Originally published by AxiTrader
Market Summary (7.35am May 30 2018)
This is what happens when people think they are playing chess but are in fact playing poker.
I’ll have more to say on that in the full note later – but suffice to say everyone has overplayed their hand here in this Italian political mess.
As a result the market, as thin slicing as ever and a hater of uncertainty, has reacted angrily, knocking the euro down to 1.15, stocks around 1.5% lower, Italian bond rates and CDS through the roof. The wash up is US rates markets have repriced Fed hikes for 2108 and driven the US 10-year bond rate down to 2.785% for a full 15 point rally on the day.
As the third biggest economy in the EU, as a heavily indebted one, and with Euroskeptics – perhaps Italexiteers - seemingly in the ascendancy, markets have worried that the EU again faces an existential crisis. I’ll go out on a limb and suggest there are a bunch of experienced political operatives in Europe and some neophytes in Italy who might just of got the shock of their lives on how quickly this situation developed and we’ll see some back peddling.
That’s for later. But at present, the recap is that Italian 10-year bonds have blown to bits and are trading at 3.18% this morning. To me that’s still expensive though if you think something really is going down and Italy may leave the EU – 7 perhaps 8 per cent may be more appropriate.
On stocks, the FTSE MIB dropped 2.65% while in London, Paris, and Frankfurt the headline indexes dropped between 1.25% and 1.53%. Across the Atlantic the Dow lost close to 400 points to finish dwn 1.58% at 24,361 while the Nasdaq dropped just 0.43%. The S&P finally broke the 3-week range closing at 2,690, down 31 points, for a 1.15% loss. Lower levels beckon.
Here at home it is target achieved for the SPI after a fall of 50 points sees it sitting at 5,963 this morning. Should be an interesting day on the ASX today.
To forex then which is where a large part of the Italexit fears played out with euro selling and yen buying. Currently, EUR/USD is at 1.1540 for a fall of 0.7%. All things considered, that’s not too bad really – the low was 1.1511. USD/JPY did what USD/JPY does when markets get funky, it fell and is now trading at 108.72 down 0.63%. Sterling is a bit of a sideshow in this environment and dropped just 0.4% to 1.3258.
Of the commodity bloc currencies, the Canadian dollar did best with USD/CAD up just 0.18% to 1.3014. The Aussie and kiwi had decent falls though to 0.7507 and 0.6898 respectively for losses of 0.5% and 0.6%.
On commodity markets themselves, copper lost 0.8% to $3.0525 a pound, oil was offered in the US but Brent held up exceedingly well. That’s left WTI down 1.55% to $66.80 while Brent is up 0.13% to $75.40. And in what might be the most remarkable move of the night, gold is just $2 higher at $1300 this morning.
Besides all this fire and fury over Italy there were a couple of other things worth noting. The US is back on the sanctions and tariffs bent against China, which surprised the Chinese they said and suggests to me the moves in US stocks weren’t all about Italy. Also Israel came under missile attack last night which might help explain the difference in the oil benchmark performance – might.
On the day ahead we start to get some decent data. It’s just building approvals in Australia but Japanese and German retail sales are out along with German import prices, German unemployment, German inflation, and French GDP. Euro area business and consumer confidence along with inflation expectations and sentiment are out. My guess is these don’t really matter in the current environment because taken today they’d all be much lower. But that adds a certain asymmetry to the outcomes – negative results to expectations will likely hurt EU markets and the euro.
In Canada we get the current account and PPI while in the US it’s the latest read on Q1 GDP, PCE prices, goods trade balance, and wholesale inventories for April.
Have a good day and the Sergeant used to say on Hill Street Blues, be careful out there.
Here's What I Picked Up (with a little more detail and a few charts)
International
- With apologies to Annie Duke I will again say that this Italian mess is what happens when everyone thinks they are playing chess but they are in fact playing poker. In here brilliant book “Thinking in Bets: Making Smarter Decisions When You Don’t Have All The Facts” Duke quotes an exchange between Jacob Bronowski and the legendary mathematician John Von Neumann on game theory. They were talking about game theory and Bronowski said “you mean, the theory of games like chess?” To which von Neumann replied – “no, no. Chess is not a game. Chess is a well defined form of computation. You may not be able to work out the answers but in theory there must be a solution, a right procedure in any position. Now real games”, he said, “are not like that at all. Real life is not like that. Real life consists of bluffing, of little tactics of deception, of asking yourself what is the other man going to think I mean to do. And that is what games are about in my theory”. Duke goes on to say that the decisions we make in life – and in politics and markets – “easily fit von Nuemann’s definition of ‘real games’. They involve uncertainty, risk, and occasional deception, prominent elements in poker. Trouble follows when we treat life decisions as if they were chess decisions”.
- And this is where President Matterella went wrong. This is where 5 Star and La Liga went wrong calling for impeachment. It is where EU officials went wrong with their comments last night (more on that below) they all thought they were being very strategic but didn’t think about the other players at the table – notably Ms and Mr Market and what they might do and how they might react. It’s how we’ve ended up with this mess we are in. Each of the players has overplayed their hand and we’ve ended up with the turmoil we’ve seen this week.
