From Trade War to Currency War?

Fred Imbert of CNBC reports the Dow plummets more than 600 points after Trump orders US manufacturers to leave China:
Stocks plunged on Friday after President Donald Trump ordered that U.S. manufacturers find alternatives to their operations in China. Apple led the way lower.

The Dow Jones Industrial Average closed 623.34 points lower, or 2.4% at 25,628.90. The S&P 500 slid 2.6% to close at 2,847.11. The Nasdaq Composite dropped 3% to end the day at 7,751.77. The losses brought the Dow’s decline for August to more than 4%.

The major indexes also posted weekly losses for the fourth straight time. The Dow dropped about 1% this week while the S&P 500 pulled back 1.4%. The Nasdaq lost 1.8%.

Trump tweeted on Friday: “Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing..your companies HOME and making your products in the USA.” However, it is not clear how much authority the president has on this front.

“The threats always been out there but there’s been no need to provoke that,” said Art Hogan, chief market strategist at National Securities. “It’s almost like the administration was expecting the Fed to announce a rate cut at the Jackson Hole meeting.”

Apple shares dropped 4.6%. The VanEck Vectors Semiconductor ETF (SMH) slid 4.1% as Nvidia and Broadcom both fell around 5%. Caterpillar shares, meanwhile, pulled back 3.3%.

Friday’s decline added to a series of sharp moves down this month. The Nasdaq has now fallen at least 1% six times this month while the Dow has posted five drops of 1% or more. The S&P 500 has closed down 1% or more four times in August. Those moves come as the U.S.-China trade war intensifies while the bond market flashes a recession signal.

Trump’s tweets come after China unveiled new tariffs on Chinese goods. China will implement new tariffs on another $75 billion worth of U.S. goods, including autos. The tariffs will range between 5% and 10% and will be implemented in two batches on Sept. 1 and Dec. 15.

Earlier in the day, stocks teetered around the flatline after Federal Reserve Chairman Jerome Powell delivered a speech from an annual central banking symposium in Jackson Hole, Wyoming.

In it, he said the Fed will do what it can to sustain the current economic expansion. “Our challenge now is to do what monetary policy can do to sustain the expansion so that the benefits of the strong jobs market extend to more of those still left behind, and so that inflation is centered firmly around 2 percent.”

He also noted there is no “rulebook” for the current U.S.-China trade war, adding that “fitting trade policy uncertainty into this framework is a new challenge.”

But traders may have wanted a clearer suggestion that the Fed would cut rates in September. The market was looking for a more aggressive walk-back of his now infamous “midcycle adjustment” comment that signaled the July rate cut was just an adjustment and not the start of a trend.

Powell said in Friday’s speech that “after a decade of progress toward maximum employment and price stability, the economy is close to both goals. ” Those comments likely didn’t assuage traders hoping for an aggressive easing cycle from the Fed.

“He’s walking a tightrope, he’s balancing so many things that no other fed chairman has had to do in terms of a very aggressive president, markets that are demanding faster and more rate cuts, the geopolitical challenges of trade and now he has a very divided group of fed presidents with very diverse views of where they should go next,” said Michael Arone, chief investment strategist at State Street Global Advisors. “His comments reflect that he’s not going to say ‘we’re cutting significantly over ht next couple of months' ... he’s really playing it down the middle.”

The yield curve was flat on Friday. The spread between the 10-year Treasury yield and the 2-year rate inverted on Thursday after Fed members indicated a September rate cut was not a certainty, raising fears that the central bank would not be quick enough to save the economy from a recession. The yield curve has been a reliable recession indicator in the past.

However, St. Louis Fed President James Bullard told CNBC’s Steve Liesman on Friday that the central bank should keep cutting rates, noting that an inverted yield curve is “not a good place to be. ”
It was another wild week that finished off with a bang when the Tweeter in Chief took to Twitter again to rail against China.

President Trump wasn't just sending China a message, his timing demonstrates he's also sending Fed Chair Powell a message: "don't be a wimp, cut rates A LOT more."

Of course Trump goes after Powell head on on Twitter which is unprecedented for a sitting president:

He has pretty much shown the world he will go after China no matter what, even if there's an election coming (he will maintain a hard stance and on some issues, he's absolutely right).

He's also making the Fed's job a lot harder because Trump knows he can't interfere with monetary policy directly but all he has to do is put out a few tweets and markets immediately tank, forcing the Fed to reconsider its policy.

