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Hell Merging With Heaven


US stocks (sector performance) dropped sharply with the S&P500 falling -3.2% (clinging to a 1% YTD gain) and the Nasdaq -3.8% (+6.2% YTD) while the small cap index dropped -4.4% (-3.6% YTD). Losses were led by banks (-5%) which fell to the bottom of our Z-score report yesterday as the sector took the one-two punch of a sharp yield decline and a further flattening of the curve generally associated with lower bank profits. The decline was however broad based as suggested by home builders (which are generally supported by lower yields) dropping -4.7% and by Berkshire Hathaway shedding -4.8% as well. While fears of a slowing economy solidifying with a yield curve near inversion played a role in accelerating losses yesterday, the main culprit for the initial kick was yet another tweet of D. Trump... “....I am a Tariff Man. When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so. It will always be the best way to max out our economic power. We are right now taking in $billions in Tariffs. MAKE AMERICA RICH AGAIN” This was read as meaning that despite his earlier jubilation, the week end meeting may not have gone that well after all (as the Washington Post suggested yesterday), leading to a sharp reversal of Monday’s initial burst of stock market enthusiasm. Weakness begot more weakness in a trend and momentum driven chasing world and the same algos that had bought the break out and above of 50dma and 200dma on Monday, were forced to sell the S&P and Nasdaq yesterday as the downdraft broke the very same averages again with flows estimated by Nomura to be around USD50bn. We have been harping on the same string for some time about the importance of trend following to explain equity markets movements but we remain wary to blindly follow those trend signals in all circumstances especially when they try to grab downside trends in equity markets. 

The Chinese currency rallied for second day despite the global equity markets sell off (Snapshot) and EM stocks outperformed in yesterday’s downdraft, suggesting a continued healing process (Diversified EM EMLC China CSI300 Russia). The Dollar index (FX PDF summary report) closed mostly unchanged although EURUSD, closed marginally down after erasing an earlier spike. GBP remained relatively volatile but lacking direction despite UK PM T. May suffering another setback on her Brexit plan, losing three votes in a contempt challenge. Given that a failure of her Brexit deal could also lead to a new referendum, GBP cannot decide which way to go despite a relatively negative news flow. In France, French President E. Macron suspended for six month a planned fuel tax increase. Sure enough, this can only be a negotiation tactic as it will in all likelihood not suffice to bring back calm. An increase in the minimum wage and some serious discussions on wage disparities, wealth taxation and how to go about them are also likely to fall on the negotiation table sooner rather than later, in our view. D. Trump added fuel to the fire with some outplaced and stupid tweets but that will be a matter of discussion for another day. US 10y Treasury yield (bond yields snapshot) closed -4bps lower (at 2.92%) with German 10y Bund yields closing at 0.26% with similar gains. BTP’s rose 1bp, driving the 10year BTP/Bund spread wider by 5bps, essentially erasing Monday’s gains. US and EUR High Yield Credit spreads climbed 14bps and 11 bps respectively (HYG) on renewed credit risk concerns. It was widely believed as has become customary this year that the rally in Treasuries (and hence the flattening) were also driven by short covering as the market continued to assess the need to hold speculative shorts around their highest levels of the past 10 years (see chart below) while Fed rate dots are being revised down even as Federal Reserve Bank of New York President J. Williams cautioned yesterday that the economy is strong enough to warrant more rate hikes next year. Bank of America on its part said in its 2019 economic outlook that "most major economies are likely to see decelerating activity", suggesting that "a steady stream of monetary and fiscal stimulus measures" would stem the slowdown. That is about what we think as well; one more rate hike this month possibly and then done…to be followed by an interruption of QT and a resumption of QE. 

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