Monthly Macro Risk Monitor – 5 Dec 18
My greatest discovery was that a man must study underlying conditions, to size them so as to be able to anticipate probabilities. – Jesse Livermore
In this recurring monthly analysis, we will look at three global risk factors in order to assess the current market state and attempt to foresee risks on the horizon. The factors that we will be using, in order of weight, are:
- Global Monetary Policy
- Global Volatility
- Global PMI readings
Together, they can assist us in shaping up underlying macro conditions, so we don’t get caught off guard by some change in market dynamics that was foreseeable.
Global Monetary Policy Stance
We use Global Monetary Policy to evaluate inflation risks, deflation risks, and interest rate risk.
Monetary policy is being tightened very gradually, which will place upward pressure on rates (as we have seen in US 10yr) which will in turn put pressure on USD-denominated debt. Rates are gradually rising elsewhere also, adding cyclical pressure although the main focus remains the FOMC and it’s impact.
Global Volatility Meter
We use the Global Volatility Monitor to capture economic growth risks and liquidity risks.Since we are tracking the implied volatility on the S&P 500, the Eurostoxx and Crude Oil, we can see the composite indicator as “the cost of hedging a price decline” in each market.
Volatility is now “high” as we are above the 22.50/23.00 mark. This is negative for cyclical assets and will make conditions more challenging.
Global PMI Monitor
Source: IHS Markit
We use the Markit/JPM Global PMI analysis as a gauge for economic growth risks, inflation risks and deflation risks. PMIs are known to be a leading indicator for GDP growth rates.
Conditions in the global manufacturing sector remained lacklustre in November. Production growth ticked higher in November, but remained among the weakest seen over the past two-and-a-half years. Efforts to raise output were constrained by the relatively muted trend in new business. New orders rose at a pace unchanged from October’s 25-month low, with international
trade flows the main drag. Inflationary pressures eased in November. Input costs increased at the slowest pace since August 2017, while output charge inflation eased to a 16-month low.
To Sum Up
Our Macro Risk Monitor (MRM) is currently showing a slow but consistent tightening of monetary policy, and higher volatility conditions which will exhert downward pressure on cyclical assets. Global growth expectations are slowing and emerging markets are already in a contraction. The PMIs usually anticipate trends in GDP by 6 months, hence the focus on them. We are seriously headed for tougher conditions moving forward and the downside risks in cyclical assets are starting to outweight the upside.
About The Macro Risk Monitor
What we are doing is neither new nor original. Anyone with a basic comprehension of macroeconomic theory, and a bit of real world experience, can do the same thing. We’re just doing it for you. What follows is a brief explanation of why we are monitoring precisely Monetary Policy, Volatility and Purchasing Managers’ Index.
- During periods of real (non-inflationary) growth, the main cyclical classes (Developed and Emerging Market Equities, Real Estate, High Yield Bonds) tend to have low volatility.
- Vice versa, during periods of economic uncertainty or outright contraction, cyclical assets have high volatility.
- However, we can also have inflationary growth, which is the best environment for Commodities (Energy, Industrial Metals).
When volatility is high, or global growth expectations (measured via the PMI) are low and monetary policy is tight/tightening, there is a collision of risk factors that produces a high uncertainty/high risk environment that is usually only favourable to fixed income and counter-cyclical assets.
When volatility is low, or global growth expecatations (measured via the PMI) are high and monetary policy is loose/loosening, there is a combination of easing factors that produces a low uncertainty/low risk environment that is favourable to cyclical asset classes.
By using just these three measures, we can create discrete market environments that can assist in selecting the right asset class to target given the current situation.
If any of this is a bit foreign or complex, our Forex Fundamentals Mastery course can bring you up to speed.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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