“And Aaron shall cast lots over the two goats, one lot for the Lord and the other lot for Azazel. And Aaron shall present the goat on which the lot fell for the Lord and use it as a sin offering, but the goat on which the lot fell for Azazel shall be presented alive before the Lord to make atonement over it, that it may be sent away into the wilderness to Azazel.” - Leviticus 16:8-10

A scapegoat is an animal ritualistically blamed for the sins of others, then driven away, cast into the desert, to carry away the evils of the entire community.  In order to go from fear back to greed, markets will have to find a scapegoat, something to blame for the last week’s turbulence and anxiety, define its community, and then find somewhere to cast that negative energy other than emerging markets or bonds. There is no one cause for the selling of risk-assets last week suggesting we may be looking for a flock of them.

Some blame the FOMC rate hike and future path for more of such. President Trump likes this argument. Others blame the President and his China tariffs as the trade war becomes more of a cold war with expectations that this may take years, not months, to resolve. China itself was blamed as well, even as its trade report showed little effects yet, but a report that China was cracking down on traveling citizens bringing undeclared designer handbags and other goods into the country – being an example of the tit-for-tat battles spooked markets.

Others point to the IMF meetings and the WEO warnings on global growth with higher rates and protectionism highlighted. Finally, some blame the 3Q earnings ahead with outlooks for 2019 very much in doubt even as profits now are expected to remain strong as many see this the best of times.  

The key US headline stories beyond the political noise of trade came with the US CPI and University of Michigan consumer sentiment reports. Markets are a confidence game and many see the fall in the S&P500 as a warning signal for growth into 2019 while others see it as a buying opportunity. So turning the tide of sentiment in markets and in the economy requires an event, or more facts like a benign CPI report, or just less selling like Friday’s bounce.

The obvious cure for bear markets is time, and perhaps, it’s like the magic Lo Shu Square found on the back of a turtle, after a flood of selling, wait 15 days. So shoot for the end of the month and look for the return of a bull market or prepare for the US mid-term elections and the larger pull down of political worry.   

What Happened over the Weekend?  

Plenty of stories about Saudi Arabia and the missing Washington Post Reporter; lots of US mid-term election focus with tight races; more on votes in Germany, Luxemburg and ongoing talks on Brexit – but perhaps the most immediate story and key focus is on CNY and the role of the PBOC.  

• Key theme – PBOC prepared for all risks in CNY policy. The Chinese central bank governor said the country’s currency was at a “reasonable and equilibrium level,” Bloomberg quoted Yi Gang as saying.
• New theme - Saudi/US rift after Trump threatens “severe punishment” on Khashoggi disappearance and Saudis reject such threats and political pressure. In an interview with Lesley Stahl of CBS’s “60 Minutes” that is airing Sunday, Trump called the journalist’s suspected murder “really terrible and disgusting.” “We would be very upset and angry if that were the case,” he said of Saudi Arabia’s potential responsibility. “As of this moment, they deny it, and they deny it vehemently. Could it be them? Yes.”  Key measure of whether this matters will be on oil prices and on mid-east balance of power – measured by Israel and Syria stability. 
• Old theme – Merkel leadership in question. Sunday voting in Bavaria left Merkel’s allies with the worst election result since the 1950s losing to the far-right. The CSU won just 35.5% losing its absolute majority for the second time since 1962. The Greens were second and AfD third, forcing a coalition leadership in the key state assembly. 
• Tired theme – EU/UK Brexit talks and politics.  EU ambassadors were told there is no deal yet on Sunday according to Reuters. While Politico reports an EU breakthrough. 

Question for the Week Ahead: Was US CPI sufficient to stop the FOMC from 4 more hikes? 

Markets are looking for some cause to celebrate amidst the ashes of last week’s fire-sales in risky assets. The benign CPI report from the US and the confirmation of the same in Europe (with final French, German and Italian HICP) all confirmed that despite higher energy prices, CPI isn’t accelerating.  In fact, there are many that see the momentum flipping the other way. 

The key question then becomes the response function of the FOMC to the data and to the Board’s view of neutral. The story line of the market has been that Trump tax cuts and stimulus have propelled the economy at the end of the cycle, along with the tariffs inevitably hitting consumers and corporate import prices, all adding up to higher inflation risks in the months ahead.

