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Anywhere you look in risk-sensitive asset classes, it’s clear that Mr. Market is still discounting the more robust easing underway in China. The latest raft of utterly awful domestic data has cemented the notion that without a significant fresh stimulus flowing through the system, the chances are that it will only get worse. We are in an full-fledged experimental mess, led by global QE, with markets having sustained as long as they have courtesy of the synthetical easings of the last 10y.
Extraordinary decade-long liquidity injection measures via G4 Central Banks, with the PBOC orchestrating the most aggressive of all, has become the drug the markets badly require to keep going. Any attempts of pulling this lifeline (liquidity) from markets as attempted by the Fed, ECB, PBOC, and the shrinking of the Central Banks’ balance sheets results in panic. Let’s face it, Central Banks are trapped in a vicious cycle given its key role as liquidity providers. Pull the QE plug, and face the consequences. That’s precisely what the Fed and the PBOC are starting to realize and ultimately won’t find an clear exit without causing more trouble in inflated asset valuations. What can we expect then? The backtracking of its intentions to further tighten (Fed) or deleverage conditions (PBOC).
And make no mistake, the ECB is sooner rather than later, next in line to admit they are in no position to commit towards a normalization process anytime soon (read 2019 most likely). During Tuesday, ECB’s Draghi appearance in the European Parliament was a precursor of what’s set to come, after noting that recent developments have been weaker and that significant amounts of monetary policy stimulus are still needed. Even touching on the possibility that if extra actions to stimulate the European economy were needed, the ECB has further tools at their disposal. This narrative starts to sound as though the Central Bank may be setting the stage for a more gloomy tone going forward.
As a result, we are presented with a ‘dejavu. A phase in which the market starts to feel and behave awfully similar to scenes we are well familiar with from all these years of QE. Whoever says this time ‘is different’, I’d be glad to hear the arguments they have.
The fact that the S&P 500 can close above 2,600.00 on a high vol regime/global slowdown, is a reminder that the narrative of Central Banks eventually forced to keep ample liquidity and stop the aggregate shrinking of global balance sheets continues to play out. The expectations for a more comprehensive trade deal between the US and China undoubtedly sustains the positive rhetoric, but it’d be more of a sideshow without a firm commitment by Central Banks that the era of further easing can’t simply go away without a reset, which they won’t allow to happen.
Let me paint you the picture. Economic data, this time globally, starts to slow down, unfounded optimism still reigns to talk markets up, markets can’t sustain the cheap talk. What Mr. Market is really after though, is signs that cheap money will ultimately be flowing back into the economy. Fail to obey the signals from the market, as the Fed briefly attempted to by wrongly assuming that further rate hikes could be justified, and face the ramifications of broad-based sell-off in assets or in the case of China, a stock market that evaporated a large portion of the country’s GDP during 2018. The phenomenon we are seeing where global yield curves are in flattening mode screams trouble w/o QE.
Talking about a mess, the UK govement, with the Prime Minister May at the forefront, suffered a ‘humiliating’ defeat on the Brexit meaningful vote, which only makes the whole situation even more dicey. UK PM’s May will now have to face a no-confidence motion, expected to win through the support of her own party and party alliances, but it’s fair to say that the plot now thickens, as the scenarios seem to be now narrowing towards an eventual 2nd referendum, a general election, an article 50 extension that allows for a soft Brexit after the deal is renegotiated. Find below a chart via Morgan Stanley Research, where they touch in the most likely scenarios.
The sustainability of the current risk environment was always going to be largely dependable on the ability of the S&P 500 to keep up the bid tone caught this year. The overhead resistance of 2,600.00 was a major red flag of a potential risk reversal point but by the end of the US session, the breakout and close above the 2,600 constitutes a victory for the bulls. The breakout should allow an extra 20-25p of leeway until an even tougher battle is faced at the 2,635.00 daily resistance.
Until then, and considering the US fixed income continues to sell-off (higher US yields), it appears as though the stage is conducive for the relief rally to find further legs. Note, this time, the conditions cannot be considered as overarching risk positive as we should see a lower USD to go full circle. The failure of the US Dollar index to find equilibrium above 96.00 provides hopes that if the resumption in the downtrend resumes, full-fledged risk on context may ensue.
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