“I’m not thrilled,” President Trump told CNBC's Joe Kernen in an interview on "Squawk Box."“Because we go up and every time you go up they want to raise rates again. I don't really — I am not happy about it. But at the same time, I’m letting them do what they feel is best.”

The balancing act for July has been global growth outstripping fears of political trade and currency drama, along with FOMC policy mistake doubts, Brexit troubles, populist politics rising and China growth missteps. The increase in volatility for 2018 stalled a bit into summer along with volumes as many appeared to follow the season, go to the beach, sell volatility, buy carry and wait it out until Autumn. Whether this works out seems to lean on actual growth data for 3Q and 2Q corporate earnings mixed with 3Q outlooks. It also appeared to shift rather dramatically last week starting Thursday with the Trump interview and Friday tweets on the USD and Rates. The July Track idea dinner brought together a great group of investors, traders, analysts and market mavens to discuss these themes.  

The first question for the event was how do markets ignore political noise? The news reaction function of 2018 is different than that of 2017. The headlines go into the market and volatility comes out whereas previous years were much more sanguine. The list of concerns was long but not dissimilar to those of other years – Trump, Italy, Germany, UK, Mexico, China, Russia. The two differences for 2018 that came up in the discussion were 1) the credit contraction in China and 2) the FOMC rate normalization approaching restrictive rates (CPI-Fed Funds =<0). The point being that both US and China policy is making the equity/bond relationship different than it was post 2008. This move away from easy money has left risk and hedging of it across markets more complicated.  This is shown by the breaking down of bond/equity correlations from positive to negative now.

It’s also shown in 2018 by the notable break of CNY/JPY which represents the carry trade and the value breakdown in factors across markets in 2018. The China growth stall and the failure to match US rate moves has left the China currency struggling. 

Risks to US Growth – FOMC or Trump? As for the arguments given by Trump and others that the USD rally and FOMC rate hikes in 2018 are offsetting his tax reform stimulus most of the room recognized that the USD is actually down 2% since Trump took office and that the FOMC rate hikes to date are still in the “accommodation” zone. The USD Real-Effective Exchange Rate (REER) is what the FOMC and US Treasury use to judge whether markets are in crisis and given the global growth backdrop and the plentiful ongoing liquidity in FX major currencies, its hard to see that USD gains or FOMC rate hikes are the key driver for tail risks rather than trade tariffs and sagging corporate/consumer confidence.

The flatter yield curve and the implication that it was more than just a term-premium noise from other central banks QE/negative rates was also discussed. The crowding out of US funding and its effect on the rest of the world was part of the story – as the US deficit and its need for global savings returned the world to 1980s plaza accord like situations – with higher real rates, higher deficits squeezing the USD stronger particularly when the stimulus of fiscal policy comes in the latter stages of a recovery driving up inflation risks. 

Growth globally was seen as the key anecdote to doubts about politics both at home in the US and abroad. There was a side discussion about AMLO in Mexico and the tail risks of his new government not correctly priced – as many see his left-leaning politics as anti-business – but one dinner participant highlighted that his real tail risk was in driving Mexico into a corruption witch-hunt that led to a Brazil “Car Wash” like crisis where government institutions and that ruling elite have no where to hide and push back on the government and hurt the economy. Institutional Trust was seen as a slippery slope when lost and one that pervades the tail-risk fears for Italy, US and much of EM now. 

Brexit and it effect on the UK was another long discussion. The present market issue follows this logic – no soft Brexit means a new election, which will likely bring in a hard socialist UK government. The role of the BOE in this was also discussed as the ability for the UK to deal with another larger shock was doubted. In March, Oliver Wyman and Clifford Chance in a report said the cost of a so-called "no deal" scenario would total around £31 billion for EU exporters and around £27 billion for U.K. exporters.

The overall EM crisis in 2018 was seen as one stemming from too much debt. The FOMC hikes and the squandered ability to reform when times were good was seen as leaving some but not all emerging markets vulnerable.  While the argument was made that much of EM troubles were idiosyncratic – with Argentina, Brazil, and Turkey given as examples – others pointed to the flow of money and its link back to rates and volatility. The ability for nations looking for liquidity to trade their way back to stability via devaluation was highlighted as being less likely to work – with Italy compared to Brazil today. The removal of US easy money has been mixed with the removal of central bank reserves as many EM nations battle to control their FX volatility. In fact, global QE has reversed since June and it maybe testing the liquidity trap fears for the rest of the year. 