The conflict for the Fed rests on the need for forward guidance on future rate hike paths against the uncertainty of growth and inflation in the months ahead. The power of central bankers surprising markets has been lost since 2009 and maybe that returns with normalization. The bigger worry may be in the relationship of US deficits and Fed hikes as they lead to a tipping point in the debt dynamic for the US and the rest of the world. The US government squeezing out other nations and corporations in a race for excess money could lead to a larger run on bonds but the politics of this are less obvious - as the PEW research suggests. 

Market Recap

Selling of equities became the news and the reasons behind it secondary to the last week. Bond yields rallying back were not enough as supply – particularly from the US dominated – with the Thursday 30Y sale showing significant demand. The Monday holidays made this a lighter week for liquidity and a slow start to news.

US PPI was higher but CPI lower (2.3%) leaving a modest hope for FOMC restraint into 2019. The week started with China focus – as the PBOC cut the RRR again by 1% - driving up speculation of more stimulus and more CNY weakness. The TRY gained on the new inflation fighting ideas and on the US pastor release deal. The BRL gained on the Bosonaro win – with 46% of vote – still shy of the 50.1% needed outright but clearly the leader for the October 28 run-off against left-wing Haddad. The IMF meetings in Bali this last week also major news drivers with WEO lower, warning on global growth risks, but central path for EM was a muddle through present mess. 

Equities 

The MSCI all-country World Index fell 4.02% to 494.76 on the week. The MSCI Emerging Market Index fell 2.11% to 980.09 on the week. The EM bounce was notable in comparison to the DM pain. 

• S&P 500 fell 4.10% to 2767.13 on the week. The worst week since March. Also the worst daily loss since February. However, the S&P 500 ended a 6-day losing streak Friday, bouncing 1.4%, and remains up 3.5% year-to-date despite being down for the 3rd consecutive week. DJIA fell 4.19% to 25,339.99 on the week. The NASDAQ fell 3.74% to 7,796.89 on the week – with a big recovery Friday notable (up 2.29%).  The Cboe VIX rose 6.49pp or 43.8% on the week to 21.31% with the index now in yellow zone for risk with 16% and 30% key guideposts for next move. 
• Stoxx Europe 600 fell 4.64% on the week. The biggest weekly drop in 8 months. The German DAX fell 4.86% to 11,523.81 while the Italian FTSE MIB fell 5.36% to 19,255.98 on the week – leading losses. The UK FTSE fell 4.41% to 6,995.91 on the week and the French CAC40 fell 4.91% to 5,096.98 on the week.
• MSCI Asia Pacific fell 3.49% to 154.26 on the week. China Shanghai Composite fell 7.60% to 2606.91 on the week, leading losses, while India Nifty50 rose 1.51% to 10,472.50 leading gainers. Japan Topix fell 5.48% to 1702.45 while the narrower Nikkei 225 fell 5.34% to 22,694.66. The Hong Kong Hang Seng fell 2.90% to 25,801.49 on the week while the Korea Kospi fell 4.95% to 2,161.85 and the Australian ASX 200 fell 4.69% to 5,895.67. 

Fixed Income

The risk-off mood swung enough to support bonds, despite ongoing fears about rate normalization globally as the IMF highlighted in its WEO this week.  Markets still obsessed about supply - $230 billion in US, still fretted about EU/Italy budget conflict and still watched to see if China did something more than its RRR cut that started the week. For the pain in equities, bonds proved a poor hedge but at least they didn’t move in the same direction as in the previous week.  Focus on CPI and growth remains key and US CPI proved to be a turning point of sorts.  

