Trade Tensions and Approaching Quarter-End Cast Pall Over Markets

Trade war between USA and China

  • The global capital markets have stabilized today after yesterday’s rout in equities, softer yields, and US dollar strength
  • Last week in Sintra, there was nearly universal agreement among central bankers that the escalating trade tensions posed risks to the economic outlook
  • The North American data stream is light
  • The Mexican peso was already rallying yesterday when Navarro comments hit the tape; this is a busy week for Brazil

The dollar is broadly firmer against the majors.  The yen and Swissie are outperforming while Kiwi and euro are underperforming.  EM currencies are broadly weaker.  KRW and SGD are outperforming, while CNY and MXN are underperforming.  MSCI Asia Pacific fell 0.1%, with the Nikkei flat.  MSCI EM is down 0.4% so far today, with the Shanghai Composite falling 0.5%.  Euro Stoxx 600 is up 0.3% near midday, while US futures are pointing to a higher open.  The 10-year US yield is down 1 bp at 2.88%.  Commodity prices are mixed, with Brent oil up 0.3%, copper down 0.1%, and gold down 0.7%.

The global capital markets have stabilized today after yesterday’s rout in equities, softer yields, and US dollar strength.  The implementation of US tariffs on China and China’s retaliatory tariffs on the US are still ten days off.  The immediate focus is on actions expected to curb the technology transfer.

However, there have been conflicting signals over the intent.  Treasury Secretary Mnuchin, who is seen as one of the remaining voices that try to minimize or soften the administration’s conflict with, well, the world, sought to broaden the actions on intellectual property, by downplaying that it is aimed at China.  Navarro, head of the National Trade Council, has pushed aside Mnuchin’s comments and reaffirmed that the Section 301 investigation was about China.

Last week in Sintra, there was nearly universal agreement among central bankers that the escalating trade tensions posed risks to the economic outlook.  This assessment resonates among investors as many, like ourselves, are watching late-cycle data accumulate in the US, Europe, and Japan.  The large fiscal stimulus that is in the pipeline in the US, and the relatively closed nature of the US economy (exports plus imports as a percentage of GDP), leaves the world’s largest economy in a better position to weather the storm.  However, as has repeatedly been experienced, American prosperity is limited if large parts of the world economy are under duress.

Equity markets have steadier today, though quarter-end adjustments continue.  Japanese equities rose fractionally, and those bourses that opened later tended to do better.  China’s Shanghai Composite, the Hang Seng, an index H-shares that trade in HK, Korea, and Taiwan markets extended their declines.  The MSCI Asia Pacific Index fell nearly 1% initially before recovering to close less than 0.1% lower.  It was near the high of the session, barely back in yesterday’s range.

European bourses are mostly edging higher in quiet turnover.  The Dow Jones Stoxx 600 is up about 0.3%, led by utilities, information technology, and materials.  Telecom and health care are laggards.  Italy’s bourse is outperforming and with its nearly 0.8% gain, today it pushes the DAX to the bottom of the major markets over the past five sessions with almost a 3% loss.  However, in the fixed income side, Italian bonds are softening in line with other peripheral bond markets, with a 2-3 bp increase in yields.  Greek bonds stand out.  They are rallying in the aftermath of S&P’s decision to boost the country’s credit rating one notch to B+ and change the outlook to stable from positive.

US stocks are little changed after yesterday’s slide.  The Dow Jones Industrials closed below the 200-day moving average for the first time in two years.  The S&P 500 gapped lower yesterday, and that gap has added significance because the gap was below last week’s low.  The gap was also below the uptrend line drawn off the early and late May lows and last week’s lows.  The gap, found between 2742.9 and 2752.7, is likely to be an important area to watch.  We suspect that with corporate share buybacks likely entering the quiet period ahead of earnings, and concerns about the impact of trade tensions, may turn investors cautious, especially given the inflows into US equity funds in Q2.

Yesterday’s dollar losses are being pared, though they were initially extended in Asia.  The Dollar Index is trying to snap a three-day slide and found support ahead of the 61.8% retracement of the ECB-induced rally from June 14.  That retracement is just above 94.10.  A move above 95.00 would lift the tone.

The similar retracement in the euro is found at $1.1720, the single currency’s session high.  Initial support is seen near $1.1640.  There are several large options expires today beginning with 1.5 bln euros at $1.1650.  An expiring option struck at $1.1690 is for 1.8 bln euros and another 2,9 bln euros at $1.1625.  Meanwhile, Merkel is still seeking consensus at the European Council later this week.  Both immigration and EU reform are divisive issues.  At the same time, German Interior Minister and head of the CSU in Bavaria played down the risks to the alliance with Merkel’s CDU.

The dollar held yesterday’s low against the yen, a little below JPY109.40.  It is near the highs of the session (~JPY109.80) near midday in London.  There are also large option expirations today, featuring $1 bln at JPY109.60 and $1.1 bln struck at JPY110.00.

Sterling is threatening to take the dubious honor of being the weakest currency of the day from the New Zealand dollar.  In a note from a fortnight ago, the RBNZ indicated policy was on hold for a considerable period, and the currency is still elevated.  The results of this week’s RBNZ meeting will be known early Thursday in Wellington (late Wednesday in the US).  The New Zealand dollar appears headed to retest last week’s low near $0.6825.

The BOE’s McCafferty, a dissenting hawk, sticks to his knitting in what may be his last remarks before stepping down.  McCafferty warns that the UK economy may be rebounding and sees a significant risk that inflation stays above its target.  Haskel, who will replace him, agrees there is little scope for lower rates but identifies potential slack in the labor market.  Haskel identifies his views as consistent with the BOE’s broad direction of interest rates – a modest rise is needed in the medium term.  There is no discussion of the immediate term and the outlook for the August 2 MPC meeting (Haskel will not vote) where the market has discounted a nearly 70% chance of a hike.  It had dipped below 50% before last week’s hawkish hold.

At roughly $1.3210, sterling retraced 50% of the rally spurred by the BOE.  It has traded on both sides of yesterday’s range.  A close below $1.3220, yesterday’s low would be a poor sign.  The 61.8% retracement is found a little below $1.3185.  The Canadian dollar is trading quietly inside yesterday’s range.  The Australian dollar has slipped through yesterday’s lows but may find support ahead of $0.7375.

The North American data stream is light.  The US reports include house prices, Richmond Fed survey, and the Conference Board’s consumer confidence measures. The Fed’s Bostic and Kaplan speak in the afternoon (ET).

The Mexican peso was already rallying yesterday when Navarro comments hit the tape.  That gave the peso another boost but the move ran out of steam near 19.88.  This is near the 38% retracement objective near 19.81 of the April-June rise in USD/MXN.  We don’t think USD/MXN has any business trading below 20 (much less 21) ahead of the July 1 elections and in light of NAFTA talks going nowhere fast.

This is a busy week for Brazil.  COPOM minutes will be released today, while the central bank will release its quarterly inflation report Thursday.  Both will be closely studied but our base case is that COPOM hikes rates 50 bp at the next meeting August 1.  Central government budget data for May will be reported that day too, and a -BRL9.2 bln primary deficit is expected.  Consolidated budget data will be reported Friday, and a -BRL10 bln primary deficit is expected.  If the real continues to weaken, the FX losses from the swaps will start showing up more in the budget data.