Developed Countries

Highlights The failure of the dollar to break out amid one of the most bullish fundamental catalysts in months suggests that many opposing tectonic forces are at play. Our bias is that short-term and longer-term investors are caught in a tug-of-war. Longer-term headwinds are a deteriorating balance-of-payment backdrop. Shorter-term tailwinds are ebbing global growth. Traders who have become accustomed to buying the dollar as a safe haven should be cognizant that correlations could be shifting amid the fall in global bond yields. The yen and gold remain the currencies of choice in this environment. Despite economic headwinds, the BoJ has historically needed an external shock to act, suggesting the path towards additional stimulus will be lined with a stronger yen. Our bias is that USD/JPY could weaken to 100 in the next three-to-six months, especially if market volatility spikes further. If global growth eventually picks up, the yen will surely weaken on its crosses, but could still strengthen versus the dollar. The reversal in the EUR/GBP is worth monitoring. Aggressive investors can short the pair now for a trade. Feature Chart I-1A Worrisome Development Consider the events over the last few weeks: U.S. President Donald Trump blindsided investors by firing a new salvo in the trade war. China retaliated by depreciating the RMB below the psychologically important 7 level. In Argentina, a heavy loss for reformist Mauricio Macri has sent the peso down almost 40% this year. Venezuela is now completely shut off from the U.S., given continued friction between the regime of incumbent Nicolás Maduro and Juan Guaidó. In Europe, Boris Johnson has all but assured us that he is taking the U.K. out of the EU, sending the pound to near post-referendum lows. And on the global economic front, July manufacturing data was dismal across the board. This is nudging the U.S. 10-year versus 2-year Treasury yield curve into inversion, adding to the recessionary indicators that have accumulated so far (Chart I-1). Both gold and the yen have bounced in sympathy with these developments, but the trade-weighted dollar (either using the DXY or the Federal Reserve’s broader measure) is up only circa 1% over the last month. Had a currency manager taken a one-month leave of absence, this setup would be incredibly perplexing upon return. Has the investment landscape changed, or are both traders and algorithmic platforms sitting on the sidelines given thin summer trading? More importantly, has the dollar lost its crown as a safe-haven currency? The answers to these questions are obviously very important for the cyclical view on the dollar.  Is This Time Different? It is too early to tell if the dollar’s muted response is just the lagged effect of thin summer trading, or a signal towards much bigger opposing forces at play. What we can infer is that both short-term and longer-term investors are caught in a tug-of-war, currently in a stalemate. The short-term boost for the dollar comes from the fact that global growth is weak and the U.S. economy has the upper hand, given the smaller contribution from the manufacturing sector to GDP. Meanwhile, U.S. interest rates, while falling, remain among the most attractive in the developed world. Portfolio flows into the U.S. economy is the ultimate link between global growth and the dollar. The caveat is that these bullish factors are slowly ebbing. We have argued in past reports that global growth will soon bottom, if past correlations between monetary stimulus and economic growth hold. Meanwhile, the Federal Reserve is slated to become more dovish, which will remove an important tailwind for the dollar (Chart I-2). The latest comments from Olli Rehn, governor of the Finnish central bank and member of the ECB’s rate-setting committee, suggests that significant stimulus will be forthcoming in September. This should keep a bid under the DXY index. However, investors also understand that other governments are unlikely to sit pat and watch their trading partners wage a currency war. Political pressure towards lower rates is now as high as it has ever been (Chart I-3), a change from the past. Chart I-2The U.S. Yield Advantage Is Fading Chart I-3Political Pressure To Cut Rates But why has the dollar not strengthened more in the interim, given that bullish forces remain present? The answer lies in underlying portfolio flows into the U.S. economy, which is the ultimate link between global growth and the dollar. Everyone understands the standard feedback loop between global growth and the greenback. The U.S., being a relatively closed