Round Table: Market Strategies As Trade War Tensions Escalate

Round Table: Market Strategies As Trade War Tensions Escalate  | Mar 13, 2018 10:01AM ET

by Diane Freeman

Every other week we've been asking a selection of our contributors for their opinion regarding what we believe are some of the most pressing market-focused questions of the week. This week we wondered: As trade tensions mount, with little to no end in sight, what will be your strategy for FX and equities moving forward?

  • Dollar should confirm a bottom in the next few months while the euro tops out
  • Big-time asset-deflation with equities, junk bonds, and housing taking a huge hit; gold, long-dated Treasuries, and cash will be the winners
  • Higher commodity prices and stronger growth have remained supportive of NZD; narrowing interest rate differentials, the threat of tariffs could threaten its strength

Tom Luongo

First off, I see Trump's push for steel and aluminum tariffs as a negotiating ploy to bring Mexico and Canada to the table about NAFTA.

This was a key plank of Trump's campaign platform, and like his moving the U.S. Embassy to Jerusalem, he's making a bold opening move to remove certain issues from the negotiations. So, a renegotiated NAFTA will likely end any tariffs quickly. But for now, this has the markets spooked, playing into Trump's desire for a weaker dollar for as long as possible. He's a mercantilist, after all.

Technically, the Dow and the NASDAQ look strong, while the euro looks toppy. Three month pound and US dollar LIBOR rates are rising, indicating a growing lack of US dollar liquidity. This is supported by The Fed's balance sheet data which is seeing massive parking of U.S. Treasuries by foreign central banks on reserve with the Fed. Emerging market central banks now have more than $3.1 trillion in USTs on reserve with the Fed, reversing the draw-down that occurred during the 'Taper Tantrum." $87 billion in 2018 alone, a huge move.

All of this is setting up for more choppiness in FX markets as a reflection of the political situation in Europe and Trump's power plays with his staff within the White House, c.f. Cohn leaving, rumors of a National Security Council shake-up. But, Trump can't keep the dollar down for much longer. Tariffs will accelerate dollar liquidity concerns. Tariffs lower money velocity. The ECB has no exit strategy for QE with Italy's election results. Draghi's 'hawkish tone' was wishful thinking.

The vulnerable asset class is still European sovereign debt. The USD should confirm a bottom in the next few months while the euro tops out, though it could put in a spike top on Italian debt fears before rolling over. Stocks will be the main beneficiary as investors continue to flee into 'hard' assets. Note how gold couldn't rally to new highs in the face of a very weak dollar, so on the first impulse up in the dollar gold will likely sell off on liquidity concerns but also confirm the 2015 low as the cycle low.

So, for now, current trends are in place while markets are confused and choppy. But, I'm looking for an exit point in the long EUR/USD trade, a bottom in the USD and a confirmatory spike low in gold. Emerging markets heavily exposed to the dollar are very vulnerable here. The Turkish lira is especially vulnerable as is the Canadian dollar.

Mike Shedlock

It is extremely foolish to think steel tariffs will increase employment or reduce the deficit. But here we go anyway.

President Trump says "Trade Wars are Good and Easy to Win" but he is mistaken. No one wins trade wars. There are about 6.5 million workers at manufacturers that use a lot of steel, but only 140,000 steelworkers, says Moody’s. The auto industry alone faces steep job losses.

US Auto Production

Even without that bit of math, it's economic madness to protest getting something too cheaply! Trade tensions are just one piece of the puzzle when it comes to equities and forex. Stocks are tremendously overvalued. In Sucker Traps and the Arithmetic of Risk I noted that some expect equities to decline as much as 67% from here.

I think we are right about here.


(Even if stocks decline only 20% over the course of the next five years, pension plans need six to seven percent returns each year. Effectively plans in Illinois, California, Kentucky and numerous other states will be wiped out.)

Housing is weakening, autos are weakening, and GDP estimates are falling.

GDPNow And Nowcast Forecasts

(For a discussion of the ISM bounce, please see GDP Forecasts Sink After Outstanding Jobs Report: GDPNow vs Nowcast. GDPNow estimates first quarter GDP at 2.5%. More importantly, its estimate of real final sales is only 1.6%. That’s the true bottom line estimate of GDP. The rest is inventory adjustment which nets out to zero over time).

