Talk From The Trenches: Can't Be Insulated In A Global Market

By Bill Sokolis, Tim Cooper and Edward Hardy

US

In some sense, U.S. rate markets are on late summer auto-pilot, widely expecting

another 25bp rate hike at the next FOMC policy meeting on September 25-26 as

equities make new all time highs and yield curves continue to hug the bottom end

of over 10 year lows.

Fed speakers have been rather quiet since last week's minutes noted flat yield

curve warranted attention but should only be considered along with other

economic data while prolonged trade disagreements will have adverse effects on

the economy.

The main focus this week were trade negotiations Emerging market (EM) contagion

concerns stemming from ongoing woes in Turkey and now Argentina, the latter

having less of a broader impact, tempered early to midweek optimism over

Mexico/US trade and Europe/Brexit negotiations.

No auto tariffs not good enough! So was U.S. President Trump's response to

Europe's early Thursday offer (in addition to zero tariffs on industrial goods,

Politico reported) that helped markets take a brief risk-on tone.

The initial headlines seemed too good to be true by some, in fact rates reversed

course, trading higher soon after while equities drifted lower despite a surge

in the U.S. dollar vs. the majors.

Rates extended session highs and equities sold off hard after President Trump

was said to back $200 billion in additional tariffs against China as early as

next week.

EUROPE

Emerging market (EM) risk came back into the spotlight this week (had it ever

fully gone away?) with Argentina hitting the wall. Argentina, along with other

emerging market names embattled of late like Turkey, had big crises between

1998-2002, so for those with a long-ish memory, the latest ructions may have

contributed to some risk aversion on Thursday after Tuesday/Wednesday's optimism

on Brexit (see section above/below) and NAFTA.

While Turkish markets took another leg lower on Thursday, Argentina was the

hardest-hit, with the peso down over 15% vs USD (over 50% for 2018 thus far, the

worst performer globally), forcing the central bank to enact a 15 percentage

point rate hike to 60% (yes, you are reading those figures correctly) and ask

the IMF for some cash and quickly. How times have changed since Argentina

launched a century USD bond last year, now just -- 99 years to go to maturity.

And the consensus appears that things could get worse before they get better,

with few in the 'trenches' talking up EM prospects. GAM fund manager Paul

McNamara said only a broad rebound in general EM sentiment would provide a quick

fix, though the government could enact capital controls, 'provided they are

properly constructed and are introduced with approval from IMF'.

The contrarian take amid the panic is that the bottom is near, but broadly

speaking sentiment may not be as bad as it could be. For instance, BoAML's Fund

Manager Survey for August showed fund allocation to EM equities at -1.0%, having

fallen 44 percentage points since April 2018, but still well above prior crises

lows of -17% in 2008 (Global Financial Crisis), -31% in 2013 (Taper Tantrum),

and -33% in 2016 (China/Oil). So sentiment has soured, but is not at extreme

negative levels, and it may take a while for any upside to play out. Danske sees

'upside for the [Argentine peso] once EM sentiment improves,' but 'continued

pressure on the [Turkish] lira unless the central bank raises its interest rate

by a significant margin and the US issue is resolved.

For non-EM focused investors, there is reason to pay attention to these

seemingly far-flung countries. You could argue that these events are not a big

deal, since Argentina and Turkey are arguably the weakest major emerging

markets, and other EMs are in a stronger position. In a report on Aug 24 Danske

Bank identified Turkey and Argentina, along with Russia, Brazil and South

Africa, as the most vulnerable among emerging markets, suffering from large

current account deficits and internal political and economic challenges. But

Danske thinks (or at least thought as recently as last Friday) 'contagion to

other EMs should be limited unless Brazil escalates into a crisis'.

But if you think Argentina and Turkey are the canaries in the coalmine, with Fed

tightening putting the pressure on the weakest EM countries, especially those

with heavy USD exposure, then this could be the beginning of a domino effect as

the Fed continues tightening.  And as we are learning, it could be a problem for

banks, particularly European ones, with lots of exposure to Turkey and

Argentina. It may have been a coincidence that Eurozone periphery spreads

widened sharply as Italian and Spanish stocks fell sharply Thursday. But maybe

not. 

GBP/BREXIT

Breadth not Depth!

"We are prepared to offer a partnership with Britain such as has never been with

any other third country" were the words that sent GBP/USD back above 1.30 and

had options traders scrambling to acquire more GBP upside exposure to cover

Brexit negotiations. Both 1- and 3-month GBP/USD risk reversals leapt to

multi-week highs to turn the broader options space the most positive towards GBP

since late June.

Alas, victory for the Brexiteers was never going to be quite so easy. Thursday

morning's interview with EU Brexit negotiator Michel Barnier threw cold water on

the softer Brexit hype: apparently what he'd meant to do was reiterate March's

offer of an unprecedented relationship in scope, covering security, R&D as well

as trade. It was the breadth of the relationship, not the depth, that he'd meant

to emphasize.

Nonetheless, GBP/USD holds 1.30 and EUR/GBP is comfortably back below 0.90. The

already overwhelmingly short non-commercial market will be looking for far more

clarity from EU / UK leaders in the coming months, but only one real certainty

remains: Sterling is more political than ever.

Talk From the Trenches is a compendium of chatter from trading rooms, and is

offered as a gauge of the mood in the financial markets. It is not necessarily

hard, verified news.

--MNI Chicago Bureau; tel: +1 312-431-0089; email: bill.sokolis@marketnews.com