Equities rattled by risk-off moves, gold surges as bond yields sink

Morning Note

Risk smorgasbord: Argentina, Hong Kong, US-China, Italy, and Brexit leave investors reeling.

Brexit, US-China trade, Argentina, Italy, Iran, Hong Kong – you can take your pick from the smorgasbord of risks facing the world right now. Risk assets are being hit as investors are rattled by civil strife in Hong Kong, the crash in the Argentine peso and mounting doubts about the global economy.

Equity indices have taken fright on a mix of factors, but chiefly I would say for the US at least it is the persistent damage being done to the global economy from trade disputes. Overnight Singapore cut its growth estimates for the year drastically because of US-China trade strife and a slowdown in the global electronics cycle, which has traders worried about the read across for other Asian economies.

Growth fears were front and centre after a Goldman note said the US economy would suffer more than thought, while Moodys and the Ifo also warned on trade risks to the global economy. Bank of America now says there is a one-in-three chance of a recession in the US. There’s nothing positive in trade, earnings have been and gone and the market already thinks the Fed will rise to rescue. Meanwhile if anything we can expect new fronts to open up (Europe) in this trade conflict.

Hong Kong stushie

Flights have resumed but the edgy press conference with Carrie Lam didn’t suggest it’s all quiet on the eastern front. Indeed we are seeing now on the wires that demonstrators have again taken the various terminals of the Hong Kong airport. The Hang Seng led decliners in Asia overnight as investors increasingly worry about further escalation and the possibility of intervention by China. Still the potential to escalate quickly – if China snaps and sends in the troops it could be very bad and send all kind of shockwaves through Asian markets. This is not going away.

The S&P 500 lost 1.23% to close sub 2900. The Dow lost nearly 400 points to finish sub 26k. The DAX wasn’t able to keep above 11,700. The FTSE 100 couldn’t hold the 7240 level. Asia has been softer overnight again, led by Hong Kong. European shares are set to extend losses today.

Bond yields dropped again as traders de-risked with the US 10-yr back to 1.64%, its weakest since October 2016, with 2s mighty close to yielding as much at 1.577%. Inversion is the classic recession red light and this is the flattest it’s been since 2007.

Havens bid

Gold is the winner in all this. We note that real yields (10yr TIPS) are as close to going negative as makes no odds (0.04%). After consolidating around $1490, the decline in yields and broader drop in risk sentiment lifted gold through $1500 which has provided cover for a push towards $1520. Resistance seen at $1525 could offer scope for near term pull backs. Breaking free opens up road to $1550. At send time it gold is heading up a one-way street to trade at $1523.

Brent remains off last week’s lows but the rally seems to have stalled around $58.50. Could now be susceptible to another pullback. Whilst fears about the global economy build there’s little upside except from a geopolitical shock, which even then one feels would be temporary. The question is what OPEC does next and will it be effective?

FX

sterling remains caught around 1.2060 in a pretty tight range. Don’t expect big directional shifts until the politicians return from holiday. The euro is likewise trapped in a very narrow range around the 1.120 level. Massive doses of central bank liquidity has pretty much killed off volatility in most FX. The yen remains bid but USDJPY is struggling to breach 105. Looking to multi year lows and the 2018 trough around 104.60 next. Recovery through 106.50 may suggest the move has lost steam. As previously noted, amid all the risks there is going to be no stopping central banks rushing to cut rates further. This should exacerbate the kind of haven flows we’ve seen lately – i.e. this ought to be good for gold, the yen and Swissy. 

A quick nod to Argentina, for remaining despite all attempts the ultimate basket case. Macri needs a miracle one feels. Spiralling debt and high inflation is the norm even without a Peronist to really mess things up. The peso tumbled 25% yesterday, while the rout in the Merval was one of the worst single-day stock market declines in history. Bonds puked – there are a few funds caught out by this.

La dolce vita

Italy changes its government on a roughly annual basis, so could the ructions in Rome mean something else this time? I don’t think so – not meaningfully anyway, longer term –  but for sure an outright Lega victory that unshackles Salvini would mean, short and medium term, higher debt, more Brussels strife and therefore pressure on Italian assets, esp govt bonds and banking shares. It’s also of course yet another drag on the euro.

Today – the senate meets to choose a date for the no confidence vote. It’s not a slam dunk but it seems likely there will be elections by the autumn.

On Brexit – Britain is said to be at the front of the queue for a US trade deal. The background music is playing to a no-deal tune. Prime Minister Boris Johnson is set for his first Parliamentary confrontation on Brexit on September 9th.