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Monthly Macro Risk Monitor – 7 Nov 18

 My greatest discovery was that a man must study underlying conditions, to size them so as to be able to anticipate probabilities. – Jesse Livermore

In this recurring monthly analysis, we will look at three global risk factors in order to assess the current market state and attempt to foresee risks on the horizon.  The factors that we will be using, in order of weight, are:

  • Global Monetary Policy
  • Global Volatility
  • Global PMI readings

Together, they can assist us in shaping up underlying macro conditions, so we don’t get caught off guard by some change in market dynamics that was foreseeable.

Global Monetary Policy Stance

Source: cfr.org

We use Global Monetary Policy to evaluate inflation risks, deflation risks, and interest rate risk.

Monetary policy is being tightened very gradually, which will place upward pressure on rates (as we have seen in US 10yr) which will in turn put pressure on USD-denominated debt. Rates are gradually rising elsewhere also, adding cyclical pressure although the main focus remains the FOMC and it’s impact.

Global Volatility Meter

Source: TradingView

We use the Global Volatility Monitor to capture economic growth risks and liquidity risks.Since we are tracking the implied volatility on the S&P 500, the Eurostoxx and Crude Oil, we can see the composite indicator as “the cost of hedging a price decline” in each market.

Volatility is now “high” as we are above the 22.50/23.00 mark. This is negative for cyclical assets and will make conditions more challenging.

Global PMI Monitor

Source: IHS Markit

We use the Markit/JPM Global PMI analysis as a gauge for economic growth risks, inflation risks and deflation risks. PMIs are known to be a leading indicator for GDP growth rates.

From this month’s report: Global manufacturing production rose at the slowest pace in 28 months in October. Output growth was constrained by a weaker increase in new business, including a second successive month-on-month decrease in new export orders. The euro area, China, South Korea, the UK, Taiwan, Brazil, Turkey, Indonesia, Poland and Thailand all saw new export work contract. The US fared little-better, with its rate of increase in new export business easing to near-stagnation.

PMIs are showing that everywhere except the USA are headed for a contraction in GDP in the near future. This will add pressure to cyclical assets.

To Sum Up

Our Macro Risk Monitor (MRM) is currently showing a slow but consistent tightening of monetary policy, and higher volatility conditions which will exhert downward pressure on cyclical assets. Global growth expectations are slowing and emerging markets are already in a contraction. The PMIs usually anticipate trends in GDP by 6 months, hence the focus on them. We are seriously headed for tougher conditions moving forward and the downside risks in cyclical assets are starting to outweight the upside.

About The Macro Risk Monitor

What we are doing is neither new nor original. Anyone with a basic comprehension of macroeconomic theory, and a bit of real world experience, can do the same thing. We’re just doing it for you.  What follows is a brief explanation of why we are monitoring precisely Monetary Policy, Volatility and Purchasing Managers’ Index.

  • During periods of real (non-inflationary) growth, the main cyclical classes (Developed and Emerging Market Equities, Real Estate, High Yield Bonds) tend to have low volatility.
  • Vice versa, during periods of economic uncertainty or outright contraction, cyclical assets have high volatility.
  • However, we can also have inflationary growth, which is the best environment for Commodities (Energy, Industrial Metals).

When volatility is high, or global growth expectations (measured via the PMI) are low and monetary policy is tight/tightening, there is a collision of risk factors that produces a high uncertainty/high risk environment that is usually only favourable to fixed income and counter-cyclical assets.

When volatility is low, or global growth expecatations (measured via the PMI) are high and monetary policy is loose/loosening, there is a combination of easing factors that produces a low uncertainty/low risk environment that is favourable to cyclical asset classes.

By using just these three measures, we can create discrete market environments that can assist in selecting the right asset class to target given the current situation.

If any of this is a bit foreign or complex, our Forex Fundamentals Mastery course can bring you up to speed.

About the Author

Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.

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