• US Bonds see bull curve flattening after supply, CPI and equity sell-off on the week: 2Y off 3bps to 2.853%, 3Y off 4bps to 2.941%, 5Y off 5.5bps to 3.015%, 10Y off 7bps to 3.161%, 30Y off 7bps to 3.335%. 
• Canadian 10-year bond yields fell 10bps to 2.495% on the week– with focus on BOC next and C$.
• Japan JGBs rally modestly, yield in 10-year off 0.5bps to 0.14% on the week– with moderate 30Y sale and nothing new from BOJ.
• Australia 10-year bond yields rose 3.5bps to 2.745% on the week- with supply, China stability, RBA talk driving. 
• UK Gilt yields off 9bps to 1.63% on the week– with the focus on Brexit deals and politics that follow, data modestly better helping GBP
• German Bund yields off 7.5bps to 0.495% on the week– with Italy safe-haven, modestly weaker data, more focus on ECB, 0.60% resistance next. 
• French OAT yields off 4bps to 0.86% on the week– doubts about ESM expansion and Italy at play, data mixed. 
• Italian BTP yields up 15bps to 3.57% on the week– war of words with EU on budget continues, growth remains a question, 3.71% highs touched with spread to Bunds 308bps – back to 2013 highs.
• Spanish Bono yields up 10.5bps to 1.67% on the week– with Friday holiday leaving a small catch-up trade likely.
• Portugal 10-year bond yields up 10bps to 2.03% on the week– tracking Spain more than Italy, supply notable. 
• Greek 10-year bond yields off 9bps to 4.36% on the week– 4.50% looking more important and capping, despite Italy moves. 

Foreign Exchange

The US dollar index fell 0.4% to 95.22 on the week – tracking US yield moves and equity doubts. 96.20 resistance held for 94.95 and 94.60 retests. In emerging markets, USD mixed on the week.

• LATAM:MXN 18.86 off 0.2%, BRL 3.78 up 2.5% with election joy driving;
• ASIA: TWD 30.858 flat, CNY 6.9220 off 0.75%, KRW off 0.1% to 1131.30 with 1140 key, INR 73.57 up 0.25% with equities driving, SGD 1.3780 up 0.3% with MAS widening band in slight snugging post GDP; 
• EMEA: ZAR up 1.7% to 14.518 better politics, TRY 5.873 up 4.4% on US Pastor deal, RUB 66.064 up 0.8% despite oil. 
• In Crypto, USD gained:BTC futures fell 5.3% on the week, while BTC was off 4.22% to $6310 – falling after stocks but matching the move. ETH was off 12% to $201.10 (break of $200 notable this week). Ripple fell 17% to $0.4195 – unwinding new settlement client contract news. 

• EUR: 1.1560 up 0.3% on the weekwith the bounce from 1.1450 convincing despite ongoing Italy budget fears, but with 1.1620-50 resistance holding. 
• JPY: 112.20 off 1.35% on the weekwith EUR/JPY 129.70 off 1% - all about risk in equities reversing and safe-haven demand with 112 still a pivotal base but 110.50 risk returns and 114 again caps.
• GBP: 1.3155 up 0.25% on the weekwith EUR/GBP .8790 off 0.15% - despite hopes for a Brexit deal, GBP lags as political costs drive. 
• CHF: .9930 up 0.1% on the weekwith EUR/CHF 1.1475 up 0.3% on the week – CHF breaking free of safe-haven status despite stocks/Italy. .9850-1.00 key for $. 
• AUD: .7115 up 0.85% on the week, bouncing back with rates, RBA, China views on growth but .7050-.7250 still key along with crosses as NZD .6505 up 1% on the week with .6440-.6550 keys.
• CAD: 1.3025 up 0.65% on the weekwith USMCA not enough, oil lower, BOC in doubt, data mixed. 

Commodities

S&P/GSCI total return index off 2.68% on the week. Coffee, Cotton and Cocoa led the winners while Lumber, gasoline and oil were the losers. 

• Oil: $71.34 off 4.04% on the week, Brent $80.43 off 4.43% on the week – both hit on US inventories, US hurricane risk unwind, OPEC talk and equities driving down global demand outlook with $70 key in WTI and $80 in Brent.
• Gold: $1217.05 up 1.1% on the week. Gold shot up with US shares and yields lower but $1225 capping still with $1215 minor and $1200 major support. Silver $1458 off 0.35% on the week with $14.77 capping still. Platinum up 1.9% to $838.25 on the week but Palladium off 0.35% to $1068.  
• Corn: $373.75 up 1.5% on the weekwith ethanol stories and WASDE driving grains along with weather. Soybeans off 0.15% to $867.50 while wheat $517.25 off 0.7% despite focus on Canada hit. 
• Copper: $2.8635 up 2% on the week, with futures Dec $2.8015, up 1.4% on the week, both driving on hopes for China stimulus driving up demand while held back with equities. Iron Ore up 4.45% to $69.63 in Nov futures – much the same logic with China demand hopes increasing. 

