Notes From Underground

The global reaction to the first round of the French presidential election was not confusing. Capital was sitting on the sidelines as the polls reflected a possibility of a second round Le Pen/Melenchon faceoff, which would have been devastating for global investors because fear of an EU break-up would have led to a massive repricing of risk premia. The avoidance of such an outcome led to a rush of capital into European markets, which provided support to Asia and the U.S. The German/French 10-year spread reacted as expected. The yield differential narrowed by a significant 20 basis points. The BUND yields rose against all European sovereign debt as Berlin’s haven status was rendered null and void for at least another two weeks. The GOLD and YEN also performed as expected as money rushed to purchase a risk on profile in a global zero interest environment. The EURO rallied by 2% as global capital flows into European stocks forced previous short euro positions to the sidelines. There’s nothing confusing about any of these outcomes. But let me throw some confusion onto some of the other geopolitical events making the front pages:

1. North Korea (and the idea that President Trump is preparing for some type of military action against the country). It seems like a preposterous idea. If the U.S. were to attack (in order to thwart the nuclear designs of the North Koreans), it will take more than 59 cruise missiles as the U.S. would have to undertake a first strike that would render the Democratic People’s Republic incapable of launching any type of attack upon Seoul, South Korea. The North has always threatened to deliver a major artillery barrage upon Seoul that would lay waste to the South Korean capital. Thus the U.S. would have to destroy President Kim Jong-un’s capacity to retaliate, which would most probably mean some type of U.S. use of tactical nuclear weapons.

The fact that the South Korean Kospi index and its currency, the WON, are all performing strongly raises doubts about the reality of any type of U.S. military action. The question remains: Will the Chinese attempt to lower tensions by intervening in North Korean politics via a removal of Kim Jong-un? But the blather from the punditry does nothing but confuse. Markets reacting to ramped-up rhetoric should be ignored.

2. It seems that the Trump administration fired some “cruise missiles” at Canada in the form of placing tariffs of 2-24% on Canadian soft-wood exports to the U.S. This may be the Trump administration sending a message to the rest of the world that the U.S. is serious about rectifying what President Trump has deemed to be abuses in global trading patterns. The tariff is a relatively benign way let the world know that President Trump and his economic team are serious about confronting the inequalities of previous trade relationships. For me, the confusion arises in how the markets responded to the announced tariffs. Typically, equity prices would drop as markets become nervous about possible retaliation from other nations.

Also, currencies like the Japanese YEN usually strengthen as the market would sense that a tariff is generally a signal about designs for the U.S. to weaken the DOLLAR. The YEN weakened after yesterday’s announcement, but this may be a result of the power of the risk-on trade as the French election undermined the haven status of the YEN. (This can be seen in the 3% rise in the EURO versus the YEN since Sunday night.) Massive Long Yen positions have been liquidated as stability reigns in the global financial system while geopolitical tensions ease.

But let’s watch to see how the U.S. tariffs are received after the tumult of the French election subsides. Unilateral efforts by the world’s largest economy to restructure trade imbalances are fraught with great risk. The rhetoric has been subdued in response to the U.S. move but history says that confusion stands to reign. Trump seems to chase soft targets but the ripples could cause more damage than many suppose. Momentarily confused but not dazed.

Tags: Bunds, Canada, Euro, French election, French oats, Gold, Japanese yen, North Korea, South Korean won, tariffs, U.S. Dollar

This entry was posted on April 25, 2017 at 7:25 pm and is filed under Canada, Currency, France, United States. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.