The tariffs implementation was not new information; US and China had been exchanging warning shots for a long time before they started shooting at each other. Markets were able to thoroughly assess the impact from trader barriers and move past the initial gloom caused by the tensed relations of the world’s two biggest economies.
The barometer of investors’ spirit in the US, the S&P 500 closed last Thursday with a rise of 0.9% before tariff introduction and allowed traders around the world to go in to the weekend on a positive note, with an additional 0.3%.
Short sales at the announcement of tariffs was likely not the smartest move. Investors are waiting for evidence of the bearish nature of the catalyst from the economic front, which is still relatively quiet. Nevertheless, we also witnessed an outbreak of anxiety in the markets. This is evident from the VIX, which came out of the “calm” range of 10-12 points, and for some time strolled higher last week, as some sellers of volatility expecting a calm in the stock market, left the scene, while the new merged again together with the VIX which, fell to 13.3 points on Monday. All due to the fact that the premium on straddle options strategy increases with increasing volatility, which allows sellers to earn more. Small pullbacks of VIX create an attractive opportunity to receive the “carry trade” just by selling straddle options (well, or VIX futures, in which many burned out due to what is essentially the same as the straddle). Instead of interest rates and a stable exchange rate there is a premium for the sale of options and necessarily low volatility.
VIX continued the decline on Monday and this means two options: either investors are deeply mistaken, wrongly assessing the consequences of trade wars on the US economy, or they are betting that Trump will say more than act. Today ShComp contributed to the general peace of mind, which added 2.47%. The risks of the collapse of the Chinese stock market are now a big threat. It is interesting that the private owners of Chinese companies often use their share of shares as collateral for loans. That is, in China there is a classic situation of a slowly maturing credit bubble. In case the borrower can not pay off his debt, he sells his share of the shares in the market, which can cause a sharp drop in their value and undermine the positions of other shareholders, who, however, may also be borrowers. According to China Securities Depository and ChinaClear more shares, the total value of more than 1 trillion dollars, circulating on the largest stock exchanges in China, in Shanghai and Shenzhen, was used as collateral for debts. And the lever on the stock market in one form or another has developed quite aggressively and doubled in comparison to 2015 by 23.8%.
In June, UBS Bank warned that in connection to the recent transfer of the Chinese market to bear territory, the assets of borrowers are depreciating, so if there is a cascade of defaults, a great many creditors will lose their own. Shares of 440 billion yuan have already descended below the level of which they should be realized and creditors returned the debt, and shares of another 500 billion yuan in the near future can face the same fate. This is approximately 1% and 1.1% of the total market capitalization of the Chinese stock market at 6.8 trillion dollars.
Therefore, we forget for a while about the US stock market and its reaction to tariffs and closely follow developments in China. Tomorrow Chinese statistics on lending, money supply and inflation will be released, which can cause local flight from risk if they turn out to be weak. For example, on a rollback, you could take gold, and also play a short USDJPY.
In the foreign exchange market, the dynamics remain uncertain, the dollar sagged after the Friday NFP, as the report was distinguishing, but slightly from the wrong angle. Unemployment has grown to 4%, wages by 0.2% in monthly terms, the number of workers has pleased a few traders. In general, the labor market is already at its peak, so no one will draw conclusions from one report. On Thursday, CPI for the US may show accelerated inflation, but there is no necessary strong Payrolls report, so buying a dollar could be risky. Most likely, the rollback of the US currency will last, oil in the fire can pour a speech of Draghi in Brussels this week. Of course, these will be introductory messages to the parliament, but it will be interesting to hear the ECB’s opinion about trade wars and its impact on Europe.