The Fed’s rate cut was supposed to boost markets and slam the dollar… it didn’t quite work out that way.
One day after stocks tumbled when Powell disappointed markets with his hawkish cut – the biggest plunge for stocks on a rate cut day since the memorable 1987 – global markets swooned as a wave of selling swept across the world, as panicked traders dumped stocks on fears that trade war between the US and China is about to escalate. Add to this a fresh trade war between Japan and South Korea, and a Trump announcement on EU trade at 1:45pm which will hang over markets, and it becomes obvious why world markets are a sea of red.
Meanwhile, safe havens such as bonds and the yen jumped in the wake of President Donald Trump’s move to escalate the trade war when he vowed to impose a 10% tariff on $300 billion of Chinese imports from Sept. 1, escalating a bruising and protracted trade war between the world’s two biggest economies, while China pledged “countermeasures” if the U.S. steps up tariffs on its goods.Trump’s New Tariffs Will Be Damaging to U.S. Consumer, Says Cazenove’s Mui
“The question for investors is whether this is the first step in a series of escalations or a negotiating stance that will compel China to make concessions and the Fed to ease,” said Steve Englander, global head of FX research at Standard Chartered Bank. “If the president can elicit concessions from both China and the Fed, it would be a double win from his perspective.”
Trump’s announcement, which came a day after U.S. and Chinese negotiators concluded a meeting in Shanghai without much progress, marks an end to a trade truce struck in June and could further disrupt global supply chains.
“The combination of the Fed delivering a cut but not really what the market expected or wanted has tightened financial conditions, and may be partly the reason why Trump has gone for this escalation,” said Gerry Fowler, investment director at Aberdeen Standard Investments. “It is not good for what was already weak business sentiment.”
The carnage was focused on equities, with European stocks tumbling 2% led by automakers and miners, posting their biggest drop of 2019 on Friday …
… as the trade-sensitive DAX and France’s CAC 40 dropped 2.7%, the former hitting a fresh two-month lows.
German bond yields hitting record lows of -0.503% and the entire German curve now trading below 0% with the German 30Y dropping below zero for the first time ever.
MSCI’s index of world stocks dropped 0.6% as Asian bourses nursed heavy losses. The MSCI Asia Pacific Index dropped as much as 1.6%, extending its selloff to a third day. While Japan’s Topix Index fell 2.2% after the country decided to remove South Korea from a list of trusted export destinations, Korea’s benchmark pared earlier losses and closed 1% lower. The Hang Seng Index dropped to an almost two-month low as technology stocks tumbled. Materials and energy were the worst-performing sectors in the region, after crude prices had the steepest one-day drop in more than four years on Thursday.
The US was spared much of the brunt with S&P futures pointing to just a modest 0.3% lower open. On Thursday, the S&P 500 skidded 0.9% to hit one-month lows overnight.
Emerging-market stocks fell for an eighth day, the longest losing streak since December 2015, as new U.S. tariffs on Chinese imports raised the temperature in the trade war after the Federal Reserve’s hawkish cut already sapped demand for high-yielding assets.
Ahead of the July employment report to be released at 8:30am ET, Treasury yields are near multi-year lows reached Thursday after U.S. President Donald Trump announced additional tariffs on Chinese imports. Even before the latest declines, a survey by BMO found strong inclination to buy any dip in prices caused by the jobs report. The release of the June U.S. jobs report spurred a sell-off in Treasuries. Four of the previous five had a fleeting impact on the market. Median survey estimates for the July jobs report include nonfarm payrolls gain of 165k, 3.6% jobless rate and a 0.2% month-on-month increase in average hourly earnings
Not surprisingly, core euro zone bond yields tumbled, with German 10-year government bond yields dropping more than three basis points to an all-time low of -0.529% while the 30Y dropped below zero for the first time ever. That tracked the drop in 10-year U.S. Treasuries yields to 1.832% – the lowest since Nov. 8, 2016, the day Trump was elected president.
Trump’s strategic move may force the Federal Reserve to cut interest rates again – just as Trump intended – to protect the U.S. economy from trade-policy risks after its first rate cut in more than a decade on Wednesday. The October Fed funds rate futures have jumped to now fully price in a rate cut in September, compared with only around 60% before the tariff announcement. Another 25 basis point move is priced in by December.
“In the grand scheme of things, it will become clearer and clearer that the Federal Reserve has started an easing cycle and will have no choice but to cut rates further,” said Akira Takei, fund manager at Asset Management One.
