It has been the worst week on US equity markets since — well, only since two weeks ago, but the mood among investors and Wall Street analysts soured notably. Instead of seeing the US-China trade war as a temporary headwind that will end in a deal, more forecasters have set the imposition of higher and more damaging tariffs as their base case. The unease is buttressed by the spectre of softening global growth. Poor economic data in the US this week and downward revisions to gross domestic product forecasts signal trouble ahead.
While “deal or no deal” headlines around trade talks have dominated investors’ attention, the latest economic data are quietly building a picture of weakness.
Two reports this week in particular were disappointing. On Thursday the manufacturing purchasing managers’ index hit its lowest monthly level in nine years, dropping to 50.6, below the consensus expectations of 53, according to IHS Markit data. That still shows an expansion in the manufacturing sector, but only just. A reading below 50 represents a contraction.
And on Friday news of the 2.1 per cent month-on-month contraction in US durable goods orders in April reinforced the dimmer expectations.
JPMorgan Chase on Friday cut its US GDP forecast to 1 per cent for the second quarter from 2.25 per cent, on an annual basis. The Federal Reserve Bank of Atlanta, which runs a model predicting US GDP, now has the second quarter at 1.3 per cent, compared with 1.7 per cent earlier this month.
Commodities markets shiver
The price of copper, a growth-sensitive asset due to its use in manufacturing and construction, has cratered in recent weeks. The S&P Global spot copper index has dropped 9.6 per cent since its mid-April highs, teetering on correction territory. The metal is also sensitive to the Chinese economy, with the country representing half of global demand.
The drop in oil prices dragged down energy stocks in the S&P 500 by 3.4 per cent for the week, making it the worst-performing sector.
Down, down, down
Minutes of the US Federal Reserve’s latest monetary policy meeting, released on Wednesday, showed policymakers did not explicitly discuss cutting interest rates, but there was no sign they wanted to keep raising them either. The market is emphatic: the next move in US rates will be down. Federal fund futures now peg the chances of a rate cut by the end of the year at 78.5 per cent, up from 53.3 per cent at the start of the month.
Investors shifted into the relative safety of US government bonds, sending yields on 10-year Treasury bonds to levels not seen since 2017 — and not far from levels seen in December 2015, before the Fed began to increase its target funding window.
This pain may endure. Bank of America Merrill Lynch analysts dropped their forecast for the yield on 10-year Treasuries to 2.6 per cent, from 3 per cent, citing a shift in expectations over a swift end to the trade dispute and weak inflation data.
“Our year-ahead numbers imply a best-case scenario for a resolution of the US-China trade dispute, which seems unrealistic,” analysts said.
Art of the deal
Investors are following every sound bite and tweet to gauge the shifting likelihood the US and China will soon overcome the trade impasse.
Goldman Sachs analysts maintain the two economic superpowers will agree a deal and unwind the escalating tariff regime, a scenario that would boost US stocks 4 per cent higher. But should a deal fail to emerge, stocks would continue to weaken, said Jan Hatzius, chief economist for the bank.
“Further escalation resulting in tariffs on the remaining $300bn of imports from China would lead to a roughly 4 per cent additional decline in equity prices,” Mr Hatzius said.