economy, sees outflows when global growth is improving. This is because capital tends to gravitate to higher-yielding currencies that are more levered to the manufacturing cycle. And during risk-off environments, that capital finds its way back home – the so-called “home-bias” – that boosts the dollar. This has been the story for most of the last two decades. However, things began to shift a few years ago. Following cascading crises (in Europe, Japan and even some commodity-producing countries, for example), interest rates outside the U.S. began to fall rapidly, and the U.S. bond market became one of the most attractive in yield terms. For example, at the onset of 2014, 10-year bond yields were at 4.4% in Australia while they were sitting at 3% in the U.S. Today, a 10-year Australian bond yields 0.9% while 10-year Treasurys are at 1.5%. The implication is that the U.S. dollar has now become an object of carry trades itself, as confirmed by current positioning data (Chart I-4). However, here comes the important crux. It is difficult for the dollar to act as both a safe-haven and a carry currency, because the forces that drive both move in opposite directions. For one, safe-haven assets tend to be lower-yielding, but also during episodes of capital flight, investors choose to repatriate capital to pay down debt, with creditor nations having the upper hand. And given that U.S. investors have already been repatriating close to $300 billion in assets over the past 12 months (in part because of better returns, but also because of the 2017 Trump tax cuts), the dollar’s safe-haven bid has partially evaporated. Traders who have been used to buying the dollar as a safe haven should be cognizant that correlations may have shifted amid the fall in global bond yields.  Flows into the U.S. capital markets are instructive. What has been supporting capital flows into the U.S. are agency, corporate, and Treasury bond purchases, with foreign investors already stampeding out of U.S. equities at the fastest pace on record (Chart I-5). This is because the starting point for the U.S. is an equity market that is one of the most overvalued, dictating that subsequent returns will pale by historical comparison. Chart I-5Banks Have Been Supporting U.S. Inflows Meanwhile, cracks are beginning to appear in the Treasury market, one of the last pillars of support for U.S. inflows. Foreign officials have already been exiting the U.S. bond market for both geopolitical and balance-of-payment concerns, but private purchases still remain robust. However, the latest data shows that net foreign private purchases of U.S. Treasury bonds have rolled over from about $220 billion dollars earlier this year to about $200 billion currently. Ebbs and flows in the U.S. Treasury market have historically had a great track record of capturing major turning points in the U.S. bond yields over the last decade (Chart I-6). To be sure, these flows are still positive, with June data robust, but they are rolling over. It is likely that July and August data will be stronger, given the drop in yields. However, long Treasurys and long dollar positions are some of the most crowded trades today. The bottom line is that if the dollar cannot rise under a bullish near-term backdrop, it is likely to fall hard when these fundamental forces evaporate. Monitoring the bond-to-gold ratio is a good way to gauge where the balance of forces are shifting, and the picture is not constructive for dollar bulls (Chart I-7). Meanwhile, currencies such as the Japanese yen or even the Swiss franc, which have been used to fund carry trades, remain ripe for further short-covering flows. Chart I-6What Happens When Bond Investors Flee? Chart I-7Unsustainable Divergence Bottom Line: Traders who have been used to buying the dollar as a safe haven should be cognizant that correlations may have shifted amid the fall in global bond yields. Stay Short USD/JPY Should the selloff in global risk assets persist, the yen will strengthen further. On the other hand, if global growth does eventually pick up, the yen could weaken on its crosses but strengthen vis-à-vis the dollar. This places short USD/JPY bets in an enviable “heads I win, tails I do not lose too much” position. Economic data from Japan over the past few weeks suggests the economy is not yet succumbing to pressures of weak external growth (Chart I-8). The services PMI remains relatively high compared to manufacturing, vehicles sales are accelerating at a 7% year-on-year pace and bank lending is still robust. The labor market also remains relatively tight, with Tokyo office vacancies hitting