Global Markets Roiled as Tariffs Keep Piling Up

  • The week is ending on a decidedly risk-off note
  • Mexico is back on Trump’s radar screen; China reported weak official May PMI data
  • Fed Vice Chair Clarida did not deviate from recent Fed messaging in his speech yesterday
  • The US has several data releases that bear watching; Canada reports Q1 GDP
  • Japan reported a slew of data that was ultimately mixed
  • BOK kept rates steady at 1.75%, as expected; India Q1 GDP is expected to grow 6.3% y/y

The dollar is mixed against the majors as risk-off sentiment came roaring back. The yen and Swiss franc are outperforming, while Loonie and sterling are underperforming. EM currencies are mostly weaker. IDR and THB are outperforming, while MXN and RUB are underperforming. MSCI Asia Pacific was flat, with the Nikkei falling 1.6%. MSCI EM is also flat so far today, with the Shanghai Composite falling 0.2%. Euro Stoxx 600 is down 1.3% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 6 bp at 2.16%, while the 3-month to 10-year spread has inverted further to stand at -20 bp. Commodity prices are mostly lower, with Brent oil down 3.0%, copper down 0.7%, and gold up 0.8%.

The week is ending on a decidedly risk-off note. Besides the usual US-China frictions, markets now must deal with the threat of US tariffs on Mexico (see below). The US curve (3-month to 10-year) has inverted further to -201 bp, reflecting even greater recession concerns. And it’s not just the US, as official China PMI came in at the lowest level since February. Yen and Swissie are up, while global equities are down. EM is likely to remain under severe pressure.

Mexico is back on Trump’s radar screen. After signs of improved US-Canada-Mexico trade relations, Trump abruptly announced 5% tariffs on all Mexican imports in response to the migrant inflows across the border. The tariffs will go into effect June 10 and will increase by five percentage points on the first of every month to a 25% limit by October 1 unless “illegal immigration problem is remedied.” This will have consequences not only for consumers, but for US producers that rely on parts and components from Mexico.

The move comes just as press reports suggest Trump is making a push for passage of USMCA. It’s clear that the two policy objectives are incompatible. Indeed, Senator Grassley (R-Iowa) warned that “Following through on this threat would seriously jeopardize passage of USMCA.” USD/MXN is trading at the highest level since January 1. The last major retracement objective from the December-April drop comes in near 19.9280, and a break above would set up a test of the December high near 20.6570.

Elsewhere, press reports suggest China has a plan in place to restrict exports of rare earths if needed. There have been rumblings ever since President Xi publicly visited a rare earths facility this month, but the latest reports are much more specific. Restrictions would first focus on heavy rare earths that the US is particularly reliant upon. Other reports suggest China will draw up an “unreliable entities” list targeting foreign firms that damage the interests of domestic firms.

China reported weak official May PMI data. Manufacturing PMI was expected to drop a couple of ticks to 49.9 but instead fell sharply to 49.4, while non-manufacturing came in at the expected 54.3. Caixin PMI readings will be reported next week, but it’s clear that the Q1 bump in the economy was a temporary one. More China stimulus seems likely as the trade war stretches on.

Fed Vice Chair Clarida did not deviate from recent Fed messaging in his speech yesterday. He said current policy is appropriate as it reflect the view that recent inflation weakness is transitory. He acknowledged downside risks and pledged to take that into account in setting policy. In the Q&A, he said that he pays attention to the yield curve and acknowledged some brief periods of inversion.

This is completely at odds with what the markets are saying, of course. The US curve inversion has worsened to -21 bp, a new cycle low. Today, we have Bostic and Williams speaking and we expect them to take a similar tone as Clarida. Will the markets eventually force the Fed’s hand? It has already done so once back in December and January.

The US has several data releases that bear watching. These include April personal income and spending (0.3% m/m and 0.2% m/m expected, respectively), core PCE (1.6% y/y expected), and May Chicago PMI (54.0 expected). These readings will set the table for next week’s jobs report. We fear that as risk-off sentiment intensifies, the data will take a back seat.

Elsewhere in North America, Canada reports Q1 GDP. Growth is expected at 0.7% annualized vs. 0.4% in Q4. BOC just delivered a less dovish than expected hold this week. Next policy meeting is July 10 and no change is expected. Despite the neutral BOC bias, WIRP shows rising odds of a rate cut late in the year.

Germany preliminary May CPI is expected to ease to 1.6% y/y from 2.0% in April. State data have been trickling out already and have come in much lower, so there are downside risks to the national number. April retail sales were already reported at -2.0% m/m vs. +0.1% expected, and this comes after weaker than expected unemployment data yesterday. The ECB meets next week, and it will have to acknowledge the deteriorating eurozone outlook.

Japan reported a slew of data that was mixed. These included April jobs data (2.4% unemployment, as expected), IP (0.6% m/m vs. 0.2% expected), retail sales (flat m/m vs. 0.6% expected), and May Tokyo CPI (1.1% y/y for both headline and ex-fresh food vs. 1.2% expected for both). BOJ next meets June 20. While further stimulus is likely this year, we continue to think it will wait until after the October consumption tax hike.

Bank of Korea kept rates steady at 1.75%, as expected. CPI rose 0.6% y/y in April, well below the 2% target. Governor Lee admitted it is a “difficult situation” and warned that the bank must also consider record household debt and the weakening won. May trade will be reported Friday evening after markets have closed for the weekend. Exports are expected to contract -6.6% y/y while imports are expected to rise 0.5% y/y.

Tensions on the Korean peninsula are likely to remain high. Pyongyang is clearly testing the US with its recent missile tests. The latest news is that Kim Jong-un executed his envoy to the US for the failed February summit in Hanoi. We expect more saber-rattling in the coming weeks.

India Q1 GDP is expected to grow 6.3% y/y vs. 6.6% in Q4. The RBI started an easing cycle this year and is likely to continue cutting rates. CPI rose 2.9% y/y in April, which is in the bottom half of the 2-6% target range. Next policy meeting is June 6 and another 25 bp cut to 5.75% seems likely.