Trade Specificities Rattle Markets

Newspaper with computer on table

  • Late yesterday, the US announced that specific tariffs and goods that would be targeted for intellectual property violations
  • China had warned of a commensurate response and earlier today made its announcement
  • Australia reported stronger than expected retail sales but a larger decline in building approvals
  • Eurozone March CPI rose 1.4% y/y vs. a revised 1.1% in February (originally 1.2%)
  • BRL underperformance is getting some attention; Poland March CPI rose 1.3% y/y vs. 1.7% expected
  • Bangladesh and Sri Lanka central banks both cut rates unexpectedly



The dollar is mixed against the majors as trade tensions roil markets. The yen and Kiwi are outperforming, while Aussie and Nokkie are underperforming. EM currencies are broadly weaker. HUF and CZK are outperforming, while ZAR and TRY are underperforming. MSCI Asia Pacific was down 0.6%, with the Nikkei rising 0.1%. MSCI EM is down 1.7% on the day, with the Shanghai Composite falling 0.2%. Euro Stoxx 600 is down 0.9% near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 3 bp at 2.75%. Commodity prices are mostly lower, with oil down nearly 2%, copper down 2%, and gold up 0.9%.

Late yesterday, the US announced that specific tariffs and goods that would be targeted for intellectual property violations. China had warned of a commensurate response and earlier today made its announcement. This sent reverberations through the capital markets, driving down equities as well as corn and soybean prices (subject to Chinese tariffs). The US dollar was sold, especially against the yen, euro, and sterling.   The dollar-bloc currencies lagged.

There has been a low level but persistent US-China trade tensions for years, though we would quickly add that the same can be said about Canada. One of the most consistent themes of the Trump Administration is reducing the US trade imbalance. Another consistent theme is doubts about the salience of “international community,” and the need for the US to defend its national interests. From these two themes arises the unilateral trade actions.

In recent discussions in China, we were struck by how many people cited what was happening in the US as reason why it is understandable that the PRC lifted the term limits for the head of state. To be sure, the Chinese president is also head of the military and head of the Party and both those positions are without term limits. By carrot and stick, the US cajoled the formation of multilateral trade mechanism and the rule-of-law.

It may not have been ideal, and it was a work in progress. The ease with which a new administration could reverse course throws many off balance. China is taking many long-term strategic initiatives, of which the One Belt One Road and Made in China 2025 are but the highest profile examples. It cannot, many people suggest, take the chance and see the strategy upended because of some arbitrary time.

The focus shifts back to the US. The billion-dollar question is whether the US initiates counter-retaliatory measures. If the US does, it would seem to be a clear escalation. Currently, the US provocations have escalated the chronic low-level tension. China took small steps in response to the US actions on washing machines, solar panels, steel, and aluminum. Now, in response to the tariffs for intellectual property violations, it has ratcheted up its response.

While there may be a disapproval of the US unilateral actions, which could violate the WTO rules, there also seems to be wide criticism of China’s trade practices. There was a chance to present a united front. It is a lost opportunity for American leadership. Turning the challenge of integrating China into the world economy into a bilateral affair seems to be the least friendly for the investment climate.

The end of the low vol period in stocks ended with a bang in late January and early February, even before trade tensions were escalated. However, it now is one of the factors preventing investors from finding terra firma. Yesterday’s stronger than expected US auto sales suggests the world’s biggest economy is recovering from a soft patch at the start of the year. Fed Governor Brainard’s comments provide additional encouragement to look past the volatility and high frequency data noise. The bar for the Fed not to hike rates in June is quite high. That said, note that while tariffs are supposed to lift prices, corn and soybean futures fell by around 3% on China’s announcement.

Outside of trade, there were a couple of developments to note. First, Australia reported stronger than expected retail sales but a larger decline in building approvals. Retail sales rose 0.6% in February after a revised 0.2% gain in January (was 0.1%). Grains were broadly distributed over the various categories. February building approvals fell 6.2%. The Bloomberg median forecast was for a 5.0% decline. What was at stake was the slowing after the incredibly strong January surge of 17.2%.

The Australian dollar rallied on the news and reached almost $0.7720, but the trade tensions eventually weighed. It recorded the session low in early Europe near $0.7665. The Aussie remain in the trough and not far from the year’s low (~$0.7645) seen a week ago.

Second, the eurozone reported March CPI rose to 1.4% y/y from a revised 1.1% in February (originally 1.2%). The core rate was, disappointingly, unchanged at 1.0%. Many had expected it to tick up to 1.1%, not that that would make a big difference. Separately, the unemployment rate slipped to 8.5% from 8.6% in January. Today’s reports are close enough to expectations that views on the ECB are unlikely to change. The euro itself remains confined a trading range since mid-January (narrow $1.22-$1.24, broader $1.2155-$1.2555).

While trade issues and the equity market drop are going to dominate investors’ focus today, there is a slew of US economic data. The highlights include the ADP private sector estimate (anything north of 200k is good), non-manufacturing PMI and ISM (both are expected to be little changed), and factory orders (a recovery after a 1.4% drop in January).

BRL underperformance is getting some attention. Our view is that BRL has been underperforming markedly because the central bank got unexpectedly dovish last month ahead of an expected period of heightened political risk. The bank is trying to push rates down too much, with markets looking for another 25 bp cut to 6.25% on May 16. With the local curve undergoing a bearish steepening, the markets clearly do not like BCB’s dovish tilt. Given today’s EM FX price action, USD/BRL should open above 3.35 to make a new high for this move, which would then target the May 2017 high near 3.41.

Poland March CPI rose 1.3% y/y vs. 1.7% expected and 1.4% in February. Inflation fell further below the 1.5-3.5% target range and this should allow the central bank to remain on hold this year. We are skeptical that it can keep rates steady in 2019, as central bankers are signaling to the markets. Next policy meeting is April 11, rates are likely to be kept at 1.5% then.

Bangladesh and Sri Lanka central banks both cut rates unexpectedly. Bangladesh Bank cut its repo rate 75 bp to 6.0%, while the Sri Lanka Central Bank cut its standing lending rate 25 bp to 8.5%. Both moves were in response to falling inflation and sluggish growth. While both currencies are heavily managed, the moves are a bit risky as broader EM FX comes under greater pressure. We will write a more in-depth report on both moves later today.