post-crisis lows. The preliminary print of second quarter GDP growth slowed to 1.8% from 2.2%, but this was entirely driven by the external sector. A return towards deflationary pressures will eventually force the Bank of Japan’s hand, but the yen will strengthen in the interim. What these developments suggest is that the hurdle for delaying the consumption tax is now extremely high. And since the late 1990s, every time Japan’s consumption tax has been hiked, the economy has slumped by an average of over 1.3% in subsequent quarters. A return towards deflationary pressures will eventually force the Bank of Japan’s hand, but the yen will strengthen in the interim. This is because the BoJ will need to come up with even more unconventional policies, something that requires time. Total annual asset purchases by the BoJ are currently running at about ¥22 trillion, while JGBs purchases are running below ¥20 trillion. This is a far cry from the central bank’s soft target of ¥80 trillion, and unlikely to change anytime soon, since JGB yields are trading near the floor of the central bank’s range (Chart I-9). Chart I-8Japan Is Fine For Now Chart I-9The BoJ Is Out Of Bullets It is important to remember why deflation is so pervasive in Japan, making the BoJ’s target of 2% a bit of a pipedream if it stands pat. The overarching theme for prices in Japan is a rapidly falling (and rapidly ageing) population, leading to deficient demand (Chart I-10). Meanwhile, domestically, an aging population (that tends to be the growing voting base), prefers falling prices. What is needed is to convince the younger generation to save less and consume more, but that is almost impossible when high debt levels lead to insecurity about the social safety net. Hence the reason for the consumption tax, which has historically been deflationary. Chart I-10Deflation Is Pervasive In Japan On the other side of the coin, the importance of financial stability to the credit intermediation process has been a recurring theme among Japanese policymakers, with the health of the banking sector an important pillar. YCC and negative interest rates have been anathema for Japanese net interest margins and share prices (Chart I-11). This, together with QE, has pushed banks to search for yield down the credit spectrum. Any policy shift that is increasingly negative for banks could easily tip them over. This suggests the shock needed for either the BoJ or the government to act has to be “Lehman” like.  The eventual bottom in global growth is a key risk to a long yen position. However, inflows into Japan could accelerate, given cheap equity valuations and improved corporate governance that has been raising the relative return on capital. The propensity of investors to hedge these purchases will dictate the yen’s path. The traditional negative relationship between the yen and the Nikkei still holds but has been weakening in recent years. Over the past few years, an offshoring of industrial production has been marginally eroding the benefit of a weak yen/strong Nikkei. If a company’s labor costs are no longer incurred in yen, then the translation effect for profits is reduced on currency weakness (Chart I-12). Chart I-11Japan: More Easing Will Kill Banks Chart I-12The Nikkei And Yen Have Diverged Bottom Line: Inflation expectations are falling to rock-bottom levels in Japan, at a time when the BoJ may be running out of policy bullets. Meanwhile, the margin of error for the BoJ is non-trivial, since a small external shock could tip the economy back into deflation. The BoJ will eventually act, but it may first require a riot point (Chart I-13). Remain short USD/JPY. Chart I-13What More Could The BoJ Do? Housekeeping Chart I-14Look To Sell EUR/GBP Tactical investors could try selling EUR/GBP for a trade ahead of our actual limit-sell at 0.95. The ever-shifting political landscape warrants tight stops, but despite all the noise, economic surprises in the euro area are rolling over relative to the U.K., which usually benefits the pound (Chart I-14). Finally, the Norges bank has chosen to remain on hold, though has begun to sound less hawkish. We remain long NOK/SEK but are ready to take profits on any sign a currency war is intensifying, or that oil prices are headed much lower.     Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have been robust: Headline and core inflation both edged up 10 bps to 1.8% and 2.2% year-on-year respectively in July. Mortgage applications surged by 21.7%, reversing prior weakness in the MBA Purchase Index. NY Empire State manufacturing index increased to 4.8 in August; The Philly Fed manufacturing index fell to 16.8, still well above the consensus of 9.5. Retail sales jumped by 0.7% month-on-month in July, up from downwardly-revised 0.3% in June. Nonfarm productivity grew by 2.3% quarter-on-quarter in Q2; The unit labor costs went up 2.4% quarter-on-quarter. Real hourly earnings in July however, slowed to 1.3% year-on-year. Industrial production fell by 0.2% month-on-month in July. DXY index appreciated by 0.6% this week. Consumer prices rebounded in July, mostly driven by shelter, and medical care services. This marginally lowered the prospect for more aggressive rate cuts by the Federal Reserve. Report Links: USD/CNY And Market Turbulence - August 9, 2019 Focusing On the Trees But Missing The Forest - August 2, 2019 Global Growth And The Dollar - July 19, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area continue to deteriorate: ZEW sentiment fell to -43.6 in August, the lowest since 2012. Preliminary GDP yearly growth was flat at 1.1% year-on-year in Q2, even though the German economy stagnated. Industrial production contracted by 2.6% year-on-year in June. Employment growth slowed to 1.1% year-on-year in Q2. EUR/USD fell by 0.9%, following the relatively soft data. However, if the world economy avoids recession, it will be tough for data to deteriorate meaningfully from current levels. We believe that manufacturing data will get a boost once global growth stabilizes. Meanwhile, the euro is currently trading at an attractive discount to its fair value. Report Links: Battle Of The Central Banks - June 21, 2019 EUR/USD And The Neutral Rate Of Interest - June 14, 2019 Take Out Some Insurance - May 3, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mixed: Producer prices contracted by 0.6% year-on-year in July. Core machinery orders increased by 12.5% year-on-year in June, while preliminary machine tool orders for July fell by 33% year-on-year, from -38% the prior month. Industrial production contracted by 3.8% year-on-year in June. Capacity utilization fell by 2.6% year-on-year in June. USD/JPY appreciated by 0.3% this week. Japanese data was notable healthier in June, suggesting that weakness in July was exacerbated by external factors. That said, long yen bets are in an enviable “heads I win, tails I do not lose too much” position, as posited in the front section of this bulletin. Report Links: Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 Battle Of The Central Banks - June 21, 2019 Short USD/JPY: Heads I Win, Tails I Don’t Lose Too Much - May 31, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 There was a flurry of data out of the U.K. this week, most of which were firm: Preliminary GDP growth fell to 1.2% year-on-year in Q2, from the previous 1.8%.  This was mostly driven by investment that contracted by 1.6%. This makes sense given Brexit uncertainties. Exports contracted by 3.3% quarter-on-quarter in Q2, but imports fell 12.9% quarter-on-quarter. The total trade balance increased to £1.78 billion in June. The unemployment rate nudged up to 3.9% in June, but the labor report was robust. Weekly earnings soared by 3.9%. Headline and core inflation moved up to 2.1% and 1.9% year-on-year respectively in July. Lastly, total retail sales increased by 3.3% year-on-year in July. GBP/USD has been flat this week. While GDP data was clearly negative, the drop in the pound is clearly improving the balance of payments backdrop for the U.K. Our bias is that the pound could soon rebound once the Brexit chaos settles. Short EUR/GBP at 0.95. Report Links: Battle Of The Central Banks - June 21, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 Take Out Some Insurance - May 3, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been positive: NAB business confidence edged up to 4 in July, from 2. Westpac consumer confidence also rebounded by 3.6% month-on-month in August. Consumer inflation expectations increased to 3.5% in August. The employment report was robust. The unemployment rate was unchanged at 5.2% in July; 34.5 thousand full-time jobs and 6.7 thousand part-time jobs were created; Participation rate was little changed at 66.1%. Wages remained at 2.3% year-on-year in Q2. AUD/USD fell by 0.4% this week. The Aussie is a very ripe candidate for mean reversion, once the appropriate catalysts fall in place.  Net speculative positions on the Aussie dollar are very close to a bearish nadir. We continue to favor the Aussie dollar from a contrarian perspective. