Monthly Macro Risk Monitor – 6 Jan 19

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 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

Source: cfr.org

We use Global Monetary Policy to evaluate inflation risks, deflation risks, and interest rate risk.

Global monetary policy has been on a tightening cycle but has currently paused in terms of rate hikes. What the policy meter doesn’t capture is the amount of QQE unwinding (CB balance sheet reduction) that is going on, and is reducing liquidity at the funding level. In brief: policy is adding pressure, despite the chart doesn’t show it.

Global Volatility Meter

Source: TradingView

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 remains heightened as we are in a decisive high-volatility/low-growth situation. Cyclical assets will remain under pressure in current conditions. This is further reflected by the current trend in SPY/TLT (another version of a risk on/off meter).

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.

The bleak picture has been confirmed by the official commentary this month :“The global economy ended 2018 on a subdued note, with the rate of output expansion slowing to a 27-month low. This mainly reflected the ongoing weakness in new order intakes, especially a second fall in international trade of goods and services during the past four months. The trend in new
export business will need to show meaningful signs of revival early in 2019 if global economic growth is to make
meaningful strides forward in the coming months.”

 

To Sum Up

Our Macro Risk Monitor (MRM) is currently showing a high volatility/low growth emvironment which will likely keep pressure on cyclical assets and makes this a trading environment rather than a buy/hold environment. There are recession risks (which the PMIs were hinting at 6 months ago) and liquidity issues at the funding level. Looking for opportunities in defensive assets should be the way to go in current conditions.

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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