Trader's View - Risk assets fall, safe-havens rally, as fears mount about global growth

Volatility lifts and risk appetite wanes

It was not a good night for risks assets, last night. Financial markets have behaved like a wound-up coil the last few weeks, since the re-escalation of the US-China trade-war. There’s been a sense that their needs to be a snap-move, one way or another. And in the last 24-hours, it’s apparently arrived. The price action speaks of a market fearful the trade-war, and how it may enervate global economic growth. Volumes are elevated, volatility is up, stocks have sold off, commodities are down, safe haven assets have been sharply bid higher, and SPI futures are pointing to 29-point drop for the ASX 200 this morning.

Markets repricing for greater growth risks

Like any major move in global markets, the momentum behind last night’s sell-off was fuelled by a heightened sense of uncertainty. The uncertainty comes from the (at present) intangibility of the trade-war’s impact on global growth, and future corporate earnings. To be clear, the argument isn’t about whether the trade-war will have a negative impact on fundamentals at-all. Conventional wisdom holds true that higher trade barriers and greater geopolitical risk is a bad thing. Instead, it is about the extent of the damage that the trade-war will inflict upon the global economy and financial markets, and how mispriced assets markets are presently as a consequence.

The trade-war impact remains ambiguous

This isn’t to say the impacts can’t be quantified, either; but just that to do so is difficult. And this is especially the case at these early stages of what is shaping-up now as a protracted conflict between the US and China. The key element to market psychology now is that given market fundamentals were softening-up anyway, and a big, new risk has emerged that could potentially exacerbate the dynamic, there remains little justification in the short term to buy risk assets. The times require capital preservation, it would seem, for at least as long as it takes for the current turbulence in the macro-environment to pass.

“Funny money” leaving the market

Furthermore, the kind of flow moving out of the stock market is likely to be the type of flow that fuelled US equities remarkable run to all-time highs. That is, not “real money”, but that of leveraged funds, and other momentum chasing types, which tend to cause overshooting in market pricing in short-term time frames. This is where the risk of greater downside emerges: if volatility continues to mount, courtesy of deteriorating market-sentiment, then any sell-off in the market might see itself slightly exaggerated. Hence, just as (ostensibly) irrational behaviour generated a distinct rally in the market, so too might it cause a precipitous retracement.

Not the cause, but an accelerant

From here, the matter is how this could all fit into the grander scheme of things. Given the demonstrable signs of late-cycle behaviour in markets, the primary risk is that the trade-war could accelerate the global economy’s path toward some sort of recession. A clear disclaimer: this isn’t the base-case for the market per se, but the one that appears to be of greatest concern for market participants right now. Given this is so, as time goes by, and higher tariffs work their way into the economic data, event risks will almost singularly become about what they imply about the trade-war and how it’s impact on the macroeconomy.

Last night’s data exposed economic vulnerabilities

In part, this phenomenon prompted the overnight sell-off. Though not the highest impact of releases, the data that’s been printed in the last 24-hours spoke of softness in the Japanese, European and US economies. Manufacturing PMI numbers from all three regions missed expectations, and compounded fears about the future health of the global economy. Perhaps the greatest surprise came in the US set of numbers. US Flash Manufacturing PMI numbers revealed a 50.6 reading – well below the 53.0 consensus estimate, and only slightly above the 50-mark, which represents the line in the sand between expansion and contraction in the manufacturing industry.

Market participants position for slower growth, rate cuts

The price action in response to the overnight shift in sentiment was quite noteworthy, with the moves in global bond markets most remarkable. It was observable across all government debt, but US Treasury yields tumbled, with the 10-year note dropping 7 basis points to about 2.30%. The rate on that security is now below the Overnight Federal Funds Rate by 10 basis points. What this move conveys is clear as day: despite the Fed’s minutes yesterday betraying a quiet optimism and a neutral policy bias, markets are betting big on a US economic slowdown and subsequent Rate cuts from the Fed.