Calendar for the Week Ahead

The Italian budget, the Japan IP, and more CPI reports globally, more China growth and monetary data with FOMC minutes – this leads the week ahead along with 3Q earnings. China Friday GDP maybe the key event for the week. In between UK CPI/PPI, retail sales and the Brexit summit are likely going to move GBP further while EU focus will be on ZEW, with little other data of note. Canada gets CPI and retail sales. Australian jobs, NZ CPI add to the mix. The US IP, retail sales round out the economic focus.

Monday, October 15:Japan IP, China M2, CNY loans, US retail sales

• 0700 pm Japan Oct Reuters Tankan 26p 25e 
• 1100 pm Chian Sep M2 8.2%p 8.3%e / new CNY loans 1.28trn p 1.34trn e / TSF 1.52trn p 1.53trn e
• 1230 am Japan Aug Industrial Production  (m/m) -0.2%p +0.7%e (y/y) 2.2%p -1.4%e
• 0230 am India Sep (y/y) WPI 4.53%p 4.9%e
• 0830 am US Oct NY Empire Fed Manufacturing 19p 19e
• 0830 am US Sep retail sales (m/m) 0.1%p 0.6%e /ex autos 0.3%p 0.4%e / control group 0.1%p 0.4%e
• 1000 am US Aug business inventories 0.6%p 0.5%e
• 1030 am Canada BOC Business Outlook Survey

Tuesday, October 16: NZ CPI, China CPI/PPI, UK jobs, German ZEW, US IP, JOLTS, NAHB

• 0545 pm New Zealand 3Q CPI (q/q) 0.4%p 0.7%e (y/y) 1.5%p 1.7%e
• 0930 pm China Sep CPI (y/y) 2.3%p 2.5%e
• 0930 pm China Sep PPI (y/y) 4.1%p 3.7%e
• 0930 pm Australia RBA meeting minutes
• 0400 am Italy Aug industrial sales and orders
• 0430 am UK Aug 3M ILO unemployment rate 4%p 4%e / average earnings 2.6%p 2.4%e / ex bonus 2.9%p 2.8%e / Sep claimant count 8.7k p 7k e
• 0500 am EU Aug trade surplus E12.8bn p E14.1bn e
• 0500 am German Oct ZEW economic sentiment -10.6p -12e / current 76p 74e / EU -7.2p -9.1e
• 0500 am Italy Sep final HICP (m/m) -0.2%p +1.8%e (y/y) 1.6%p 1.6%e
• 0540 am German 2Y sale
• 0800 am Hungary central bank rate decision no change from 0.9% expected
• 0915 am US Sep industrial production (m/m) 0.4%p 0.2%e / Cap Utils 78.1%p 78.2%e
• 1000 am US Aug JOLTs job openings 6.939mn p 6.90mn e
• 1000 am US Oct NAHB housing market index 67p 68e
• 0400 pm US Aug net TIC flows $52.2bn p $20bn e / long term $74.8bn p $48bn e 
• 0430 pm US weekly API oil stats 9.75mb p 2mb e

Wednesday, October 17: China holiday, EU Brexit Summit, UK CPI, US housing starts, FOMC minutes

• 0430 am UK Sep CPI (m/m) 0.7%p 0.5%e (y/y) 2.7%p 2.8%e / core 2.1%p 1.8%e / RPI 3.5%p 3.2%e
• 0430 am UK Sep PPI output (m/m) 0.2%p 0.2%e (y/y) 2.9%p 2.9%e / Core 2.1%p 2.3%e / PPI input (y/y) 8.7%p 5.7%e
• 0500 am Eurozone Sep final HICP (m/m) 0.2%p 0.2%e (y/y) 2.1%p 2.1%e / Core 0.9%p 1.0%e
• 0500 am Eurozone Sep Construction Output (m/m) 0.3%p -0.1%e (y/y) 2.6%p 1.7%e
• 0540 am German 30Y Bund Sale
• 0830 am US Sep housing starts 9.2%p -4.5%e / 1.282mn p 1.237mn e
• 0830 am Canada Aug manufacturing shipments (m/m) 0.9%p -0.6%e
• 1030 am US weekly EIA crude oil stocks +5.987mb p +2mb e
• 1210 pm Fed Gov Brainard speech
• 0200 pm FOMC Minutes

Thursday, October 18: EcoFin meetings, Japan trade, Australia jobs, UK retail sales, US Philly Fed, employment cost index. 

