Risk appetite requires tariff rollbacks


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Markets are sending one clear message at the moment: rolling back tariffs as part of any China-US trade deal is essential for sustaining risk appetite. But whether Donald Trump, the self-styled Tariff Man, and his negotiating team are willing to adopt such a course is a renewed point of conjecture. 

As it stands, the US has levied a 25 per cent tariff on $250bn of Chinese imports and 15 per cent tariffs on an additional $112bn of imports. At stake is the threat of new 15 per cent tariffs on another $156bn of Chinese products in December. 

Reports during the New York afternoon that trade negotiations were at an impasse over China’s purchases of US agriculture products and unresolved technology transfers, briefly clipped Wall Street. The S&P 500 ultimately edged into record territory, up 0.1 per cent at 3,094.04.

Expectations of the White House rolling back tariffs and delaying action against introducing levies on European cars entering the US has supported equity markets of late. Looking at the Stoxx Europe 600 index, which has bounced 7.5 per cent from its early-October nadir, its auto and parts sector has more than doubled that pace, up nearly 16 per cent over the same period (for context, the sector is up 10 per cent over the past 12 months).

Wednesday’s jittery trading sparked a drop of 2.1 per cent for the Stoxx autos and parts sector, before its losses were trimmed to a 1.2 per cent fall. Performing worse, however, were European banks that slipped 2 per cent, yet again highlighting the close relationship of financial stocks with government bond yields.

A corrective tone to Wednesday’s trading was not unexpected given the sharp run higher for equities and bond yields of late, but with the US president defending his protectionist policies and public impeachment proceedings starting in Washington (which only becomes an issue for markets should Senate Republicans shift against Mr Trump), there is a sense of a bumpy road ahead before a trade detente is a reality. 

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Wednesday’s risk aversion also reflects the grim tidings from Hong Kong — these observations from the FT’s Jamil Anderlini are certainly worth reading. As a one-time resident of Hong Kong many years ago, the current situation hits hard. Closed schools and shuttered 7-Eleven stores are not good signs. 

Pointedly, the 10-year US Treasury note yield dipped below 1.90 per cent on Wednesday, leaving a test of 2 per cent and beyond further adrift for now. A mixed consumer price inflation report for October (see Quick Hits) left the focus of the bond market on Jay Powell and his remarks before the Joint Economic Committee of Congress in Washington.

The Fed chair noted in his prepared speech that “sluggish growth abroad and trade developments have weighed on the economy and pose ongoing risks”. As expected, he also indicated that the policy pause was set to continue. It was all pretty much the party line from last month’s Fed gathering and Mr Powell’s previous press conference. Indeed, in terms of not moving markets, Mr Powell’s question-and-answer session with lawmakers passed with flying colours. There were minimal changes across bonds, equities and the dollar.

Given the broader focus of markets on trade, that was not surprising. But during the course of Mr Powell’s speech, he noted that “the current low interest rate environment may limit the ability of monetary policy to support the economy”. Mr Powell also made this point:

“In a downturn, it would also be important for fiscal policy to support the economy. However, as noted in the Congressional Budget Office’s recent long-term budget outlook, the federal budget is on an unsustainable path, with high and rising debt.”

Chatter about the prospects of fiscal stimulus has picked up in Japan and Europe, pushing up global yields at the margins as hopes of trade progress and a bounce in business spending have been bigger drivers. Some doubt yields are set for a pronounced climb. 

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Steven Ricchiuto at Mizuho Securities believes a weakening global economy “shows no signs of having hit bottom” and adds:

“Global excess supply conditions are seen deteriorating further, while the recent firming of the dollar increases the risk of deflationary pressure being imported.”

Mizuho expects a renewed flattening of the yield curve, whereby the difference between short- and long-dated Treasury yields narrows, a signal of weaker growth and slack inflation. 

Such an outcome would not please recent buyers of the “value” and “cyclical” share trade, as the revival of these equity sectors has mirrored steeper yield curves in developed-world bond markets. Some do argue, of course, that the recent steepening has simply reflected expectations of growth picking up, rather than any firm evidence. The Fed’s purchase of Treasury bills has pumped more liquidity into the financial system, while the European Central Bank has resumed bond buying this month, an important fillip for broader risk appetite. 

Steven says a steeper Treasury yield curve does beckon should the Fed expand its current purchases of Treasury bills. He writes:

“A sustainable curve steepening is not seen as a credible scenario unless the Fed expands its purchase program beyond bills into short coupons, and embraces the balance sheet as its primary policy tool.”

An outcome of much weaker US growth in 2020 means Mr Powell’s description of T- bill purchases as not representing “a change in the stance of monetary policy” will fade quickly as during an election year, fiscal stimulus looks tough to pass. That leaves the Fed and monetary policy the only lever in town. Plus ça change.

Quick Hits — What’s on the markets radar

US inflation data surprised to the upside on a monthly headline basis, arriving at 0.4 per cent in October versus a forecast rise of 0. 3 per cent, driven by higher energy and medical care prices. The core measure, which excludes food and energy prices, dipped for the year to a 2.3 per cent pace, from 2.4 per cent, as rental costs eased. The annual rate for core CPI sits above the Fed’s measure, the Personal Consumption Expenditure core rate of 1.65 per cent. The core annual PCE measure has been stuck below 2 per cent, (the Fed’s target) since October of 2018. 

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Chris Rupkey at MUFG writes:

“The biggest discrepancy remains the measurement of medical care services where CPI says these are up 5.1% in October from year-ago levels versus PCE inflation medical services that are up just 2.1% in September from year-earlier levels.”

And as Jon Hill at BMO Capital Markets notes:

“One of the ironies of all the consternation around the Fed’s inflation mandate is that had they chosen core CPI as their target, they would now have been at or above [the 2 per cent target] for 20 straight months.”

From a Treasury market perspective, US inflation expectations for the next decade have been below 2 per cent for the past year, (having peaked at 2.20 per cent in May 2018, the high during the Trump administration). At just under 1.70 per cent on Wednesday, (up from 1.47 per cent a month ago) market expectations for inflation are stuck in the middle of their medium-term range, given the early 2016 low of 1.2 per cent. 

Eurozone economic data took a small step in the right direction on Wednesday as industrial output surprised to the upside (up 0.1 per cent in September versus a forecast drop of 0.2 per cent), buoyed by domestic consumer goods demand. But as the chart below reveals, export-dependent capital goods remain in the basement.

The best that can be said is that Europe’s manufacturing malaise is abating, but a rebound remains an open question.

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.





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