Markets Calm Even as Trade Tensions Mount

  • The main drivers for global markets remain in play: trade tensions and higher US rates
  • The US moved ahead with its plan to slap 10% tariffs on another $200 bln of Chinese imports next Monday
  • Markets have to start thinking about the inflationary implications of these tariffs
  • The implied yield on the December 2019 Fed Funds contract has shot up this month
  • EM remains under pressure; National Bank of Hungary is expected to keep rates steady at 0.9%

The dollar is mixed against the majors as trade tensions mount.  The dollar bloc is outperforming, while sterling and yen are underperforming.  EM currencies are mostly weaker.  RUB and KRW are outperforming, while TRY and INR are underperforming.  MSCI Asia Pacific was up 0.7%%, with the Nikkei rising 1.4% after returning from holiday.  MSCI EM is flat so far today, with the Shanghai Composite rising 1.8%.  Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year US yield is up 1 bp at 3.0%.  Commodity prices are mixed, with Brent oil up 1.6%, copper down 1.4%, and gold down 0.2%.

The main drivers for global markets remain in play: trade tensions and higher US rates.  The dollar is mixed against the majors but is getting some more traction against the emerging currencies.  Euro is trading near the lows of the day after failing to find a toehold above the $1.17 area.  Same goes for sterling after failing to build on yesterday’s multi-month high near $1.3165.  Dollar/yen is moving and could see an upside out day with a close above yesterday’s high near 112.10.

Global equity markets are surprisingly calm so far today, perhaps because the trade moves had been so well-telegraphed prior.  MSCI Asia Pacific is up 0.7%, with the Nikkei rising 1.4% upon returning from holiday.  The Shanghai Composite rose an outsized 1.8%, while Euro Stoxx 600 is up 0.1% and US futures are pointing to a higher open.

The US moved ahead with its plan to slap 10% tariffs on another $200 bln of Chinese imports next Monday.  As reported, the final list of goods to be targeted excludes some high-end electronics like smart watches.  The US said the tariffs would be increased to 25% effective January 1, to give US businesses more time to adjust their supply chains.

China promised retaliatory measures but gave no further details.  The US has said such measures would trigger tariffs on another $267 bln worth of Chinese imports.  China has also said that it would cancel the next round of trade talks if the US went ahead with another round of tariffs.

Elsewhere, it was reported that US-Japan trade talks would be delayed until after the new Chinese tariffs have been imposed.  They had been scheduled to start this Friday.  Military strategists can attest to the difficulty of fighting a war on two fronts.  By our last count, the US is fighting one on four fronts, as NAFTA remains unsettled and tensions with the EU rise.  We continue to believe that global equity markets remain too sanguine on the risks posed by widespread trade tensions.

Markets have to start thinking about the inflationary implications of these tariffs.  The US has long-enjoyed cheap manufactured imports from China.  A 10% (rising to 25%) tariff will be passed on to consumers to some degree that that will add to the inflationary pressures already present in the US.  Tariffs can pose a bit of a dilemma for monetary policymakers, but we can safely say that the Fed is watching trade developments closely.

Richard Clarida was sworn in yesterday as Federal Reserve Vice Chairman.  It’s worth noting that after Clarida’s confirmation, the Board of Governors still has three vacancies.  Marvin Goodfriend and Michelle Bowman have been nominated to fill two of those vacancies, but a third nominee still needs to be named.  Last week, Mary Daly was chosen by the San Francisco Fed to be its next president.

The implied yield on the December 2019 Fed Funds contract has shot up this month.  It ended August around 2.65% and it’s currently 2.83%.  The market has basically priced in a second hike next year and is on its way to pricing in a third.  The next big potential event for markets is if (when?) the Fed or the markets start thinking about a fourth hike in 2019 vs. the three currently in its Dot Plots.

Ongoing trade tensions and rising US rates are a negative backdrop for EM.  MSCI EM bounced last week after setting a new cycle low just below 1000.  We expect to revisit that low on the way to a test of the April 2017 low near 951.

RBA minutes were released overnight.  The bank warned of negative risks from US-China trade tensions, adding that there was “no strong case” for a near-term rate hike.  However, it noted that growth is likely to remain above potential even as unemployment falls and wage growth picks up.  For now, the central bank is showing no urgency to start the tightening cycle.  Next policy meeting is October 2, and rates are likely to be kept steady at 1.50%.

Canada reports July manufacturing sales, which are expected to rise 0.6% m/m.  This is an eventful data week for Canada, with August CPI and July retail sales to be reported Friday.  With the economy remaining robust, markets are looking for another 25 bp rate hike to 1.75% on October 24.

US reports July TIC data.  This is typically not a market-moving report.  However, the data is likely to show that net foreign inflows to the US remain as strong as ever.

EM remains under pressure.  TRY has weakened three straight days after rallying on the central bank’s hawkish surprise last Thursday.  The lira has basically given up its post-hike gains and given the absence of any other significant measure, it is likely to revisit its lows in the coming weeks.

National Bank of Hungary is expected to keep rates steady at 0.9%.  CPI rose 3.4% y/y in both July and August.  While this is the highest since January 2013, inflation remains within the 2-4% target range.  As long as the forint remains relatively firm, the central bank is likely to retain its ultra-dovish stance.