The fragile calm that came over markets on Tuesday only reinforced the importance of the renminbi. In the wake of the US Treasury branding China a currency manipulator, the People’s Bank of China set the renminbi at a level that was stronger than markets had expected.
With little sign of trade tension abating between the US and China, markets seem to be at the mercy of the next official announcement, while the bigger picture suggests any kind of detente looks more like a 2020 story, if at all.
Steve Englander at Standard Chartered says naming China as a currency manipulator and referring the matter to the IMF for a year of negotiations “may work politically for the US administration if it is unable to cut a trade deal with China in the coming months”.
That’s not a good backdrop for investors, though. In fact, it suggests that a bigger market rout is required before temperatures cool.
The current pattern of escalation and partial retreat between the US and China also reflects a misplaced view that both countries have scope to keep pushing each other’s buttons. The argument put forward is that the US Federal Reserve and the PBoC have room to ease should economic data deteriorate, while Wall Street and Chinese equities are still holding on to significant gains for the year to date. That leaves the global economy hostage to a growing war of words and retaliatory actions between the US and China.
In turn, markets spanning equities, currencies, commodities and bonds face rolling bouts of higher volatility that only encourages a more defensive posture. In such a climate, expect recoveries in risk sentiment like Tuesday’s to be faded by the market. As seen in previous periods of market turmoil, it takes time for equities to carve out a bottom. For now the FTSE All-World index has halted just above its 200-day moving average (as shown below) as Asia and European equities were unable to steady on Tuesday. But a clean break of that level looks unlikely just yet as the S&P 500 (the largest slice of the All-World index) remains above the important 2,700 area.
Technical analysts at Bank of America Merrill Lynch spell out the stakes for investors:
“The lows from early June and early March at 2,728-2,722, or SPX [S&P 500] 2,700, is the must hold level for the rest of 2019. The reason: A break below this level would invalidate the bullish 2019 vs bullish 2016 and 2012 comparison.”
Playing a pivotal role at the moment is the US dollar, which was mainly steady on Tuesday. Labelling China a currency manipulator (after not doing so back in May via the Treasury’s semi-annual report) highlights the sensitivity of the Trump administration around dollar strength. The Treasury’s action also looks political as China has spent billions of foreign exchange reserves in recent years preventing a weaker renminbi as the greenback has gained ground against all rivals.
Sebastien Galy at Nordea Asset Management thinks Treasury pressure on China is an attempt to stem any rapid weakening of the renminbi and says talk of the Treasury intervening to weaken the dollar misses a key point:
“Contrary to commentary there is little incentive for the United States to intervene in the CNY [renminbi], it would accumulate reserves in Chinese sovereign fixed income and become a prisoner at the time when it is trying to disentangle.”
In this current climate, the threat of dollar-selling by the US is keeping a lid on the reserve currency for now. But a stronger dollar is hardly surprising from here, and Mark McCormick at TD Securities has this telling observation:
“The Trump administration is seeking mutually incompatible outcomes where the focus lies in stealing growth from the rest of the world, but seeking to limit the natural shock absorbers that cushion these blows to the global economy. Higher US stocks and a stronger US dollar simply can’t cohabitate and a weaker global economy fuels a stronger USD.”
Tighter financial conditions via a stronger dollar means a much more aggressive rate-cutting cycle from the Fed is on the way, with the question being when, and not if, there will be another cut should the trade war continue into September. Jay Powell’s “mid-cycle” cut last month was driven by worries over trade and the global economy, so further deterioration on that front means lower yields from here.
As Steve Englander notes:
“Fed easing is likely to be the most effective long-term means of weakening the USD; the US administration’s actions may be in part driven by the desire to add pressure on the Fed.”
Quick Hits — What’s on the markets radar
The Japan playbook is getting an airing — The latest slide in global bond yields — the Australian 10-year briefly dipped below 1 per cent on Tuesday for the first time — is arousing plenty of chatter about developed-world rivals facing a Japan-style fate of stagnant bond yields for the duration. HSBC was the latest bank to knock down its bond yield forecasts this year, as noted here by the FT’s Tommy Stubbington.
Steven Major, HSBC’s global head of fixed income research, notes:
“For bonds, ‘Japanification’ means permanently low yields and curve flattening that extends up the curve from shorter maturities. It also means lower yields elsewhere as trillions of dollars flow to places that offer better returns.”