By Michael O’Neill
A cacophony of discord is deafening markets and distracting traders. The European Union is at odds with Italy, Brexit is dividing the United Kingdom, China and the US are in the throes of a trade war, the American Congress is split, and President Trump antagonizes friends and foes alike. Headlines, sound bites, and Twitter tweets ambush markets, playing “Whack-A-Mole with trading positions and wreaking havoc on daily P&L statements. It is going to get worse before it gets better.
American political drama will intensify. The Democrats have taken control of the House of Representatives. They plan to use their new-found power to roll back Republican tax cuts and to strengthen the Affordable Health Care act. They now have the power to get President Trump’s tax returns and to reopen the Russian campaign meddling investigation. And the 800 lb gorilla in the room (no not Hillary Clinton) is that the Democrats can start impeachment proceedings against Mr Trump. It will be an uphill battle. The Republicans added to their Senate majority making it easier for them to thwart Democrat legislation. This session of Congress promises plenty of vitriol and animosity, but for financial markets, it merely provides a distraction, not direction.
The European Union and United Kingdom “Brexit” negotiations have rounded the clubhouse turn and are galloping toward the wire, and that wire is March 29, 2019. It is less than five months away, and both parties have a lot of work ahead of them; notably the UK. Sterling rallied 3.8% this week on endless headlines suggesting a Brexit deal was imminent. There was a flurry of negotiations in attempt to arrive at an agreement that could be presented to an Emergency EU Summit in November. Those hopes are fading. An Irish official pointed out that a Theresa May Cabinet decision does not mean that everything is agreed. The Irish border issue is the major hurdle. Another report suggested a deal was unlikely, quoting former Brexit negotiator David Davis. He said that UK Prime Minister Theresa May would not garner enough votes to pass her Brexit deal. If the November deadline passes, it will be replaced by the December 14 EU Council meeting. More noise, more drama.
The China/US trade war is ongoing but faded from the radar screens ahead of the US midterm elections. The vote is done, and trade is in focus especially after China reported a $34.01 billion trade surplus for October, led by a 15.6% rise in exports. Some analysts suggest that the numbers show the trade war is only having a minimal impact helped by a decline in the value of the Chinese yuan. Others say the data reflects increased orders placed before the tariffs were levied. President Trump and President Xi Jinping are expected to meet during the G-20 summit in Argentina on November 30-December 1. There will be no shortage of market churning, headlines, comments, and tweets in the run-up to the gathering.
Italy and the European Union are at odds over Italy’s proposed budget. The new Italian government plans to ramp up budget deficit spending to 2.4% of GDP, much to the dismay of the mandarins in Brussels. They have threatened to impose financial sanctions on Italy. Italy doesn’t seem to care. Italy Prime Minister Giuseppe Conte said that his government will stick to their estimates on public finances. The war of words will continue at least until the November 13 EU meeting. EURUSD jitters tend to leak into other FX markets, creating volatility.
The Federal Open Market Committee policy statement was issued November 8. It was widely expected to be a “non-event,” and it was. However, FX markets acted like they were surprised. For the most part, the only difference was that in September, the Fed raised rates. The US dollar rally may not be sustained.
FX and other financial markets constantly react, sometimes violently, to inflammatory headlines about these and other events. November reactions can be exaggerated because of the US Thanksgiving holiday. It may be just one day (November 22), but it is the biggest holiday in the country. Many workers schedule vacation for that week, and market liquidity becomes scarce.
Traders should take a page or two from the Central Banker’s playbook when they try to manage their market exposures. How do global central banks manage market turmoil triggered by headlines? They ignore it.
The FOMC often says that they will assess realized and expected economic conditions by taking “into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international.”
The Bank of Canada (BoC) closes its policy statement saying “Governing Council will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt. In addition, we will pay close attention to global trade policy developments and their implications for the inflation outlook.”
The Bank of England and European Central Bank give similar guidance.
Bank of Canada Governor Stephen Poloz often reminds markets that Governing Council decisions are data dependent, not headline dependent.” If it works for Central Banks, traders should make a greater effort to tune out the noise.