Eerie Calm in Global Markets as Trade War Escalates

  • Higher US tariffs on Chinese goods went into effect today at midnight; markets should go further into risk-off trading
  • US data highlight today is April CPI; Fed’s Brainard, Bostic, and Williams speak
  • Canada highlight will be April jobs data; RBA released its Statement on Monetary Policy
  • RBA released a dovish quarterly Statement on Monetary Policy
  • UK reported Q1 GDP; Norway reported April CPI
  • Japan reported March household spending and cash earnings; risk-off trading should push USD/JPY lower
  • ANC is headed to a solid victory; Brazil April IPCA inflation is expected at 5.0% y/y

The dollar is mostly softer against the majors as US tariffs went into effect at midnight. The Scandies are outperforming, while yen and sterling are underperforming. EM currencies are broadly firmer. TRY and ZAR are outperforming, while RUB and MYR are underperforming. MSCI Asia Pacific was up 0.2%, with the Nikkei falling 0.3%. MSCI EM is up 0.7% so far today, with the Shanghai Composite rising 3.1%. Euro Stoxx 600 is up 0.7% near midday, while US futures are pointing to a lower open. 10-year UST yields are up 1 bp at 2.45%, while the 3-month to 10-year spread has steepened 2 bp to 4 bp. Commodity prices are mixed, with Brent oil up 0.3%, copper down 0.2%, and gold up 0.1%.

Higher US tariffs on $200 bln of Chinese goods went into effect today at midnight. This came hours after chief China negotiator Liu arrived in Washington and went straight into talks with chief US negotiator Lighthizer. The 25% tariffs will also be extended to another $325 bln of Chinese goods, but no further details have emerged.

Talks will resume today but the mood will be decidedly sour. China confirmed that it will be forced to retaliate against the US. Can a deal be struck with this backdrop? As things stand, no. We do not believe President Xi will give in to US threats, as it would be taken as a sign of weakness domestically.

The current deadlock is clearly the worst-case scenario for markets. Yet so far, the reaction has been muted. Markets should go further into risk-off trading that favors the dollar, yen, and Swiss franc at the expense of EM, the dollar bloc, and the Scandies. Bonds should rally, stocks should sell off. We got a taste of this earlier this week, and this should resume after today’s (so far) inexplicable calm.

US data highlight today is April CPI. Headline CPI is expected to pick up a couple ticks to 2.1% y/y, while core is expected to pick up a tick to 2.1% y/y. Yesterday, headline PPI was steady at 2.2% y/y, while core was steady at 2.4% y/y. Both were expected to rise a tick.

The Fed’s Brainard, Bostic, and Williams speak today. Currently, Powell and Clarida are of the view that low inflation is transitory. Others at the Fed are not so convinced. By the way, higher tariffs should feed into higher inflation, though this is a very inefficient method. Tariffs lead to all sorts of distortions in the economy, while consumers are worse off. We suspect the Fed will have to start talking more about the impact of tariffs on the economy.

Canada highlight will be April jobs data. A gain of 11.6k jobs is expected vs. -7.2k in April, while the unemployment rate is seen steady at 5.8%. March building permits will be out today too, where a 2.4% m/m gain is expected. Next BOC meeting is May 29. After moving to a neutral bias at its April meeting, we see no change this month. USD/CAD is on track to test the April 24 high near 1.3520. After that is the January 2 high near 1.3665.

Reserve Bank of Australia released its quarterly Statement on Monetary Policy overnight. For the year ending in June, the RBA cut its growth forecast sharply to 1.75% from 2.5% previously and cut its trimmed mean inflation forecast to 1.5% from 1.75% previously. However, it sees growth picking up to 2.75% for the year. The forecasts reflect market pricing of two rate cuts ahead, but the implied H2 pickup in growth seems too optimistic.

AUD remains vulnerable due to the dovish RBA outlook. WIRP suggests 34% odds of a rate cut at the June 4 meeting. US-trade tensions should also weigh on the Aussie. Key level ahead if .6955, as a break below would set up a test of the January low near .6740.

UK reported Q1 GDP. Growth came in as expected at 1.8% y/y (0.5% q/q) vs. 1.4% y/y (0.2% q/q) in Q4. The growth mix was unexpected, however. Private consumption (0.7% q/q), government spending (1.4% q/q), and GFCF (2.1% q/q) were all stronger than expected. However, net exports were a much greater drag than expected.

UK also reported March IP (0.7% m/m), construction output (-1.9% m/m), and trade (-GBP5.4 bln). Despite the Bank of England’s efforts at a hawkish hold last week, implied rates on short sterling futures have fallen, not risen. The short sterling strip is pricing in the next hike by end-2020 vs. mid-2020 pre-BOE, while the next one is priced in at end-2022 vs. mid-2022 pre-BOE.

As a result, sterling remains heavy. Despite yesterday’s recovery, we look for a test of the late April low near $1.2865. But first, cable must break below the 200-day moving average near $1.2960.

Norway reported April CPI. Headline inflation was steady at 2.9% y/y, as expected, while underlying inflation eased a tick to 2.6% y/y vs. 2.5% expected. The Norges Bank just met yesterday and signaled a hike at the June 20 meeting. Today’s CPI data will do little to dissuade the bank.

Japan reported March household spending and cash earnings. Spending rose 2.1% y/y vs. 1.6% expected, but cash earnings contracted -1.9% y/y vs. -0.5% expected. In real terms, earning contracted even more (-2.5% y/y). We suspect many are spending now ahead of the consumption tax hike in October. Next BOJ meeting is June 20. While we expect the bank to add more stimulus this year, we think it will revolve around the impact of the October consumption tax hike.

Risk-off trading should push USD/JPY lower. The pair traded yesterday at the lowest level since February 4. Next key level to look for is 108.65, which is the 50% retracement objective of this year’s rise. It also coincides with the January 31 low near 108.60.

State-owned Turkish banks were reportedly selling USD during Asian hours. This stealth intervention was done during thin markets to get the biggest bang for the buck. However, like stealth tightening earlier this week, this tactic is doomed to failure. Investors will most likely sell into TRY strength to get out of their current positions at favorable levels. Until something fundamentally changes for the better, Turkish assets will remain under pressure. We’d also note that Turkey has very limited foreign reserves and cannot intervene on a regular basis.

With 81% of the votes counted, the ANC is headed to a solid victory. Currently, the ANC has a 57% share of the vote, down from 62% in the 2014 national election but up from the 54% in the 2016 municipal elections. Furthermore, it is at the high end of poll estimates that ranged anywhere from 51-61%. This is the best outcome for South Africa, but we remain very negative as Ramaphosa must still deal with deep structural issues that are hindering the nation.

Brazil April IPCA inflation is expected at 5.0% y/y vs. 4.58% in March. If so, it would be the highest since January 2017 and nearing the top of the 2.75-5.75% target range. COPOM delivered a balanced hold at its meeting this week. As such, markets still do not expect a rate hike until early 2020. If price pressures continue to rise, we cannot rule out a hike in H2 2019.