Livin’ on the edge as tariffs rise

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Trade talks have ended on a “constructive” note in Washington on Friday, triggering a nice rebound for Wall Street, but market sentiment remains a little on the edge.

In spite of the overnight jump in US tariffs on $200bn of Chinese goods, market expectations of an eventual deal have helped limit a bigger global equity sell-off this week, as seen via the chart below. Wall Street certainly liked the constructive tone from officials after trade talks concluded with the S&P 500 rebounding from an early slide of 1.6 per cent. Friday’s bounce in Chinese equities likely reflected state-directed buying, and barring any adverse weekend headlines, Asian markets should enjoy further relief at the open on Monday.

Another factor has been the absence of retaliatory measures from China for now. 

Marc Chandler at Bannockburn Global Forex reminds us:

“This is not always how China plays its hand. Sometimes, it skips the American-style big announcement and simply takes action, as it has with Canada recently and Japan in the past, for example.”

President Donald Trump’s morning tweet that there was “no rush” to ink a deal bookends a turbulent week for markets and for all the optimism, there’s no guarantee of a breakthrough soon. And the US threat of applying a 25 per tariff on the $325bn of Chinese goods that have escaped that fate to date also remains on the table.

Here’s an interesting take from the FT’s Jamil Anderlini on the how “global trade is now hostage to the fragile egos of two autocratic men”. 

This week’s market debate over who has the stronger hand at this poker table and hopes of an “beautiful” trade agreement misses a far more important point.

Tariffs are likely to stay and the struggle for dominance between the world’s two largest and most important economies will run well into the next decade. Any treaty on trade that eventually emerges will probably not pass enforcement over time. In the event of any deal being announced, the risk is one of a market “relief rally” being sold as the details reveal plenty of leeway. 

David Page and Aidan Yao at Axa Investment Managers note:

“A lasting agreement between China and the US has always appeared a bit of a stretch. The US attempts to address structural issues of state subsidy, intellectual property violations, and market access in these negotiations were always likely to prove difficult. Nevertheless, we had assumed that an extended truce, rather than a lasting peace, was possible — and [that] may well still be what is delivered over the coming weeks.”

This leaves the global economy stuck between a rock and a hard place. 

William O’Donnell at Citi has an interesting observation:

“Underneath the plate shifts in US-China trade negotiations we’re wondering if enough focus is being paid to the increasing creep of Asian-region central banks toward more monetary accommodation.”

This week, central banks in New Zealand, Malaysia and the Philippines cut interest rates, and Australia will follow after Friday’s downgrading of growth and inflation forecasts by the Reserve Bank.

Bill also highlights how the global auto and semiconductor industries remain in recession and notes the 17 per cent drop in China’s passenger car sales in April compared to the same month a year ago and the 11th straight monthly drop.

Credit growth in China also softened in April. Capital Economics notes:

“There is also evidence that fiscal support is waning, after local governments front-loaded spending for this fiscal year. That all supports our view that hopes of a rapid stimulus-driven rebound in China’s economy are likely to be disappointed, even if the two protagonists in the trade war do find a way to bridge their differences.”

The danger from this week’s escalation in trade tension is that asset prices fall further, reflecting increasing doubts that China stimulus flows into the global economy and having to deliver a bigger market shock before policymakers up their easing efforts. 

Thanks for reading and enjoy the weekend before another big week kicks off for markets. 

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Quick Hits — What’s on the markets radar

US inflation — Core consumer prices rose but fell short of expectations during April in a further test of the Federal Reserve’s view that weaker inflation is transitory. Indeed, the bond market extended its recent retreat in the wake of the data, with the break-even rate for the next five years dipping below 1.70 per cent, down from a recent rise to 1.90 per cent. 

The bond market will have to wait for any signal from the Fed says economists at TD Securities and they noted after the data:

“Despite the slight disappointment in this report, we would fade any inference that the Fed may be nudged toward ‘insurance cuts’ due to weak inflation. Rather, we would need to see a run of multiple months with core PCE inflation around 1.5% in order for the FOMC to start that conversation.”

Watching the renminbi — China’s onshore renminbi strengthened by as much as 0.5 per cent to Rmb6.7928 per dollar on Friday, but its performance in the coming weeks is important for risk sentiment, particularly across emerging markets. 

Brad Bechtel at Jefferies says: “The price action tells you the market remains cautious” and for now the currency is holding above its 200-day moving average.

In the Rmb currency risk-reversal space (highlighted in Thursday’s note) there has been a touch of cooling. Demand for options that become profitable from a much weaker Rmb over the next month remains elevated, but has retreated from Thursday’s peak. 

A test of Rmb7 per dollar is not out of the question and some weakness would help the economy. But this is a big level and depreciating further would trigger broad-based selling across financial markets.

Win Thin at Brown Brothers Harriman thinks the Rmb will not be used as a weapon in the trade war as Premier Li has “acknowledged that a devaluation will do more harm than good to China, and we concur”.

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