It ain't over till it's over

Initially, the market was interpreting higher US rates as a signal to deleverage, given that most of the economic expansion was assisted by QE, both in the US and globally. So draining the punch bowl and tightening rates were weighing on sentiment. Ok, we get that! But gradually moving interest rates higher in themselves are not necessarily a bad thing for markets especially coming off historically low rates. Most market participants have never traded a rate hike cycle, and for some of the dinosaurs, it appears they have forgotten what rate hike cycle is. When in fact it's the moment the Fed's shift toward a dovish defensive stance after a period of tightening is the time to worry! Presumably, the Federal Reserve Board tightens when the economy is on heat, and then eases when it's not.

Maybe and just maybe investors are waking up to the fact that much of this market frothiness is a result of financial engineering aided by the intravenous drip of seemingly endless supplies of cheap money. The result could end up being a stock market built on a leveraged House of Cards which is about to topple after the US tax cuts have run their course. Indeed, credulousness may be giving way to the facts on the ground.

The possible Fed implication

If the equity markets continue to fall into December, the Fed will most certainly consider pausing raising interest rates. You can imagine what type of signal that will suggest to investors in the face of soaring equity valuations, escalating global trade tensions and divergence in the whole growth narrative, especially now that their fingers are glued to the sell button after last week's carnage. In addition, an abrupt shift in Fed policy will likely lead to a lack of confidence in the world's most important central bank and could destabilize markets further.

And while the bar is exceedingly high for the Fed to pause in December, it's not as high this morning as it was a week ago!

Oil Markets

WTI prices have shot higher at the NYMEX futures open after Saudi Arabia warned Sunday it would respond to any "threats" against it as its stock market plunged following President Donald Trump's warning of "severe punishment" over the disappearance of Washington Post contributor Jamal Khashoggi.

Given that oil supply is Saudi Arabia's "ace in the hole," the Kingdom has motioned it could use oil supply as leverage against any sanctions. Another geopolitical hotspot for the US administration to navigate, but this one extremely testy given that President Trump has been pressuring Saudi to up supply to counter the US-led Iran oil sanction.

Despite oil prices making a fast retreat last week and the global growth downgrades at this week's IMF in Bali, the spare production capacity argument should continue to support oil over the short term. The IEA pegged spare capacity at around 2 million barrels per day. But the markets know these reserves have never been tested, raising the question how much spare capacity can be brought online immediately. But in the meantime, until additional supplies are made available, that crimp in supply should be enough to support oil prices until proven otherwise.

Oil bears came out of hibernation last week even despite falls in Libya's crude output. But price actions were driven primarily by an Oct. 8 report from the IMF, in which it downgraded global economic growth forecasts for 2018 and 2019 to 3.7 per cent per annum, from 3.9 per cent, which would consequently lower oil demand. Then pandemonium was unleashed across global markets as the worldwide stock markets tanked, triggering an exit from riskier assets. And while the S&P stabilised well and continued to roll with the punches, oil markets were so eager to snap back. Oil prices initially struggled to follow the equity market lead, after the International Energy Agency monthly Market Report adjusted demand lower by 110,000 bpd for both 2018 and 2019, reported an increase of 100,000 bpd in September OPEC production while pointing out OECD data suggest oil stocks are at the highest level since February. While advising the markets have adequate supplies again highlights uncertainty of supply once the US sanctions on Iran take effect. Lordy, Lordy, it's a noisy market.

Despite managing to eke out a win on the day, Brent was lagging WTI on Friday, highlighting the lack of fundamental deficit in the oil market, with the International Energy Agency monthly Oil Market Report terming demand lower and terming supplies "adequate for now." And WTI could still be drawing support from Hurricane Michael-induced outages.

Drillers added eight oil rigs in the week to Oct. 12, according to Baker Hughes, mainly attributed to the November 1 Plains All American Pipeline Project which is set to start flowing on November 1 and should ease pipeline bottlenecks that have lower crude prices in the Permian Basin. The Sunrise Pipeline has a reported capacity of about 500,000 barrels per day.

Oil COT report

The Commitments of Traders data, HEDGE FUND net position changes in the week to Oct 9:
Brent -6mn
WTI -37mn

Gold Markets

The precious complex is trading the intersession highs as one would expect, after the largest jump in years. In reflection, the move was a combination of a haven and full short covering. But this would leave the current landscape extremely shaky if both stocks and US rates markets recovered significantly in the days ahead.

Currency Markets

Euro

Given all these tectonic shift in market sentiment, currency markets have this air of unpredictability about them, not more so than the euro as it is completely unclear if Friday's move was confirmation of the downtrend or nothing more than weekend position squaring. Talking to my circle of G-10 traders this morning I get the feeling that more are coming to a conclusion ahead of the US midterms and wobble equity markets, the USD is there for the taking. After the market's reaction to Nikki Halley's resignation when the USD sold off, it is probably a sign of things to come as the pendulum swings between the GOP keeping or losing control of Congress.

Japanese Yen

Kuroda and company have been floating trial balloons at the IMF conference in an attempt to gauge market sentiment and prepare currency traders for the inevitable rate hike. The BoJ desperately wants to help Japan's banking sector and improve the monetary transmission mechanism channels to allow the banks to raise the cost of borrowing, after a decade of struggling.

The Malaysian Ringgit

Traders are awaiting US Treasury Department's currency report on Monday/ Tuesday, where it is rumored they won't classify China as a currency manipulator which could avert an EM Asia currency meltdown and would forestall an escalation of the U.S.-China trade war. Oil prices look supportive in early trade, but the overhang from fiscal concerns around the upcoming budget should temper any strengthening in the local note.

The IMF Bash in Bali

IMF Managing Director Christine Lagarde doubled down on the messaging.

"Our message was very clear: de-escalate the tensions," she told Bloomberg Television in an interview, about US-China tensions. But with no hints of a resolution or fixed purpose for that matter, the parties are no closer than they were before the soiree.