Intraday Market Thoughts

Tariffs and Terminal Rates

by Adam Button
Sep 17, 2018 11:39

A weekend report (another one) suggested Trump could finally announce the long-rumored $200 billion in Chinese tariffs as soon as Monday. We will also take a shift in Fed rhetoric that could keep a bid under the US dollar. CFTC positioning showed GBP shorts easing up. Friday saw a miss in US retail sales after, 2 day after a miss in CPI.  Equity indices are in the red due to the latest signs of pessimism on the trade front. Thursday's pre-ECB Premium trade is 70-pips in the green but will likely be kept open after a key support has been broken. Later today, Ashraf shall post the weekly Premium video, shedding important technical light on the US dollar.

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Tariffs and Terminal Rates - Yields Spx Sep 17 2018 (Chart 1)

The good news is that tariffs won't be as harsh as feared. The bad news is that we may be a day away from another step closer to a US-China trade war.  Several reports suggest Trump will announced tariffs on $200 billion in Chinese imports on Monday or Tuesday in an effort to win trade concessions. China has promised to retaliate. Trump called for 25% tariffs but after hearings, the reports say that will be scaled back to 10%. Ashraf tell me Trump will continue sending mixed messages and delaying resolution until after the Nov mid-term elections to garney support from his base.

It's been remarkable how the US market has brushed off trade risks so far this year and we will be watching very closely to see how markets react.

In the bigger picture, the US dollar made some headway last week against the yen in part to due to comments from Brainard. We often focus on the next central bank meeting or maybe two meetings ahead but we should rather be looking at the terminal rate – how high interest rates will rise before the Fed or any other central bank pauses. Lately, indications are mounting that could be higher than believed.

Right now the market thinks the Fed sees risks of a pause or at least a significant slowdown in hikes at 3.00% or sooner. However last week, Fed Governor Lael Brainard introduced a new wrinkle. She started talking about 'short-term neutral' and 'long-term neutral'. Her point was that short-term neutral might be higher than long-term neutral.

Extrapolating from that, rates could rise well-above 3.00%. Looking at derivatives pricing, the market sees about a 20% chance of more than four hikes in the next year-and-a-half. So if we get two more hikes this year, the pace would slow to just two hikes (or less) in the following 14 months.

What Brainard is hinting at is there could be more. We'll be watching closely to see how that debate evolves but it will take some patience – the Fed is now in its pre-FOMC blackout period.

CFTC Commitments of Traders

Speculative net futures trader positions as of the close on Tuesday. Net short denoted by - long by +.

EUR +11K vs +8K prior GBP -61K vs -70K prior JPY -54K vs -52K prior CHF -35K vs -40K prior CAD -27K vs -26K prior AUD -44K vs -44K prior NZD -23K vs -25K prior

There were no dramatic shifts and the preference for the US dollar remains high but the slide in cable shorts is notable. If the tone on Brexit talks improves, it could be a quick rush to the exits.


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