Patience Has Frayed

Investors are very afraid
That things will get worse in re trade
Trump’s latest attack
Caused China to back
More tariffs as patience has frayed

Once again trade is the key topic of the market conversation this morning as the US imposition of tariffs on $50 billion of Chinese imports, announced last evening, was followed by the Chinese response of tariffs on $50 billion of US goods announced overnight. While the trajectory of this process is certainly disconcerting, there are still many policy pundits who seem to believe that all this can be contained without having too large a negative impact on economic growth. I hope they’re right, but at the very least we will need to see evidence that the two nations are discussing the issues beyond the simple tit-for-tat actions that have been announced. And thus far, evidence of that is scant. The thing to keep in mind is that trade has been one of the most important drivers of global economic growth in the post WWII era, and has benefitted virtually every nation on earth. If this paradigm is changing, it will have far reaching consequences beyond simply the economic data. Rather, it will almost certainly change the political dynamic in countries in every region including such topics as migration and defense. And compared to the world in which we have lived for essentially all of our lives, prospects could well be darker. But that is a discussion beyond the purview of this note, which is focused on markets with particular emphasis on FX.

So heading back to markets, it should be no surprise that equity markets have taken this news poorly given the potential ramifications on specific company profitability as well as general economic performance. In the US, equity futures are currently lower by ~1.5%, more than offsetting yesterday’s rebound, while we are seeing weakness throughout European shares and saw such in Asia as well overnight. Treasuries, meanwhile, continue to perform well despite the increased supply, as they remain the number one safe haven asset for large money managers. This morning, the yield on the 10-year has fallen 2bps, although that is after having risen about 3bps during yesterday’s stock market rally. Gold has also benefitted, rising about 0.7% overnight, as it remains a clear safe haven. (As an aside, it is interesting to me that Bitcoin, the alleged digital gold, has fallen some 3% overnight. Perhaps it does not seem as safe as its strongest adherents claim!)

In the FX markets, we have seen a very traditional risk-off response. In the G10, that means the yen is the leading gainer, +0.5%, followed by the Swiss franc, +0.25%. The other currency gaining against the dollar has been the euro, but that is a very muted 0.1%. Regarding the euro, two things need to be addressed: first that yesterday it fell about 0.3%, so this morning’s rally still leaves it lower than this time yesterday morning, and second, the release of the flash March CPI estimate (headline 1.4%, Core 1.0%, both as expected) has generated some discussion that the ECB will be better able to take the next steps in ending QE later this year. I take issue with the latter idea as the fact that the core data continues to run at half their target rate, and has remained between 0.8% and 1.2% since 2014 implies that the underlying inflationary impulse that the ECB needs to see before abandoning QE remains absent. The euro bulls continue to suffer the costs of negative carry and unfortunately for them, the data has not solved their problems yet. As to the rest of the G10 space, the dollar is modestly firmer as might be expected.

Turning to the EMG bloc, it should be no surprise that the dollar has been the main beneficiary of the trade spat. Interestingly, the renminbi has fallen more than 0.5%, which is a pretty big move given the normal volatility in the currency. I guess the PBOC wanted to try to add further pressure on the US given the situation. But weakness abounds in the space with MXN down by 0.5%, RUB down a similar amount, TRY -0.8% and ZAR also lower by 0.8%. Most of the other currencies have also fallen, just by lesser amounts, but the theme is quite clear. After all, given that every one of these countries is heavily reliant on trade, and that the US continues to be the largest trading partner for so many of them, the idea that the US is going to be raising trade barriers cannot be seen as a positive for any currency in the bloc.

And while trade has been THE story of the overnight session, and will certainly continue to get play as an issue, this morning we start to see some data points that may also have a market impact. We start with the ADP Employment number (exp 185K), which while much lower than last month’s NFP outcome is in line with the recent monthly average gain. In other words, the employment situation appears to continue to be quite positive in the US. That is followed by the ISM Non-Manufacturing Index (exp 59.0) and Factory Orders (1.7%) with the former likely to have a larger impact than the latter. We also have two Fed speakers today, St Louis’s James Bullard and Cleveland’s Loretta Mester, a dove and a hawk respectively, so at the very least we should hear both ends of the Fed spectrum. As such, I expect Bullard to argue that the lack of inflation in evidence so far means the Fed should slow down while Mester will be focused on making sure the Fed doesn’t fall behind the curve.

While today’s data might impact markets at the margin, I think once it has been released, all eyes are going to begin to focus on Friday’s Payroll report, and more specifically on the AHE number released. The one thing that remains clear is that the escalation in the trade ‘war’ is going to add to what I believe is already a rising inflationary picture in the US (and elsewhere round the world) and that the Fed is not blind to this process. Given that inflation remains the Fed’s primary focus right now, it seems a very plausible path going forward is more trade tension leading to still higher inflation readings and the Fed responding more aggressively. This cycle is not going to end soon, and accordingly, in combination with the growing risk-off sentiment, I see the dollar remaining as the main beneficiary of the current situation (excepting, of course, the yen which will rise most).

Good luck