China growth. The China slowdown in growth has been blamed on its own credit tightness and regulatory ambitions to restrict the shadow-banking sector along with US rate tightening, US trade tariffs, and uncertainty hitting. The private access to cheap money in China is gone and with it some of the quicker growth hopes.

Some argued that China was going through its own 2008-2009 crisis now with debt deleveraging forcing a retrenchment of all markets there. Others argued that the flip of owning homes or stocks or commodities was still in play with the last jump up in housing prices in July – even with restrictions on ownership – making it clear that money is scared about stocks and bonds in China still. All agreed that the restrictions on capital outflow make it more difficult for China to fix itself and for money flows to return to China. 

The biggest issue for Europe maybe in the budgets of the periphery still – particularly that of Italy where the IMF sees the debt ratio falling from 130% in 2017 to 110 by 2026 only with tighter fiscal policy – the primary budget surplus is supposed to rise from 1.7% to 3.6% of GDP and stay there. Only if Italy grows faster can the new government see any hope of reducing its debt burden but that may still not work given it will surely mean the cost of debt service will rise in tandem. 

The fears about Italy and UK as they clash with the core EU plans for greater integration also are in play and highlight the role of populist politics at play across the Western World. The role of the ECB and QE in these politics remains a sore point and one that the ECB is working hard to unwind – see this working paper here– arguments that QE is about asset price inflation only with arguments that lower rates help consumers on mortgages, jobs, and their own asset ownership, while noting that savers are hurt in traditional bonds/cash holdings. 

No dinner would be complete without a discussion of bubbles and the role of cryptocurrencies. Many saw cryptocurrencies as lacking the regulatory framework necessary to become institutional, but that preparing for that day made sense. Others saw that the variety of approaches that encompass the class – from alternative stores of value, to better, faster settlement, to cleaner audits and information chains to tokens and more efficient shared business networking – all that made many pay attention to the space but not in an active way. Bubbles in real estate particularly in Asia were seen as the biggest issue while those in credit in Europe were also feared.  

Best Trades: The discussion on market risks and themes was far longer than the discussion of where to put money in the next few months. This doesn’t make the ideas listed below less powerful but its worth mentioning that there was little time to debate the merits of each.

1. Short EM debt, long core debt / or short BB and long AA debt. The July rush for carry was seen as temporary and unlikely to last. 
2. Long Argentina linkers – view that inflation has peaked and IMF deal will help
3. Long Argentina equities with the MSCI return a key factor and a view that banks are set up for a rally – with some discussion as to timing – waiting for confirmation of recession.
4. Long Volatility – with a short USD tilt – using G4 currencies – so long USD puts on EUR/GBP/JPY and CHF. Responding to Trump comments and discussion of risks
5. Long forward 3M/3M volatility in equities and bonds – trading through midterms
6. Short Gold – same as last month – negative carry trade with little value seen even if USD reverses
7. Long e-commerce and financial technology shares – with Tencent seen as entering the US markets in next year.
8. Short EUR/JPY with view that stock market pain trade correlation high
9. Short S&P500 and long US bonds via 3M option structure

Worst Fears: The list of big issues that we discussed may have tired the room out so that the listing of big, new fears is shorter. It could also be that many were focused on the present calm being difficult to break given summer vacations.

1. Too much debt leading to another crisis of forced deleveraging. 
2. Complacency as shown by low levels of implied vols in equities and FX even though risks are higher in 2018 
3. President Trump focus is only on ratings. There was a consensus that the biggest fear was that Trump reacts to polls more than to an agenda for real change. 
4. US inflation surges.  The fear that US CPI has a spike to 4-5% and that the FOMC has to react to it was discussed with a number agreeing this was a “worst case” outcome.
5. Geopolitical crisis.  The testing of US allies by Trump’s pushes on NATO and trade whether NAFTA or EU was seen as dangerous should the US face a real crisis and find its allies no longer supportive. 

Conclusions: Markets may be quiet in July but they aren’t calm. The Track dinner lasted longer and proved more full of debate and ideas than usual indicating that its not an easy time to go on vacation and forget about the balancing act of growth against politics. The role of political economics in the framework for trading all markets has returned and macro appears to be on the upswing, perhaps at the expense of passive money flows. How the rest of the summer plays out will be interesting to follow in the context of the trades and fears listed from this July dinner.