We live in interesting times. I went to an event last night hosted by Crystalline Management, one of the oldest hedge funds in Canada focusing on merger arbitrage and other absolute return strategies. It's an annual gathering of industry professionals and it was a beautiful evening.

I recognized some old faces from my time at the Caisse and there were a few traders, portfolio managers and risk managers there and everyone was talking about how insane these markets are.

One CTA told me flat out: "I don't carry overnight positions any longer. It's too risky. One tweet from Trump or an announcement from China, and you're cooked."

He did however tell me he's still long gold and thinks it's headed much higher. He's so convinced about this that he has been long the Direxion Daily Junior Gold Miners Index Bull 3X Shares (JNUG), which is a 3x levered ETF, and has been making a killing on it (be careful with these levered ETFs, you can just as easily lose your shirt!).

Anyway, he was telling me he has six screens up and one of them is dedicated to tweeter feeds from Trump and others (mostly Trump). I chuckled and told him a buddy of mine in New York City who used to trade for Izzy Englander's Millennium, one of the biggest and best multi-strategy hedge funds, told me a few months ago to "analyze Trump's tweets, everything he says comes true, he has a near perfect record on markets."

Trump or no Trump, a couple of weeks ago, I warned my readers to brace for a bumpy ride ahead. When interest rates fall so fast around the world, one thing is guaranteed, volatility will pick up and that's typically not good for stocks:

But earlier this week, I also explained how recent bond market jitters are overdone as mortgage funds hedging convexity risk and CTAs front-running them exacerbated the downward move in long bond yields.

That's why I take the inversion of the yield curve with a grain of salt. The 2 and 10-year yield curve is an important indicator to watch to a looming recession ahead but it's not just economic data driving the recent inversion, a lot of technical factors explain the inversion.

Still, escalating trade wars aren't good for risk assets, especially if they lead to a full-blown currency war. China is hurting and if it pops out one day and massively devalues the yuan, put your crash helmets on, risk assets will get clobbered.

More worrisome, a massive devaluation of the yuan will export deflation across the world at a time when the global economy is very fragile.

And it's worse than you think. That CTA told me that everyone is worried about another 2008 but he sees another 1997 Asian financial crisis. "You have a lot of US dollar denominated debt, the USD keeps rising but oil prices aren't plummeting, so emerging markets are getting squeezed on both ends, the rising greenback and rising oil prices which are denominated in US dollars."

Typically when the USD rises, commodity prices fall but that's not what's happening because of the flight to safety trade where everyone wants US assets.

Interestingly, emerging markets bonds (EMB) have rallied like crazy since the beginning of the year (yield chasers are gorging on them) but emerging markets stocks (EEM) are getting clobbered and testing important support levels here:

Something is going to give, and if we do see another emerging markets debt crisis, it's going to get ugly very quickly.

Of course, if you look at the S&P 500 ETF (SPY) led by tech shares (XLK), it's not time to panic yet, it looks like another normal retrenchment:

Still, I can't emphasize enough how risky these markets truly are and escalating trade wars are definitely adding to these risks. President Trump and China’s president, Xi Jinping, are locked in and neither side is backing down, and my fear is a currency war is next.

What worries me is if China decides to massively devalue the yuan, exporting deflation throughout the world. I keep saying this because it's the biggest risk to all risk assets yet everyone seems to think it's "highly unlikely," just like negative interest rates will never hit the US (ridiculous, all these bond bears who have been wrong claiming negative interest rates will never happen in the US, only in the rest of the world).

Below, Mohamed El-Erian, chief economic advisor at Allianz, calls into CNBC's "Closing Bell" team stating the escalating trade war between the US and China increases the odds of a currency war.

Second, Nancy Tengler of Tengler Wealth Management and David Rosenberg, chief economist with Gluskin Sheff, join CNBC's "Closing Bell" team to break down what investors should watch as the trade war between the US and China escalates. Rosenberg thinks the global recession is spreading and it's hard to argue against that.

Third, Michael Farr of Farr, Miller & Washington, Jack Ablin of Cresset Wealth Management and Ron Insana, a CNBC contributor, discuss how things are happening all over the world that could crack the global economy. If you ask me, the global economy has cracked, we'll see how bad it gets.

Lastly, Kyle Bass, Hayman Capital Management founder and CIO, joins "Squawk on the Street" to discuss the trade war between the US and China as recession fears loom. Great interview, watch it.