Tariff Man shatters the trade silence

The three main scenarios for the trade talks outcome — read our Market Forces newsletter. FT subscribers can sign up here.

Words are very powerful for markets which is why investors focus so acutely on what central banks say and more importantly, imply.

Nothing at the moment, however, comes close to matching the influence of President Donald Trump and his twitchy fingers via Twitter. Two tweets delivered on Sunday sparked a comeuppance for global equities on Monday. Mr Trump followed up on Monday, tweeting:

“The United States has been losing, for many years, 600 to 800 Billion Dollars a year on Trade. With China we lose 500 Billion Dollars. Sorry, we’re not going to be doing that anymore!”

Beyond the failure of US trade hawks to understand the comparative advantage of trading between nations, this hotter tone is worrying for markets that have long reflected on the prospect of rapprochement between the US and China. After all, it’s in the interests of both countries, their economies and equity markets to avoid a game of chicken over trade.

The modest scale of losses in eurozone and US share markets on Monday, however suggests that investors lean towards a view of Mr Trump pursuing the “art of the deal” by upping the ante just before the scheduled final round of US-China trade negotiations start on Wednesday. With Wall Street near record territory, the Federal Reserve firmly on the sidelines and the US economy chugging along, Mr Trump no doubt believes he has a strong hand in gaining better terms from Beijing. 

At this juncture, Liu He, Chinese vice-premier, and a 100-strong delegation still plan to travel to Washington. It leaves markets focusing on the prospect of a binary outcome — Deal or No Deal — that will have ramifications for asset prices. 

Mark McCormick at TD Securities says:

“As always with Trump, it is vital to unpack the policy and the show. We suspect that the Tweet is designed to accelerate decision-making in the hopes of getting a deal done. It is unlikely that China wants to send the impression of rolling over, suggesting brinkmanship will rule the day.”

There are some hurdles towards a deal and a risk that Mr Trump overplays his hand. 

Alan Ruskin at Deutsche Bank names a couple here for starters:

“This gives China very little room for maneuver without appearing weak, which usually has been a good recipe for getting China to dig in their heels. Secondly, the focus in the latest tweets on the scale of the bilateral deficit (‘with China we lose $500bn dollars’), sets the bar even higher to make progress in a relatively free trade context.”

Just as Mr Trump thinks a resilient US economy strengthens his hand in negotiations, one can argue that the recent steadying in Chinese activity means Beijing may walk away from tough terms.

Worth noting is how others share Mr Trump’s view on China and from across the political aisle.

Chuck Schumer, the top Democrat in the US Senate tweeted on Sunday: 

“Hang tough on China . . . Don’t back down. Strength is the only way to win with China.”

While there is a sense at least in Europe and the US that investors still see a deal emerging from the current fog of negotiation, there is a danger that trade talks break down this week. Under that scenario we will see — and pretty quickly — just how much of this year’s rebound in equities and other risk assets has reflected the view that China and the US would strike a deal over trade and other commercial points of tension such as intellectual property rights and open markets. Don’t forget how late last year the likes of Apple, Caterpillar and Ford rattled market sentiment with downgrades to their forecasts as the trade war was running hotter. 

The prospect of a trade deal has been kicked down the road since the US threat of higher tariffs was delayed earlier this year. In turn the “tail risk” from a trade shock has been downgraded by equities and emerging markets. Witness the strong gains for global industrials, European carmakers, chipmakers and US tech giants for example, while market volatility has enjoyed an extended holiday for much of 2019.

DataTrek note how non-US sales represent 58 per cent of the S&P 500 tech sector, the highest of any major group.

“That makes it [Tech] the poster child for international trade, and not just with China. Markets were hoping that a calm resolution to US-China trade disputes would pave the way for other agreements.”

They make a telling point here:

“The bottom line here is one we highlight whenever a sudden selloff hits US stocks: there’s always one sector to watch for signs that the fear has hit a crescendo, and this time it is Technology.”

At the open on Monday in New York, tech led the market lower as chipmakers were hit while materials and industrials also suffered before losses were trimmed during the afternoon.

Not surprisingly, implied S&P 500 equity volatility jumped, briefly returning to intraday levels seen in late January. Crucially, the CBOE Vix has not entered the red zone, or territory above a reading of 20; at least yet. 

Other sectors to watch in the coming days are commodities — industrial metals began turning lower a month ago — emerging markets and currencies like the Australian dollar, seen as a proxy for China growth prospects. On Monday the Aussie dipped below 70 cents versus the US unit, a level that has long been a market floor. Playing a role in weakening the currency is the policy signal from Tuesday’s Reserve Bank of Australia meeting.

The biggest hit on Monday was inflicted on Chinese equities, suffering their sharpest one-day loss in three years. Returning from a three-day break, this was shaping up as a big week given how Chinese equities had peaked in mid-April and were showing signs of fatigue since an epic rally began in January. Monday’s losses leave mainland share markets in correction territory, having dropped more than 10 per cent from their recent peaks. As the jury remains out on whether activity really picks up speed this summer, a hotter trade war that overshadows China’s economy is the last thing Beijing needs. 

Earlier on Monday, Caixin reported April China services arrived a little higher than expected at 54.5, but the composite PMI was 52.7, just under the March reading of 52.9.

As analysts at Morgan Stanley note:

“Should trade tensions re-escalate, we see an annualized 0.3ppt impact to China GDP growth and expect further easing efforts. For Asia / EM equities we see near-term downside of 8-12%.”

One comfort for markets is that a trade shock would open the way for greater China stimulus, but that’s not the story for today. 

For high-flying equities and risk assets, what goes up indeed runs the risk of being tweeted down. A pity Mr Trump is no fan of Depeche Mode, for this is certainly worth listening to at the moment; Enjoy the Silence.

Your feedback

I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.

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