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 There is scant data from New Zealand this week: Net migration to New Zealand fell to 3100 in June. House sales increased by 3.7% year-on-year in July. NZD/USD fell by 0.5% this week. We remain bearish on the kiwi due to decreasing net migration, and falling terms-of-trade. Remain long AUD/NZD as a strategic holding. Report Links: USD/CNY And Market Turbulence - August 9, 2019 Where To Next For The U.S. Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been negative: Housing starts came in at 222K in July from 246K. Building permits decreased by 3.7% month-on-month in June; Existing home sales increased by 3.5% month-on-month in July. The labor report was poor. Unemployment increased to 5.7% in July. 11.6 thousand full-time jobs and 12.6 part-time jobs were lost in the month of July. Average hourly wages however, soared by 4.5% year-on-year in July, from the previous 3.6%. Bloomberg nanos confidence index fell to 57.8 over the past week. USD/CAD increased by 0.7% this week. A combination of robust wage growth, accommodative fiscal policy, and low interest rates, has supported the Canadian housing market in the summer. Moreover, energy prices should hook up which will benefit CAD. We remain positive on the loonie in the near-term. Report Links: Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been negative: Unemployment rate was stable at 2.3% in July. Producer and import prices contracted by 1.7% year-on-year in July. USD/CHF has been flat this week. The terms-of-trade in Switzerland soared to 128 in June from the previous 117 in May. We continue to favor the franc due to a positive current account, and its safe-haven allure. Report Links: What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been mostly positive: Headline inflation was stable at 1.9% year-on-year in July, while core inflation fell slightly to 2.2% year-on-year in July. Producer prices contracted by 8.6% year-on-year in July. The trade balance widened to NOK 6.5 billion in July. USD/NOK increased by 1% this week. The Norges Bank kept interest rates unchanged yesterday at 1.25%, and said the policy outlook has become more uncertain amid rising global risks. The central bank guidance had been irrefutably hawkish prior to yesterday. The current dovish shift reflects more uncertainties in the global market and energy prices. Remain long NOK/SEK for now, while earning a positive carry. Report Links: Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been mixed: Household consumption decreased by 0.3% year-on-year in June. Unemployment rate nudged up to 6.3% in July. Headline and core inflation both fell to 1.7% year-on-year in July. USD/SEK increased by 0.5% this week. The July inflation has been the lowest since early last year, mostly due to a slowdown in the prices of transport, recreation and culture, and durable goods. That said, disinflation is now a global phenomenon. We remain long SEK/NZD as a relative value trade. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Overweight Household products stocks are in a V-shaped recovery since the early-2018 market peak and these safe haven stocks have more upside in times of tumult (middle panel) despite their pricey valuations (bottom panel). Demand for staples remains robust despite the growth slowdown and the current message from the latest PCE report calls for additional relative share price gains (second panel). Not only domestic demand is upbeat, but industry exports are also on a roll, in spite of the U.S. dollar’s recent appreciation (fourth panel). This suggests that non-discretionary items remain in high demand in the rest of the developed world and the emerging markets despite the loss of consumer pricing power. Bottom Line: We reiterate our overweight stance on the S&P household products index. The ticker symbols for the stocks in this index are: PG, CL, CLX, KMB, CHD. ​​​​​​​  

How important is the potential thawing of the Sino-U.S. trade war to oil markets?  On a scale of 1 – 10, this goes up to 11 (Chart of the Week). Brent’s and WTI’s one-day rally of ~ 5% on Tuesday, followed by a 4.5% sell-off on Wednesday, is a testimony to the importance these markets place on the evolution of the Sino-U.S. trade war, and anything that suggests a change in the status quo.1 The rally was an almost-immediate response to the announcement the U.S. would delay until December 15 the imposition of tariffs on ~ $160 billion of $300 billion of goods that become effective September 1. The tariffs were announced August 1 by President Trump. Wednesday's sell-off was triggered by weak global economic data and building U.S. crude stocks. It also was a wake-up that nothing substantive was advanced to resolve the Sino-U.S. trade war. The rally indicates pent-up