Nibbling At The TACO Trade Once More

WHERE WE STAND – Right then, ‘as you were’, folks. Well, almost.

After a defensive, tumultuous and risk-off end to last week, it was time for market participants to jump back onboard the ‘TACO trade’ yesterday, with risk assets rebounding, and havens facing headwinds. It’s almost as if Friday was just a bad dream.

Sadly, it wasn’t a bad dream, and did leave quite the trail of capital destruction in its wake, but it also looks like we can relatively safely chalk up the latest threats (additional 100% tariffs on China plus export controls on ‘critical software) as yet another example of the escalate to de-escalate strategy that President Trump has become so reliant on, not only since his second term begun in January, but for the bulk of his life.

In fact, it’s even written out in his book, ‘Art of the Deal’, from which I’ll quote – “there are times when the only choice is confrontation…when people treat me badly or unfairly or try to take advantage of me, my general attitude, all my life, has been to fight back very hard. The risk is that you’ll make a bad situation worse…things usually work out for the best in the end”.

I think it might be worth market participants plastering that quote to their screens, as it’s probably a decent guide to how the next three years or so are likely to pan out.

However, while this all looks to be another ‘TACO’ moment, there is still a lingering risk, even if it’s a very slim possibility, that Trump does indeed follow through on the threats made at the back end of last week. That’s largely why we’ve, broadly speaking, only unwound about half of the damage wrought on Friday.

The way I would characterise the general vibe of trade, then, is one where participants are leaning into the TACO trade again – taking a bite out of it, if you will – but are not quite yet prepared to go ‘all in’ on the idea, as we saw in that face-ripping rally on the back of the ‘Liberation Day’ U-turn in April. As such, yesterday saw stocks rally across the board, and on both sides of the pond; the dollar rebound against most peers, save for the high-beta AUD and NZD; crude benchmarks gain considerable ground; and, last but not least, precious metals continue their sizeable recent rally.

Going ‘all in’ on the TACO trade once more, which remains my base case in terms of how this pans out, for what it’s worth, is probably going to need some degree of greater clarity as to where US-China relations actually stand. That could be confirmation that Trump and Xi are still planning to meet at the end of the month, a leader-level call beforehand, or even the official rolling-back of last week’s threats (on both sides).

With that in mind, in the meantime while headline-watching becomes everyone’s favourite hobby once more, we will likely have to endure higher levels of both implied and realised vol, not only amid the immediate reaction to headlines as they break, but likely also as a result of increased hedging activity, particularly to protect against equity downside.

In any case, I’m prepared to buy into the ‘TACO’ vibe for the time being, with my base case remaining that this will prove to be (yet) another negotiating ploy from President Trump and that, as he said in his book, things will work out ok in the end.

As such, I view this as an equity dip to be bought, with the looser monetary backdrop, coupled with robust economic and earnings growth, ample reason to think that the path of least resistance continues to lead to the upside.

Meanwhile, I also remain happy to ride the wave of momentum to the upside in precious metals, though principally in gold as, despite silver hitting fresh record highs yesterday, the latter is increasingly being driven by an almighty short squeeze, and physical supply crunch, leaving the market susceptible to a reversal, in rapid fashion, if those shortages are resolved.

Lastly, the aforementioned ‘run it hot’ strategy that the Fed are adopting continues to tilt risks to the US outlook to the upside, and risks to the greenback in the same direction, especially with the DXY continuing to trade comfortably above its 50- and 100-day moving averages.

LOOK AHEAD – As the US government shutdown continues, with no end in sight, so does the vacuum in terms of official economic statistics, with numerous October figures also now under threat, such as the October jobs report, given what are now inevitable delays in data collection.

Anyway, there are still a few bits & bobs to get our teeth into. This morning, the August UK labour market report should show unemployment having held steady at 4.7%, while earnings pressures are set to remain close to 5% YoY, clearly incompatible with a sustainable return to the BoE’s 2% inflation target over the medium-term. Meanwhile, we also receive the latest ZEW sentiment surveys out of Germany this morning, where there is hardly much cause for optimism these days.

On the speaker front, Fed Chair Powell is due to make remarks this afternoon and, while J-Pow’s view on the latest tariff threats will be of interest, he’s unlikely to move the needle much in terms of the policy outlook, with 25bp cuts in October and December still the base case.

Lastly, third quarter earnings season kicks off on Wall Street today, with the likes of JPMorgan, Goldman Sachs, Citi and Wells Fargo getting us underway before the opening bell. For the S&P 500 at large, earnings are expected at +8.8% YoY, which would mark the 9th consecutive quarter of growth.