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July 4, 2018

US Equity Market Volatility Spikes as Global Trade War Fears Loom


US Markets

The US stock market closed the first half of the year trading with significant volatility as the market continued to lose its upward trend. Investors employed options to manage risk and hedge the equity market downward momentum. The VIX is based on option prices on the S&P 500 and tends to increase in value when stock prices fall. At the time of writing, year-to-date the VIX is up 41.30%, indicating investors rising perception of risk.

The majority of the biggest options positions in the CBOE index are calls. Some of these positions will pay out only if the VIX above 25, 55% above 16.09, the level where it closed Friday according to the Wall Street Journal. This is a bearish market signal. That is, investors seek to protect their portfolio values.

“Volatile markets are clearly reacting to the escalating trade war rhetoric,” Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets. Investors often offset risks in their stock positions with options, that is, contracts that give them the right to buy or sell shares at a later date. Analysts, are of the opinion that while hedging using options is still relatively low as a nine-year bull market continues into 2018, activity has picked up. 

What has changed is an escalation of the geopolitical stress. Last year, tensions with North Korea negatively influenced some investors, but the threat of a trade war between the U.S. and China; the world’s two biggest economies has caught investors’ attention in 2018 mid-year. Signs of slowing growth in countries outside the U.S. have added to the anxiety. Gains in the technology sector and smaller-company shares this year have made investors more ‘at risk’ during market pullbacks, leading investors to seek insurance via options strategies.


The trans-Atlantic trade fight that started in June has continued and led major European equity markets declines since June 2018. According to the communique from the Group of Seven meeting in Quebec, President Donald Trump said the European Union’s ability to hit back at the U.S. on trade made European Commission President Jean-Claude Juncker a “brutal killer.” Policy makers in Brussels last week, imposed tariffs on €2.8 billion of U.S. exports as part of the EU targeted retaliation for Mr. Trump’s metals tariffs.


EU Trade Commissioner Cecilia Malmstrom has taken a firm stance against the U.S. tariffs, calling them unjustified and a threat to the global free-trade regime that liberal democracies developed over recent decades. As the trade war tension escalates markets in Europe and Asia continue to feel the impact. In particular the technology, manufacturing and financial sectors. Mr. Trump has responded by threatening duties on some $60 Billion of European Auto exports to the U.S. An Auto market backlash will be felt in the U.S. economy given the number of jobs that the industry creates.

U.S. Trade Representative Robert Lighthizer recently defended Washington’s national-security-based metals tariffs and accused the EU and countries that launched their own countermeasures against the U.S. of abusing World Trade Organization’s rules. The EU is seeking to maintain unity on trade even as internal fights over migration threaten to topple the Government of German Chancellor Angela Merkel. European leaders gathering for a summit in Brussels on July 5th and are set to reaffirm their endorsement of the commission’s tough approach, according to the EU diplomats comments.


Following recent revelations of Malaysia’s ballooning debt under Mr. Najib Razak, the ousted Prime Minister, there is a growing concern that South-East Asia’s infrastructure drive is pushing the region towards a debt crisis. Using the World Bank’s International Debt Statistics report for 2018 to assess the severity of debt in south-east Asia, excluding Brunei, East Timor and Singapore. 

The politics of Chinese loans in Indonesia, rising debt, particularly from China is likely to become a big political issue ahead of national elections next year, when President Joko Widodo will seek a second term of office. As in Malaysia during its recent general election, anti-China rhetoric is more than likely to win some votes for the opposition. 


While many headlines feature gloom about the precarious state of relations between the U.S. and its economic partners, Japan's most widely watched indicator has some sunny patches worthy of attention. Japanese companies plan a surge in capital spending in the year through March 2019, according to the central bank's quarterly survey released this week. Some increase was anticipated, in part because the second quarter usually shows an improvement, but the 13.6 percent gain was a major surprise. It looks even better when compared with the 2.3 percent recorded in the preceding three months. The labor market data has been positive, with the unemployment rate at 2.2 percent, the lowest since 1992.   

This can be attributed to Japanese shrinking population and the country's traditional reluctance to fully embrace free trade. While Japan has ceased to be the biggest player in Asia, it is still major, and its companies are embedded in the fabric of the world economy.  The strong numbers should be viewed with caution given the context of global fears about trade wars between the U.S. and China and other global trading partners. The outlook for corporate Japan could be more uncertain as we head into the second half of 2018. 


Regional Economies

Trinidad’s Minister of Finance, Mr. Colm Imbert provided the preliminary outline of the National Investment Fund (NIF) bond offering, in his debate of the Corporation Tax (Amendment Bill) 2018.


Further to the transfers arising from the liquidation of CL Financial/CLICO’s assets, the Ministry of Finance took the decision to monetize these shares through the formation of the National Investment Fund Holdings Company Ltd (NIF). As part of the plan, the Government will vest shares valued at TT$7.9 Billion of major Trinidadian corporations to the NIF.


The NIF will then issue TT$4 Billion of bonds in 3 maturities: 5 years, 12 years and 20 years, with the proceeds of the bond issues going to the government. The proposed yields on these bond issues are approximately 1% above the yield (interest rate) of equivalent maturities in direct Government of Trinidad TT$ debt. Compared to similar rated debt available in hard currency (USD) on the international bond market these yields/ interest rates are relatively unattractive. However, the T&T domestic currency market remains with high banking system liquidity which would argue well for NIF.


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