demand awaits a resolution of trade uncertainties. In this report, we introduce our new proprietary Nowcast model of EM commodity demand.2 We also look at the overall macro backdrop for commodity markets, which is largely supportive, with most of the world’s central banks moving to a recession-fighting mode.3   In addition, we could get a deal between the U.S. and China following the resumption of tariff negotiations in Washington come September, which allows some resumption of trade. We have little doubt markets would welcome such an outcome. However, we remain skeptical of the deeper issues separating the two sides – e.g., IP protection, an end to forced technology transfers – will be resolved in the near future. Highlights Energy: Overweight. Saudi Aramco held its first-ever investor call this week, disclosing it earned close to $50 billion in 1H19. Earnings were down ~ 12% in the period, according to the company, partly as a result of a 4% decline in realized prices for crude oil vs. 1H18. This is a relatively small decline vs. the 7% and 12% 1H19 y/y declines in Brent and WTI, over the same period, reflecting the Kingdom’s premier position as the largest exporter of medium and heavy crudes in the world. These streams are in short supply relative to the light-sweet crude being produced in the U.S. shales. Base Metals: Neutral. Copper also got a lift from renewed trade-talk hopes, rising 2.3% on the back of the unexpected trade news from the Trump administration earlier in the week. Many of the products exempted by the Office of the U.S. Trade Representative are electronics – cell phones, laptop computers, video game consoles, and computer monitors – which will marginally support copper prices, and Christmas retail sales. Copper held on to most of its gains Wednesday. Precious Metals: Neutral. Gold and silver sold off following the U.S. trade representative’s announcement, but recovered later in the trading day, and Wednesday. Gold continues to trade above $1,500/oz, while silver trades over $17/oz. We remain long both metals as portfolio hedges against policy risk. Ags/Softs: Underweight. With the exception of corn, grains and beans mostly rallied on the trade news, with soybeans ending the day up 1.2% Tuesday. Corn traded down 6.1% Monday and a further 5.0% Tuesday, following the USDA’s WASDE report, which indicated acres planted would fall by less than analysts estimated going into the Monday morning release of the department’s supply-demand estimates, according to agriculture.com. Feature Commodity markets are noted for their ability to cover a year’s worth of price movement in a matter of days. The past two weeks in the oil markets have not disappointed, as the Chart of the Week attests. Despite the volatility introduced by exogenous policy shocks, we remain constructive on crude oil. The underlying resilience in the growth of EM economies, which drives commodity demand generally, is apparent in various gauges we’ve developed to track something close to current conditions in markets. In addition, as noted above, fiscal and monetary policy globally remains supportive of commodity demand. While growth may not match the halcyon pre-GFC days shown in the top panel of Chart 2, growth still is strong and, importantly for commodities, is coming off a higher base level.4 Broader indicators – e.g., global and country-specific LEIs – support our expectation for improved EM growth, which, ultimately is what drives commodity demand. We are compelled to note considerable uncertainty around the prospects for global growth – particularly for EM GDP growth – exists in markets and within BCA Research. Our Special Report on these divergent views elegantly presents these differences, and we highly recommend it to our readers. Fundamentally, we align with the bulls, who argue global growth can be expected to rebound this year, for reasons we cite above. The bears in BCA, which include our Emerging Market strategists, have a different view to ours, particularly on EM domestic demand. The bears expect a further deterioration in global economic activity or a delayed recovery. As a result, they expect additional downside in stocks and risk assets – including commodities – and outperformance of defensives relative to cyclicals, low safe-haven yields, and a generally stronger dollar.5  EM GDP Resilience Our BCA EM Commodity-Demand Nowcast model points to an underlying recovery in oil demand, despite the continued policy-induced volatility in prices (Chart 2). This model is a weighted index of our Global Commodity Factor (GCF), Global Industrial Activity (GIA) Index, and