While China has yet to offer details on what measures it would take, the sudden escalation of the trade war has put markets in a spin in an already action-packed week. The developments come after the Federal Reserve chief cast doubt about a long cycle of interest-rate cuts, provoking the president’s ire and disappointing many investors. The monthly U.S. jobs report will be the next big event later Friday, and while the market has priced in more trade cuts it is unprepared for an especially strong report, which will likely take place due to a surge in census hiring.
Meanwhile, as we wait for China to start dumping bonds, Japan’s cabinet approved removing South Korea from its export white list and Industry Minister Seko said they ready to talk only after South Korea corrects its statement regarding July meeting. It was also reported that BoK Governor Lee was to hold a meeting with officials and South Korean President Moon to chair a cabinet meeting following Japan’s decision to remove South Korea from its white list. Subsequently, South Korea have stated they will remove Japan from their White List as well. South Korea’s Deputy National Security Advisor states that Japan has generated obstacles in the way of achieving peace on the Korean peninsula, will review whether to maintain agreement on military intelligence sharing.
Oh, and just in case there wasn’t enough going on, the White House schedule for US President Trump showed that an announcement regarding EU trade is scheduled today at 1845BST, while reports later stated that US President Trump is to formally announce a deal to open up EU to more beef exports, according to sources familiar with the plans
In geopolitical news, North Korea conducted further short-range projectile launches early on Friday, which reports stated appeared to be a new type of missile.
In currency markets, the Bloomberg Dollar Spot Index was up for a third week; the gauge reached a two-month high Thursday, having gained 1.3% since July 12. The safe-haven Japanese yen surged to a five-week high against the dollar and soared to a 2-1/2-year peak against the pound. The euro recovered to $1.1099, from a two-year low of $1.1027 hit in U.S. trade. The British pound held near a 30-month low versus the dollar as the ruling Conservatives’ majority in parliament was reduced to one seat, adding to concern over politics three months before the country is due to leave the European Union. Sterling was last 0.1% lower on the day at $1.2116. China’s onshore yuan slumped to its lowest since November 2018, falling some 0.7% to 6.9428 per dollar. In the offshore market, the yuan fell to as low as 6.9778.
In commodity markets, gold dropped slightly to $1,435.46 per ounce after rising 2.3% on Thursday, near a six-year high of $1,453 touched two weeks ago. Oil prices bounced back after suffering a sharp, 7% selloff on Thursday, its biggest daily percentage drop since February 2016. U.S. West Texas Intermediate (WTI) crude rebounded 1.9% to $54.96, having shed 7.9% the previous day.
Exxon, Ferrari and Sprint are among companies reporting earnings
Top Overnight News from Bloomberg
Asian equity markets traded lower across the board with global risk sentiment spooked after US President Trump upped the pressure on China by announcing a 10% tariff on the remaining USD 300bln of Chinese goods to the US beginning September 1st. ASX 200 (-0.3%) was subdued with hefty losses seen in the energy sector after crude prices dropped over 7% the prior day and with broad weakness across mining names aside from gold stocks after the precious metal was boosted by safe-haven demand, while Nikkei 225 (-2.1%) was dragged lower by a firmer currency, soft earnings and as regional bilateral relations further deteriorated after Japan approved the removal of South Korea from its white list of preferred trading partners. Elsewhere, Hang Seng (-2.4%) and Shanghai Comp. (-1.4%) conformed to the washout across stocks following Trump’s tariff announcement in which he said he is taxing China until a deal can be reached and suggested that tariffs could be raised to 25%. Finally, 10yr JGBs were higher and notched their biggest gain since early January as they tracked the upside in global bonds due to safe-haven demand and with the BoJ present in the market for longer-dated bonds.
Top Asian News
European equities are submerged in a sea of red [Eurostoxx 50 -2.5%] and have extended on opening losses as the region succumbs the global risk sentiment following US President Trump’s latest tariff threat, which would see USD 300bln worth of Chinese goods taxed at 10% from September 1st. Major EU bourses are currently lower in excess of 2% with France’s CAC (-2.7%) one of the worst hit due to its broader exposure to trade-sensitive stocks, i.e. autos, chip names, materials and luxury goods. Sectors are firmly in negative territory with material names lagging as the sector bears the brunt of plummeting base metal prices, whilst IT and consumer discretionary follow closely. Defensive sectors fare slightly better as investors flock to the “safer” stocks , i.e. healthcare, utilities and consumer staples. Some notable trade-related movers include Infineon (-6.9%), STMicroelectronics (-6.0%), Arcelormittal (-5.0%), Hugo Boss (-6.0%), LVMH (-3.5%) and Fiat Chrysler (-3.5%). Elsewhere, RBS (-6.2%) is hit post-earnings after the bank stated that it is unlikely to meet its 2020 ROTE goal, whilst Pirelli (-5.1%) became the second EU tire name to slash guidance this quarter.