- Okay, so you think I’ve gone off on an esoteric tangent. I promise you I haven’t. We now have to think about what the reaction of the players is going to be to the markets turmoil. My sense is we might see some backtracking. Already last night we saw 5 Star leader Luigi Di Maio say that his party never sought a Euro exit (which is true as this excellent Twitter thread points out) and this morning he’s said he’s no longer seeking President Mattarella’s impeachment. And there is now talk the two parties will again try to cobble together a government.
- Also last night EU president Donald Tusk – thank goodness for him - backtracked from comments made by Germany’s EU commissioner Gunther Oettinger that “the coming weeks will show that developments in Italy’s markets, bonds and economy will become so far-reaching that it might become a signal to voters after all to not vote for populists on the right and left”. The will of the people, heaven forbid. Oettinger has now apologised.
- But showing how tone deaf EU policy makers can still be we had ECB vice-president Constancio telling Italy it had to read the rule on any help and then German ECB member Sabine Lautenschläger say the bank is still looking at ending QE this year. Not today, Sabine. Not today.
- Enough of Italy though – they will sort it out eventually because the cost of not doing so is too high for the very people who elected the “populists” and, as Donald Tusk said, they are all there to serve the people. But before I go here’s two charts which put this week’s turmoil into context.
- Global 10-year bond rates – Italy is yellow and the US is orange.
- And the daily percentage moves in Italian 2-year bonds – both pictures speak of earthquakes.
- And it is worth noting that the washup in all of this is that US rates markets have materially repriced the chance of not only a fourth hike in December this year back to 10% but also of Septembers third hike to just 36%.
- One other very important thing happened last night is that the White House has again signalled it is going after China on trade and tariffs. The Chinese have announced they are “surprised” and said in a statement, “No matter what the actions that the US plans to take, China has the confidence, the capability, and the experience to defend the core interests of the people and the nation”.
Australia
- The SPI has both achieved the inintial target I had for it and also – possibly – found some support on the previous trendline. As it stands as long as last night’s low holds the SPI and ASX may find their feet. But the reality is that in this current market, with this turmoil, we’ll need to see a recovery in bigger markets for that to be sustainable. As the 50 point fall in the SPI suggests overnight, yesterday’s rally on the ASX 200 was aberrant.
- The Australian dollar is down around half a percent against the US dollar in what is a natural reaction to the risk off tone in markets right now. That and the combination of a dip in commodity prices and a push higher in the US dollar has knocked the AUD/USD back to 75 cents. Last nights low of 0.7496 isn’t far away. And the key to the outlook seems to be that the uptrend from the May lows just a little above 74 cents has now broken. That gives the Aussie a downside bias once again. 0.7470/75 looks like support if 0.7492/96 gives way. Below that it is 0.7447 then 09. There is always a chance of a rally if things sort themselves out. But the day after the rock has been chucked into the pond is probably not the day. Not for a sustainable Aussie bounce anyway
Forex
- The turmoil kicked off in Asia yesterday as the sellers came for USD/JPY and the yen crosses. At the time the only thing I could find that was remotely worthy of such a reaction was a story in the SCMP saying Philippine President Duarte was prepared to go to war with China over resource extraction on a disputed shoal. With the benefit of hindsight though this was clearly the first move in what was a broader shift of money away from Italy and a growing concern for the actually continuation of the EU project. That the move kicked off in USD/JPY suggests it was a big asset allocation shift – or bet against the EU – by someone with very deep pockets.
- So the wash up this morning is that the trend toward US dollar strength has been reinforced. And even if this Italian mess settles down and volatility goes back to where it was a week or so ago the reality is that the current situation, the slide in EU data, and now growth expectations which must flow from the turmoil utterly reinforces that the US economy and the US dollar are the place to be (unless you want to be short USD/JPY for a blow up). So to that end when the bounce comes in the euro, and weakness in the dollar, it’s likely to find plenty of folks keen to take the opposite position.
- So I am utterly recommitted as a US dollar bull this morning. But, while I don’t like to catch falling knives, the question I’m asking myself is whether last nights moves in forex, and other markets, was actually the pessimistic crescendo we often get before a reversal. It’s too early to tell. But I’m watching closely.
- If USD/JPY can hold above 107.95/108 then maybe that might be the as.
Commodities
- Oil was interesting insofar as the two benchmarks we talk about each day diverged in terms of performance. What’s also interesting is that even though WTI was down 1.5% it was actually an up day in terms of the candle – opened lower finished higher. That’s curious and suggests here is still some underlying support in the market.
- What’s interesting to me is whether or not the turmoil in markets impacts OPEC and Russia’s view on demand as they head toward the June meeting and whether or not that then changes the discussion about a supply response to the issues in Venezuela and Iran. I have know way of knowing yet. It depends on if this Italian turmoil is more than a storm in a tea cup. Either way though only a close in Brent below $71.25 or WTI below $65.75 would turn the outlook bearish. Here’s Brent.
Have a great day's trading.