Next phase of volatility is approaching

As the chill winds of New York’s seventh month of winter weather flow through the canyons of Wall Street, market volatility has subsided. Programmed, as they are, to jump at every Presidential tweet, it was only a matter of time before the markets’ pavlovian response faded away. 

While the market narrative changes from time to time depending on the catalyst of the day we remain on course for an overall bearish view on equities and asset prices in general because the underlying growth of money continues to decline. At this time there is no sign that this declining trend in the global growth rate of the global monetary aggregates is turning. Nor is there any sign that the trend decline in velocity has reversed.

Looked at individually we can say that the decline in US and Chinese monetary data is policy induced while in Europe and japan it is declining despite continued QE programs. While Eurozone and Yen QE programs have been cut back the consequent fall in money growth shows how dependent their economies are to financial pumping to generate any growth at all. It highlights our principle criticism of QE in general that it is for emergency only. Excessive application is self-defeating and leaves no painless exit for central Banks.

That an exit attempt is underway means that the pain has begun. The @federalreserve under Powell has been clear that it is no longer targeting the stock market and will accept a normal stock market correction. Whether such a correction, however defined, can be contained is one of the unknown factors that should keep bankers awake. Bearish as we were in 2007–8 we never imagined that investment banks would be forty times levered. So today, after a decade of central bank created moral hazard in the reach for yield can we say that there is no existential risk coming from leverage? There are so many forms and opportunities for leverage the true situation is incalculable and so we are dealing with the imponderables of the unknown.

Returning from the bright reality of the sunlit Alps with the benefits of a late winter three foot snow pack we found the markets bouncing from oversold conditions. The target in the US for this recovery is the falling 50-day moving average now close at hand. This should give or take a little, mark the limit of the recovery before the next leg lower gets underway. This decline should break the February lows but for now we are leaving open the question of what happens after that.

Our central case remains that the markets will recover with the operating narrative of a good earnings season, no trade war and still moderate economic growth including the possibility of a lower trajectory in US interest rates. What could break this is a credit event where our indicators suggest one could erupt at any time. This is fundamental. Yes there are geopolitical risks and economic surprises but these are manageable for now. We have remained optimistic that relations with North Korea and China are heading towards a constructive solution and the occasional police action in the Middle East such as a strike on Syria is just a minor news event with little implication for markets.

Thus our market views remain unchanged. The $USD continues to base against the majors and a mild break of the 88 low on the #DX index will not change that view. In fact we expect that the volatility that has characterized equities will soon morph into higher volatility in currencies and commodities

We still expect the narrative of Fed tightening to remain intact. This should remain the case at least until stocks are significantly lower and that therefore bond yields will chop higher. A break above 3% on the 10 year Note would be an opportunity to cover bond shorts and go long. Bunds and Gilts continue to correlate with US yields.

Currencies are retesting recent highs and may make slightly higher prints but the next dynamic move will be down for the #Euro and #GBP and up for the #JPY where a break below $/Y100 is likely. These currency moves are likely to come as equities fall in a de-risking environment.

Commodities such as $Crude and $Copper will decline as the $USD recovers but $GLD is likely to strengthen albeit in a contained manner. The large and growing short position in $SLV will limit the downside there. Crude is making yet another test of the highs and we again expect it to fail. The Saudis are making a great effort to hold the price up but they are up against the backdrop of weakening demand and growing Texas output. More precise trading targets are available on request but the target for $Copper is 2.72.

Malcolm Tulloch

The writer is director of the firm Tulloch Research. The company provides bespoke advice to clients on macro-opportunities in financial markets.

“Intuition is a product of accumulated experience”

Tobias Truman