EM Import Volume (EMIV) models (Chart 3).6  Chart 2BCA EM Commodity-Demand Nowcast Suggests Oil Demand Rebounding Chart 3BCA EM Commodity-Demand Nowcast Components   Chart 4Global Growth Poised To Resume The GCF uses principal component analysis to distill the primary driver of 28 different commodity prices traded globally. The GIA index uses trade data, FX rates, manufacturing data and Chinese industrial activity statistics, which can be updated monthly. Lastly, the EMIV model is driven by EM import volumes reported with a two-month lag by the CPB in the Netherlands, which can be updated to current time using FX rates of economies highly sensitive to EM trade. Our BCA EM Commodity-Demand Nowcast is strongly correlated with y/y growth in nominal EM GDP and non-OECD oil consumption, as Chart 2 shows. This highlights the strong connection between EM GDP growth and oil demand growth. This also is critical to price formation – indeed,  our Nowcast is highly correlated with crude oil prices, which explains why EM GDP is our principal demand variable in forecasting oil prices (Chart 2, bottom panel). Other, broader indicators – e.g., global and country-specific LEIs – support our expectation for improved EM growth, which, ultimately is what drives commodity demand (Chart 4). However, these can change as local economic activity changes.7 One important thing to note, however: While China’s nominal import volumes are weaker y/y, its volume of crude oil imports (Chart 4, top panel) are growing. Partly this is the result of strong refinery margins; but there is a risk too much product will be produced, which could saturate Asian refined-product markets.8 Bullish Crude Oil Term Structure While price levels have been hammered lower by trade policy uncertainty and weekly pivots in direction, the Brent and WTI forward curves remain backwardated (Chart 5). This normally indicates market tightness – i.e., refiners are willing to pay more for prompt-delivered crude than for deferred delivery. Crude oil markets continue to be buffeted by policy shocks – particularly in regard to the Sino-U.S. trade war. Chart 5Crude Oil Forwards Remain Backwardated This is consistent with our reading of the underlying supply-demand dynamics of the crude market. It is important to note the backwardation in these forward curves weakened almost every month since the beginning of the year. This suggests demand slowed – the market is tight, but closer to balanced, and not in as large a supply deficit as it was expected earlier in the year. We expect OPEC 2.0 to continue to maintain production discipline, and for demand to turn up in 2H19.9 In addition, we continue to expect strong demand in 2H19 and in 2020 as we’ve noted above, given the supportive fiscal and monetary backdrop globally. Bottom Line: Crude oil markets continue to be buffeted by policy shocks – particularly in regard to the Sino-U.S. trade war. Despite these shocks, demand for crude is holding up, although it still is lower than what we expected previously – along with the EIA and IEA, we’ve been revising demand lower in our last three monthly Global Oil Balance assessments. Demand is now supported by monetary and fiscal policy easing globally. However, escalation in trade tensions could bring demand down again. Indeed, an escalation in Sino-U.S. trade tensions could push this to a lower equilibrium. It is important to point out our Nowcast is a coincident indicator, and that most of our series' last data points were observed in July, which is before the latest escalation in trade tensions. We could see a move down in some of our indicators next month. To be clear, we are not sounding an all-clear on the trade front, although we are seeing signs of recovery from relatively high base levels of EM GDP activity.   Robert P. Ryan, Chief Commodity & Energy Strategist rryan@bcaresearch.com   Hugo Bélanger, Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com   Footnotes 1      Please see USTR Announces Next Steps on Proposed 10 Percent Tariff on Imports from China, issued by the Office of the United States Trade Representative August 13, 2019. The USTR’s press release appears to be something of an olive branch, noting, “On May 17, 2019, USTR published a list of products imported from China that would be potentially subject to an additional 10 percent tariff.  This new tariff will go into effect on September 1 as announced by President Trump on August 1.”  This suggests the opening of a possible compromise ahead of trade talks set to resume next month. 2      As discussed below, our BCA EM Commodity-Demand Nowcast combines three of our proprietary models gauging EM commodity demand.  