Despite that forecast and despite weak housing sales, the Fed is busy hiking. There is global coordinated tightening for the first time in over a decade. On top of all this, Trump is on the verge of starting trade wars.

Nearly every economist on the block thinks inflation is on the horizon. When economists are in overwhelming consensus agreement, history suggests they are wrong.

I believe Inflation is in the Rear-View Mirror. Why? Because we already had inflation. It’s visible in stock market bubbles, housing bubbles, and junk bond bubbles. The Fed does not think we have inflation because it’s clueless how to measure it. Housing prices are not even in the CPI. None of this is any good for the markets. I expect big-time asset-deflation with equities, junk bonds, and housing taking a huge hit. Gold, long-dated Treasuries, and cash will be the winners in this deflationary environment.

Matt Simpson

It’s been great to see volatility return recently as it tends to favor momentum-based strategies. There’s really one of two methods we’d choose to time a trade entry which hinges on where we think we are within the volatility cycle.

We need to see a clear directional bias on the daily chart before deciding between trading an actual breakout, or trading the retracement following a break. Breakouts we’d consider could include key levels of support and resistance, swing highs or lows or the break of reversal/continuation patterns. And as breakouts tends to be followed by periods of consolidation, we can also enter during these times if we chose not to trade the original break. We can demonstrate this with a few ideas from this week’s FX watchlist:

NZD crosses / NZD/CAD: Higher commodity prices and stronger growth have remained supportive of NZD yet narrowing interest rate differentials and the threat of tariffs could threaten its strength.

Unlike Australia, New Zealand is yet to be confirmed as exempt from steel and aluminum tariffs, although officials are currently doing what they can to achieve the sought-after exemption. Whilst Canada are exempt, it is only a ‘temporary’ status which could be revoked if NAFTA talks don’t play to Trump’s liking (essentially making it a strong bargaining chip for Trump). So, if New Zealand do receive a permanent exemption it may provide enough momentum to take NZD/CAD to new highs.

The daily chart on NZD/CAD shows a firmly bullish trend structure with orderly retracements and higher swing lows. We’ve seen the hourly chart break a bearish channel which suggests momentum is turning and could mark the end of a correction. However, if we find that New Zealand won’t be exempt from the tariffs, we’d expect the news to broadly weigh on NZD crosses and remove NZD/CAD from our watchlist.

NZD/USD Daily Chart

AUD/CHF: After a failed-break beneath 0.7265 and a bullish RSI divergence, we’ve seen a clear momentum shift from the 0.7241 low coupled with bullish range expansion. Last week’s break also took AUD/CHF above 0.7420/28, a pivotal level which may act as support in future. Ideally, we’d prefer to see a better trend structure, but it is the momentum shift and subsequent rally which has this on our radar. However, the move is beginning to look over-extended so we now need to see volatility subside and provide evidence of daily compression or a low volatility retracement. Compression include candles such as narrow-ranged days, inside days etc. But the key here is to wait until volatility subside and trade the break to new highs or a decisive break of an hourly retracement line. If bearish momentum is to return, AUD/CHF will make its way to the back-burner.

AUD/CHF Daily Chart

EUR/CHF: We have a very close eye on this one. We’ve seen a clear directional move away from the April 2017 trendline to show bullish momentum is back in the driving seat. But we have now seen two consecutive days of price compression in the form of NR4 days (narrow range 4). It’s plausible to think we could see further compression or a slightly deeper retracement, but we’d consider a long trade if we are to see a decisive break above the 1.1740 high.

It’s hard to give the exact level at which we’d remove it from our watchlist, but we only need to see volatility spike in the wrong direction (lower in this example) for it to be removed from the watchlist.

EUR/CHF Daily Chart

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Charles Erhuanga
Charles Erhuanga

This is a great insight...  ... (Read More)

Mar 13, 2018 10:58PM GMT· Reply
bon jour
bon jour

Exactly what I think, fed ********up the stocks and the houses, but they just put the eye on foods and autos, etc. Most of its QE poured in the bonds, stocks and houses, but it doesn't know why inflation not coming.  ... (Read More)

Mar 13, 2018 09:41PM GMT· Reply
Vitor fx
Vitor fx

Great article!  ... (Read More)

Mar 13, 2018 08:38PM GMT· Reply
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