• 0750 pm Japan Sep trade deficit Y444.6bn p Y50bn e / exports 6.6%p 2%e
• 0830 pm Australia 3Q NAB business confidence
• 0380 pm Australia Sep jobs 44k p 15k e / unemployment rate 5.3%p 5.3%e / participation 65.7%p 65.6%e
• 0200 am German Sep wholesale prices (m/m) 0.3%p 0.4%e
• 0430 am UK Sep retail sales (m/m) 0.3%p -0.4%e (y/y) 3.3%p 3.7%e / ex fuel 3.5%p 3.7%e
• 0445 am Spanish 3-5-10Y Bono Sale
• 0500 am French 3Y-5Y BTAN sale
• 0830 am US weekly jobless claims 214k p 208ke
• 0830 am US Oct Philly Fed Manufacturing index 22.9p 20.0e
• 0830 am US 3Q employment cost index 0.6%p 0.5%e
• 0830 am Canada Sep ADP employment change 13.6k p 37.5k e
• 0900 am St.Louis Fed Bullard speech
• 1000 am US Sep Conference Board LEI 0.4%p 0.5%e
• 1215 pm Fed Vice Chair Quarles Speech

Friday, October 19: Japan CPI, China IP, retail sales, 3Q GDP, Canada CPI/retail sales, US existing home sales.

• 0750 pm Japan Sep core CPI (y/y) 0.9%p 0.9%e /core-core 0.4%p 0.4%e 
• 1000 pm China Sep retail sales (y/y) 9%p 9%e
• 1000 pm China Sep industrial production (y/y) 6.1%p 6.0%e
• 1000 pm China Sep Asset investments (ytd y/y) 5.3%p 5.3%e
• 1000 pm China 3Q GDP (q/q) 1.8%p 1.6%e (y/y) 6.7%p 6.6%e
• 0235 am BOJ Kuroda speech
• 0430 am UK Sep PSNB GBP5.89bn p GBP4.6bn e
• 0600 am UK Oct CBI retail trade 23%p
• 0830 am Canada Aug retail sales (m/m) 0.3%p 0.4%e / ex autos 0.9%p -0.2%e 
• 0830 am Canada Sep CPI (m/m) -0.1%p -0.1%e (y/y) 2.8%p 2.7%e / Core 1.7%p 1.8%e
• 0900 am Dallas Fed Kaplan speech
• 1000 am US Sep existing home sales (m/m) 0%p -0.3%e / 5.34mn p 5.30mn e
• 1200 pm Atlanta Fed Bostic Speech

Conclusions: What is safe?  

The loss of bonds two weeks ago, the tepid rally in gold and drop in silver, breakdown in the USD – all the things that worked to offset equity losses earlier in 2018 have failed – except perhaps the long JPY and long volatility trades. The CHF/JPY move last week merits some attention and some explanation. Technically, CHF looks vulnerable to a much larger move to 111 on this cross in the near term. One has to wonder if this is the work of the SNB and so an increase in reserves that inevitability supports stocks and EU bonds. 

Perhaps the most interesting chart of the week was from AM/FX at HSBC – (if you don’t get on his list you are missing out).  This chart of 2Y spreads in the G10 space is revealing in how much the AUD/NZD have moved down the list and CAD up the list – implying a long CAD, short AUD trade would make sense in that space but it didn’t work last week. The move in CHF/JPY does follow the rate chart. Point is that rates aren’t the key driver of FX like they were earlier in year as equity jitters return to drive the view that financial conditions will eventually matter to the FOMC and keep the Powell Fed from 4 more hikes. 

The key for many into next week will be how reactions to stock market pain and bond markets plays out with central bankers. The effect of higher rates has been most notable in EM and the USD gains in EM remain a key focus and barometer for the success in other markets like equities. The US pain this week proved to be a modest relief to the EM but not clearly in all the currencies. This is something to watch going forward.