Top European News
In FX, the clear outperformers amidst a sharp deterioration in risk sentiment on another flare up in US-China trade tensions, as President Trump follows through on additional tariff threats with a date set for at least 10% to be levied against the remaining Usd300 bn goods. Unsurprisingly, Beijing has responded in kind with the ‘promise’ of countermeasures and the Yen has extended gains vs the Dollar through 107.00 and beyond 1 bn expiry options at the round number, while the Franc is back above 0.9900 and testing 1.0950 against the Euro following weaker than forecast Swiss CPI and manufacturing PMI prints that could well arouse SNB interest. However, the Buck is forging gains elsewhere and just enough on balance to keep the DXY afloat between 97.147-45 parameters awaiting US jobs data.
In commodities, the oil complex is posting a mild recovery following the prior day’s 7% sell-off in which a bout of risk aversion and global growth concerns resurfaced following President Trump’s announcement of fresh China tariffs and a potential levy hike. WTI futures found a base at 54/bbl while its Brent counterpart tested support at 60.00/bbl with both benchmarks currently just above 55/bbl and 62/bbl. Elsewhere, gold has eased off highs following its Trump-induced rally which saw the safe haven print a peak of around 1449/oz before stabilising sub-1440/oz. Meanwhile, copper plunged to a 3-week low to below 2.6/lb on the tariff threats as the red metal followed suit with the global risk sentiment and the prospect of lower demand. Finally, Dalian iron ore futures slid over 4% and is on course to notch its second consecutive weekly loss amid demand woes (from US-China trade developments) and oversupply concerns after Brazil announced a rebound in exports in July.
US Event Calendar
DB’s Jim Reid concludes the overnight wrap
If you thought it was now safe to pack your bags and go off on holiday with the FOMC out of the way, in the knowledge that you’ll be leaving behind quiet markets, then you may want to think again. A surprise tariff announcement from President Trump after Europe went home last night has changed the tone for August and ironically done far more for dovish rate expectations than the Fed managed the day before. However it comes at a time of fragility in the global data, an increasing risk of a hard Brexit, a worryingly flat US yield curve, collapsing yields and a US equity market that was ignoring all the risks and only 0.54% off the all-time highs just before the Trump tweet. An interesting set up for today’s payrolls and indeed for August – a month where through history volatility often disproportionately picks up on bad news.
In more detail, Trump tweeted that he will implement new tariffs of 10% on the remaining $300bn of imports from China, effective September 1st. As a reminder, that’s on top of the 25% on around $250bn of other imports, with Trump having previously deferred the implementation of this list of tariffs after meeting with President Xi at the G-20 in June. Trump specifically said that Xi has not followed through on his promises, by not increasing purchases of US agricultural goods nor stopping the flow of Fentanyl, a synthetic opioid, into the US. He also said, “Until such time that there is a deal, we will be taxing the hell out of China.”
US equities saw a significant reversal on the news, with the S&P 500 down -1.99% from its earlier high after it had nearly recouped the post-FOMC losses. The moves in the NASDAQ and DOW were even steeper, down -2.41% and -2.18%, respectively from the highs. The S&P 500, NASDAQ, and DOW ultimately ended -0.90% , -0.79%, and -1.05% on the session. When asked after the close what he thought about the negative market reaction to his tariffs, Trump said he’s “not concerned at all,” and added that if China doesn’t “want to trade with US anymore, that would be fine with me,” and suggested that the tariff rate could rise further. He also said the new tariffs will be “short-term” which is a bit difficult to read. His series of earlier tweets did include one that said “We look forward to continuing our positive dialogue with China on a comprehensive Trade Deal, and feel that the future between our two countries will be a very bright one!” So he is leaving the door open for a more positive solution but everything is very uncertain and confusing at the moment and global business confidence could have done without this. We’ll await a China’s response. Typically they have been proportionate.
Sectorally, the energy sector dropped -2.28% after WTI fell -6.98% for its worst session since November, down to a 6-week low of $54.51. Bank stocks (-3.40%) also underperformed, as the moves in fixed income were pretty severe. 10-year yields ended -12.6bps lower at their lowest level since election day 2016 at 1.8969%. Two-year yields dropped even more steeply, down -13.6bps, helping the curve to steepen back +1.0bp to 15.0bps. On the other hand, the Fed’s preferred curve metric, the 18m forward 3m versus spot 3m, flattened -21.7bps, its sharpest drop since March 2009.
