Monthly Macro Risk Monitor – 3 Oct 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
We use Global Monetary Policy to evaluate inflation risks, deflation risks, and interest rate risk.
Monetary policy is being tightened very slowly in 2018 and the FED will continue to hike. Being the Central Bank of the world’s reserve currency, other CB’s will need to follow, in due time. We are on a path that leads to more difficult financial conditions and the RBNZ seems to be one of the only central banks admitting that stimulus is still required. We might be very well hiking into a contraction.
Global Volatility Meter
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 conditions remain inconclusive right now, since we are in no man’s land. Monetary policy and PMIs are more influential in this context.
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.
Global manufacturing output growth dropped to a two-year low. The performance of emerging markets (on average) was the
main drag on global manufacturing growth and this is where signs of “distress” will come from, before reaching developed nations.
To Sum Up
Our Macro Risk Monitor (MRM) is currently showing a slow but consistent tightening of monetary policy, which has yet to translate into heightened volatility. 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. I do think that Vix and OVX are not truely discounting the risks we are facing.
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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