Currency Wars

The currency wars have been brewing for years as central banks have been racing to the bottom with zero interest rates and expanding balance sheets in an attempt to create perpetual growth machines for their respective countries. The byproduct of these policies have created staggering levels of debt and an ever increase wealth gap as stock markets advance on ever increasing amounts of liquidity. Negative rates are the standard now for Japan and the EURO zone.

The Fed’s attempt to reverse course last year didn’t work as global stock markets plunged in reaction to the withdrawal of liquidity. 2019 has brought us an inverted yield curve, a rate cut by the Fed and more tariffs against China. In response, the Chinese devalued their currency approximately equal to the amount of the tariffs sending a signal that there will be no resolution coming anytime soon (see below). What happens in the coming months will be one for the history books.

There are many variables to consider in the macro picture today but there is a potential technical pattern developing in the S&P 500 which may provide clarity on what happens next. Below is a chart of the S&P 500 index back to the 2007 high. Some observations on this chart: the 200 week moving average (blue line) has contained major drawdowns such as January 2016 and December 2018; the Fibonacci grid from the recent high to 2009 low has its most common retracement level of 38.2% coinciding with the 2015 top; there is an expanding triangle forming (yellow lines) which, if right, would imply we take out the December 2018 low.

S&P 500 Long-term Chart

If the expanding triangle theory is correct, that would fit with a slowdown in global growth coinciding with the tariffs levied against China. Expanding triangles do not mark the end of a bull market so the silver lining is that this scenario calls for one last run to new highs once the triangle pattern is complete. What would cause a bottom and a reversal to new highs? How about a trade deal with China? Politicians always succumb to pressure caused by the financial markets so don’t be surprised if there is a trade deal with China prior to the Presidential election next year.

The expanding triangle theory would be broken if we take out new highs in the coming weeks at which point the longer-term chart pattern would need to be revisited. We should have some clues on the bigger picture by this time next week.

Chart of the Week!

Every time the 30 year Treasury yield has moved by 40+ bps in 5 days something very major has happened. In this case, the trade war with China has escalated beyond a skirmish and may have broader implications for global growth.

Economic & Central Banking Snippets 

  • The Chinese renminbi has weakened beyond the Rmb7 per dollar level for the first time since the global financial crisis as prospects of a trade deal fade in the wake of Washington’s latest tariff threat. The chart below shows how the Chinese devalue their currency as more renminbi currency units are needed to buy one dollar – this relationship is set overnight daily by China’s central bank. (FT)
  • Private sector business activity in Hong Kong plunged to its lowest level since the financial crisis as the city’s economy grapples with weeks of political unrest regarding mainland China’s grip on the territory. The latest IHS Markit Hong Kong purchasing managers’ index survey, which measures private sector activity in the territory, sank further to 43.8 in July from 47.9 in June which implies a recession is in the making.
  • The U.S. July ISM services index weakened to 53.7 from 55.1 which is the weakest since August 2016. Of the 18 industries surveyed, 13 saw growth vs 16 in June. The ISM said, “The non manufacturing sector’s rate of growth continued to cool off. Respondents indicated ongoing concerns related to tariffs and employment resources. Comments remained mixed about business conditions and the overall economy.”
  • Fear over trade and currency wars is prompting monetary action around the globe. New Zealand’s central bank stunned the markets this week by dropping its benchmark rate by 50 basis points, double the expected reduction and sending the kiwi tumbling. Thailand also surprised, cutting by 25 basis points and India’s central bank lowered its rate by an unconventional 35 basis points. Meanwhile, benchmark German rates dropped to a fresh record low after industrial production registered the biggest annual decline in almost a decade. (Bloomberg)
  • Industrial production in Germany dropped by a larger-than-expected 1.5% month on month in June, compounding fears that Europe’s largest economy could be heading for its first recession in more than six years. (FT)
  • The UK economy contracted in Q2 amid rising Brexit uncertainties and weakening global growth according to data from the Office for National Statistics. Britain’s economy has not contracted since the final three months of 2012. (FT)
  • Turkey removed at least nine senior people in their central bank including the chief economist just weeks after President Erdogan sacked its governor over the pace of interest rate cuts. (FT)
  • Japan’s economy expanded by 1.8% in the second quarter of 2019, according to preliminary data, convincing analysts that it is now all but certain that Prime Minister Shinzo Abe will push ahead with a long-delayed rise in consumption tax later this year. (FT)
  • Economists’ expectations for a September Federal Reserve rate cut rose sharply this month, along with their expectations for a recession in 2020. Private-sector economic forecasters surveyed by The Wall Street Journal on average saw a 63.9% probability for a rate cut at the Fed’s Sept. 17-18 meeting, up from 49.8% in the prior month’s survey. They saw a 33.6% probability of a recession in the 12 months. (WSJ)

Macro Snippets

  • Berkshire Hathaway’s profits jump as Warren Buffett’s cash pile has swollen to a record $122B thanks to a surging US stock market that saw second-quarter profits climb 17% — but with its last major takeover now three years old, investors are waiting for an “elephant-sized acquisition”. (FT)
  • A cocktail of trade tensions and Brexit risks has driven UK bond yields to a record low, as investors ignore slightly stronger economic data to pile into haven assets. (FT)
  • Barneys New York is preparing to file for bankruptcy and nearing an agreement with lenders for a financing package that would give the luxury retailer time to find a buyer, according to people familiar with the matter. (WSJ)
  • The Trump administration is moving to impose a total economic embargo against the government of Venezuela, a significant escalation of pressure against the regime of President Nicolás Maduro and countries including Russia and China that continue to support him, a senior administration official said. (WSJ)
  • EMarketer predicts the number of US households with a traditional pay TV subscription will fall below 80 million by 2021, with more than one-fifth of households having become “cord-cutters” since 2014 when cable subscribers numbered 100.5m. Streaming is blamed, with Netflix and Hulu being joined in the coming months by Disney, Apple, AT&T’s WarnerMedia and Comcast’s NBCUniversal all launching new online video services. (FT)
  • The U.S. market for heavy-duty trucks is running out of road. Orders for class 8 trucks fell last month to their lowest level since 2010. The waning demand follows heavy investment in new equipment last year, and faltering freight-market demand and weakness in the manufacturing sector this year. FTR, which tracks equipment purchases by freight transportation carriers, expects factory output of heavy-duty trucks to decline 22% in 2020. (WSJ)

That is all for now until next week’s Market Update. Thanks for being a subscriber!


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.