Please see Getting Long Silver, To Hedge Exogenous Shocks, published by BCA Research’s Commodity & Energy Strategy August 8, 2019.  It is available at ces.bcaresearch.com. 3    Our prior remains it is highly unlikely the PBOC or the Fed will let their economies weaken substantially without deploying additional monetary stimulus.  In addition, we believe Chinese policymakers will hold off on major stimulus in the next couple of months to get thru National Day, which will allow them to deploy further fiscal stimulus after October and next year, in the event the trade war and currency war worsens.  We also draw attention to the fact that, globally, central banks all are acting as if they’re already fighting a recession – last week, three central banks announced further easing (India, New Zealand, Thailand), following similar action by the Fed and Asian central banks (South Korea and Indonesia).  A full-blown trade war between the U.S. and China would be tumultuous, but, after the dust settles, global supply chains would have to be rebuilt or augmented, as trading blocs centered on the respective antagonists regrouped and reorganized their trading relationships and supply lines. 4     Using World Bank quarterly GDP figures, we calculate Emerging and Developing markets’ GDP will be up close to 74% between 2007 and 2019, averaging $7.24 trillion in constant 2010 USD this year. 5      We urge our clients to read this Special Report, What Goes On Between Those Walls? BCA’s Diverging Views In The Open, published by BCA Research July 19, 2019. 6       The nowcasting index uses the weighted average of each component’s coefficient of determination that falls out of a regression against EM GDP growth. Our analysis indicates EM oil demand is driven by EM GDP growth.  For additional information on the separate gauges, please see Getting Long Silver, To Hedge Exogenous Shocks, Expanded Sino – U.S. Trade War Could Be Bullish For Base Metals published by BCA Research’s Commodity & Energy Strategy August 8 and May 9, 2019.  Both are available at ces.bcaresearch.com. 7      We note Indian economic activity is slowing due to strains on the shadow-banking system in that country.  This bears watching, as India is the second largest EM economy we track in our oil-demand estimates.  Please see India's passenger vehicle sales drop at steepest pace in nearly two decades, published by in.reuters.com August 13, 2019. Auto industry representatives are pushing for government support to address the sales downturn.  S&P’s BSE index measuring the health of Indian banks is down 23% ytd.  8     Please see UPDATE 1-China's July crude oil imports rise as refiners ramp up output published by reuters.com August 8, 2019. 9      We are updating our supply-demand balances and prices forecasts for Brent and WTI next week. For our most recent forecast, please see Weak 1H19 Oil Demand Data Fuels Market Uncertainty published by BCA Research’s Commodity & Energy Strategy July 18, 2019.  It is available at ces.bcaresearch.com.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q2 Commodity Prices and Plays Reference Table Trades Closed in 2019 Summary of Closed Trades

While the stock market cheered the news that President Trump will postpone the tariffs on certain Chinese made goods to December – slightly reminiscent of Trump’s Mexican tariffs backtracking – we continue to heed the negative messages from a number of our indicators and remain cautious on the broad market on a cyclical time horizon. Our Equity Market Internal Dynamics Indicator (comprising economically sensitive equity sector tilts, EMIDI) continues to emit an unambiguous sell signal. Historically, this indicator peaks in advance of the broad market as it sniffs out trouble ahead of the overall market (see circles, top panel). With regard to troughs, the EMIDI’s track record is more coincident than leading. Beyond this negative omen, stalling earnings also suggest at least a digestion period in the SPX. As a reminder the last time EPS hit a wall near $118/share for three years running between 2014 and 2016, the SPX moved laterally with a lot of volatility post the August 11th, 2015 Chinese renminbi devaluation (bottom panel). Fast forward to today and it appears as though the overall market cannot clear the $165/share level. Sell-side analysts are also feverishly downgrading Q3/2019, Q4/2019 and overall 2020 EPS, warning that the SPX has more downside. Bottom Line: Absent a turnaround in profits we remain cautious on the broad equity market on a cyclical 3-12 month time horizon. ​​​​​​​