Somehow, I doubt anyone needs an explanation for what's shaping up to be yet another manic week on Wall Street, but just in case, I thought I'd pen a quick missive for readers on this platform.
Below, I'll endeavor to briefly crystallize the current market zeitgeist by reference to three things: 1) acute growth concerns, 2) worries that the Fed is behind the curve (figuratively and literally) and 3) exaggerated price action spurred along by thin liquidity into an already favorable seasonal for volatility.
First, on global growth, the last several weeks have been death by a thousand cuts.
For instance, bellwether Singapore slashed its 2019 growth outlook this week to between zero and 1.0%. Non-oil domestic exports are in free fall, diving 14.6% in Q2, after a 6.4% decrease in the previous quarter.
That comes amid similarly dour data out of South Korea, another "coal mine canary" (if you will) which now boasts the world's worst-performing stock market.
In Hong Kong, the ongoing protests have served to make a bad situation worse. Civil unrest and the prospect of Chinese military intervention have conspired with jitters about the trade war to deep-six sentiment for city stocks, which last Monday "celebrated" their longest losing streak since 1984. Here's a snapshot of that:
On the mainland, it's been disappointment after disappointment on the data front. This week alone, July credit growth for China came in woefully short of estimates (total social financing for July was just 1.01 trillion yuan, versus estimates of 1.63 trillion) and the closely-watched retail sales/IP/FAI trio was a veritable disaster. Industrial output growth slowed to a 17-year low last month.
The situation in Germany is increasingly dire. Data out Wednesday showed the world's fourth-largest economy contracting for a second quarter in four. Over the past month, we've digested a string of numbers so bad (e.g., Ifo, ZEW and industrial production) that analysts had trouble finding polite ways to describe the perilous state of the country's manufacturing sector.
And I could go on (and on and on). The outlook for global growth is bad and the longer the trade war drags on, the worse it's going to get. It is just that simple.
Second, on the perception that the Fed is behind the curve, note that what you saw on Wednesday morning in the bond market is a combination of a panic bid for duration and worries that Jerome Powell isn't moving quickly enough to head off a downturn.
On the former point, note that ultra-long bond futures tripped the extended hours circuit breaker around 7:30 AM in New York. 30-year yields of course hit a record low on Wednesday morning.
According to BofA's latest FX and rates sentiment survey, we’re now "just shy of the September 2007 record" when it comes to duration exposure and have already shattered the mark for "the most sustained duration overweight" by a full three months.
The August installment of the bank's closely-watched global fund manager survey (out Tuesday) had "Long US Treasurys" as the most-crowded trade on the planet for the third month in a row.
Growth concerns, a flight-to-safety bid associated with recent market turmoil and term premia spillover from overseas are together pushing long-end yields in the US inexorably lower. The perception that Jerome Powell and the Fed are still inclined to push the "mid-cycle adjustment" narrative (versus admitting that a full-on rate cut cycle is coming) is leading the curve to "rage bull-flatten" (to quote Nomura's Charlie McElligott). Hence the first 2s10s inversion since 2007.
The Fed will need to do something soon to dispel the notion that the committee is behind the curve, and not just for the sake of engineering a bull-steeping to take some of the pressure off. Rather, because the current state of affairs is exacerbating dollar funding stress which was already pretty acute thanks to the deluge of issuance occasioned by the debt limit resolution.
Another couple of IOER tweaks will be necessary to buy some time, but after that, the Fed will either need to rush to roll out a standing repo facility, or else start outright QE again. If not, you're going to see further money market stress, and that will feed into dollar strength and serve to tighten financial conditions.
Third, on exaggerated price action due to illiquidity, note that even for August, market depth is low across all assets. The following chart from a Friday JPMorgan note has shown up all over the place this week:
Remember last Wednesday's dramatic bounce, when the Dow recouped a 589-point loss to close nearly flat? Yeah, well E-mini liquidity was non-existent that day. Have a look:
That contributes to wild price action, especially when it collides with dealer gamma hedging, buybacks and systematic flows from CTAs and vol.-sensitive strats.
In brief, the above serves as a framework for understanding what's transpired in August. More broadly, we've now clearly transitioned out of the "bad news is good news" regime, wherein disappointing economic data is greeted warmly by risk assets to the extent it argues for more central bank accommodation.
Now, we are squarely in an environment where bad data casts further doubt on the capacity of monetary policy to respond given how little room central banks have to move on policy rates and how bloated balance sheets are. In other words, the "policy impotence" trade is starting to take shape.
As far as the latest U-turn in the trade war (the Trump administration on Tuesday announced that tariffs on some key consumer goods planned for September 1 will be delayed until December 15), the only thing that does is prove the administration is more worried about tariff-related inflation than they previously let on.
Throw in yet another hot core CPI print (the MoM read was 0.3% for July, equalling June's print which was itself the hottest since January 2018), and the Fed is in an impossible bind. The delay in tariffs on consumer goods is nice, but if price pressures keep materializing and wage gains pick up, it's going to be hard to justify the kind of dovish "shock" Powell needs to deliver in order to convince the market that the Fed isn't behind the curve.
If the labor market stays healthy, there will be very little in the way of an economic rationale for delivering three additional cuts in 2019, which is what the market is looking for.
Traders are clearly having a difficult time reconciling all of this, and the manic pace of the trade headlines isn't helping. A quick look at President's Trump Twitter feed on Wednesday is all you need to know that the White House is concerned about the market, the economy and the Fed's perceived lack of an adequate response.
There is no readily identifiable resolution to all of this. It's possible that the Fed can convey a message dovish enough to shore up market sentiment, but that risks getting us right back into the circular dynamic illustrated below:
If the Fed tries and fails to assuage markets (e.g., if a 50bps cut in September combined with dovish forward guidance isn't enough), it may be lights out.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.