What a messy month June has proven to be. It started with European political strife around the Italian elections which quickly faded from headlines. Trump is always good for a headline or tweet and he did not disappoint this month, escalating trade wars with China and Europe. OPEC also got involved this month and raised production output, but not as much as the market wanted or expected. This bearish news though was outdone by inventory data and even more so by a rumour that the White House is wanting to block Iranian exports.
The central bankers did not want to be outdone on supplying volatility. Powell at the US Fed led with the FOMC, raising rates and providing a hawkish forward guidance. So, expect a few more rises this year from them. The biggest volatility however came from Draghi. Whilst they behaved as expected, keeping rates steady and tapering the QE by end of year, it was the forward guidance that caught the market on the hop. The ECB want to keep rates “frozen” at zero for 2019. The market was expecting that once QE had finished then rates would be rising throughout 2019. This sent investors bailing out of the Euro. This divergence in monetary policy will continue to hurt the Euro but I do not expect Mario to hold policy down for too long.
The US dollar spent the month whipsawing in a 180-pip range. As I write it is testing 95.00, a key resistance level which it has tested twice in June. It also tested this level in May and twice in October last year. What has been the revelation this month is the lack of correlations. The only trend that is ascertainably linked to fundamentals is the trade war effect on emerging markets and commodities. Protectionism, as expected, would lead to lower demand of raw materials, which mostly come from emerging markets. Although Australia, New Zealand and Canada are large providers of raw commodities too, and their currencies have been hit hard.
The breakdown in correlations is most notable in oil, which has rallied strongly despite the strong greenback and increase in production output. Another break is in gold, which has tumbled 4% in June. In an environment of protectionism, you would expect some safe haven flow but the yellow metal has not gotten any. This war Trump has started will slow global growth, which is why stocks are finally taking notice, commodities are plummeting and bonds are rallying. The flow seems to not be one of safe haven but one of sovereign bonds. And not bonds that have high yields either, the Japanese, German and US bonds have had the most significant positive flows, yet they (10yr) run at yields of: 0.02%, 0.32% and 2.83% respectively.
Whilst on the subject of rates, that is the final correlation I have noticed that has broken down. Traditionally, in a rate rising environment, the US dollar is weakened. Until 2018 that has been the historical correlation. Even in 2015, 2016 and 2017 this held true, with the US$ legging down on each rise from the FOMC. Yet since the FOMC raised rates in March and again in June, the US dollar has strengthened and even turned into a bullish uptrend. I can only put this down to the Trumpster and his desire to make US great again, via Protectionism and destroying old relationships. We have not seen this economic policy stance since the 1920/30’s.
With the month behind us, lets look at what is in front of us. We will get the minutes from the FOMC early in July (6th) but otherwise we will not get further data from the US Fed, expect plenty of talking heads though. The key central bank this month will be again the ECB, which meet at the back end of the month on the 26th. We’ll have usual data points to focus on for economic sentiment. However, the biggest threat, or cause of volatility, will be Trump. His trade war waxes and wanes and we cannot be certain of the outcome. His tweets are often dialled back the next day. Makes for very tricky trading conditions. As mentioned above, the only certainty is that if it continues to build momentum then the trend in commodity currencies and emerging market FX will also continue.