One way to interpret the price action in fixed income is that the market moved to price in much higher odds for near-term accommodation from the Fed. Indeed, the fed funds futures curve went from pricing a 60% chance of a rate cut in September to assigning around 94% odds. Through year-end, the market now implies 49bps of cuts from here, up +15bps from Wednesday’s close after Powell. The implications for the dollar are a bit more nuanced, as the greenback weakened against developed market currencies as a result of higher Fed easing odds, but it strengthened +0.62% versus the offshore yuan, leaving the overall dollar index close to flat.
The selloff was exacerbated as major asset classes had spent the morning retracing their post-Fed moves. Equities and front-end rates had pared their moves and were back to right around their pre-Fed levels. The dollar had pared around 75% of its post-Powell rally as well. Partially those reassessments were driven by a soft but nowhere near as bad as feared ISM manufacturing report earlier in the day. The headline index came in at 51.2, down -0.5pts, but better than many expected after the terrible Chicago PMI the day before. The forward-looking new orders index rose +0.8pts to 50.8, while the prices paid index fell -2.8pts to 45.1, its lowest since February 2016. Separately and as expected, the US Senate passed the recently-negotiated spending bill which will raise the budget caps for the next two years and suspend the debt ceiling until July 2021 as well. President Trump is expected to sign the bill into law soon.
Overnight, the trade headlines have continued to dominate with China’s Foreign Minister Wang Yi suggesting that the new tariffs were definitely not the correct, constructive way to resolve trade friction. Meanwhile, Trump is also expected to make an announcement on EU trade today in Washington at 1:45pm local time (06:45pm London time). So hold onto your hats for that one. Elsewhere, Japan has decided to remove South Korea from a so-called “white list” of countries that benefit from less stringent trade checks and said the removal will take effect on August 28. South Korea had urged Japan not to go ahead with the change, saying it would have grave consequences and prompt a rethink of security cooperation. South Korea’s President Moon Jae-in called for an emergency cabinet meeting shortly after the decision was announced and Bank of Korea Governor Lee Ju-yeol plans a meeting at 2 p.m. local time to discuss the impact of Japan’s decision. South Korea’s electronics giants Samsung (c. -2%) and SK Hynix (c. -3%) have declined on the news. So we are likely to end the week with trade tensions remaining at the fore.
Asian markets are trading in a sea of red this morning with the Nikkei (-2.48%), Hang Seng (-2.37%), Shanghai Comp (-1.68%) and Kospi (-0.84%) all down. We have also seen some big moves in Asian FX this morning, with the Japanese yen being up +0.28% while the Chinese onshore yuan is down to its lowest level since November at 6.9346 (-0.52% this morning). The Taiwan dollar (-0.59%), South Korean won (-0.62%) and Indonesian rupee (-0.80%) have also seen declines. Elsewhere, futures on the S&P 500 are down -0.24% while those on Nasdaq are down -0.35%.
In other overnight news, President Trump labeled recent protests in Hong Kong as “riots,” adopting the language used by Chinese authorities and suggested that the US would stay out of an issue that was “between Hong Kong and China.” Elsewhere, North Korea has again launched unidentified projectiles into its eastern sea this morning after the country skipped a chance at talks with US Secretary of State Michael Pompeo.
Back to yesterday and Sterling fell -0.18% (-0.21% this morning) to a fresh two-and-half year low against the dollar yesterday as the Bank of England’s Monetary Policy Committee voted unanimously to leave interest rates unchanged. The Bank’s statement said that “global trade tensions have intensified and global activity has remained soft” in the period since May, and Governor Carney said in his press conference that “the underlying pace of growth has slowed to below-potential rates as a result of weaker global demand and more entrenched uncertainty about Brexit amongst UK companies.” The growth forecasts were cut for this year to +1.3% (from +1.5% in May) and 2020 to +1.3% (from +1.6%), which would be the slowest annual growth rate for the UK economy since 2009. The Bank’s forecasts also said that assuming interest rates remained unchanged, there was a 33% chance that the economy would have fallen into negative growth in Q1 2020.
Acknowledging the impact of Brexit, the statement also said that “Brexit-related developments, such as stockbuilding ahead of previous deadlines, are making UK data volatile.” An issue for the Bank in recent months has been that their forecasts have been predicated on “a smooth adjustment to the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union.” This scenario analysis doesn’t have a hard Brexit as anywhere near as high a risk as the market increasing does. 10-year gilt yields fell by -1.8bps yesterday, reaching their lowest level since August 2016.
Staying with the UK, the anti-Brexit Liberal Democrats won a by-election in Brecon and Radnorshire, reducing Prime Minister Boris Johnson’s House of Commons majority to a single seat. Thereby making his balancing act ever more difficult as he seeks to deliver Brexit by October 31.
Elsewhere in Europe, equity markets made modest gains, with the STOXX 600 up +0.50%, while the DAX (+0.53%), CAC 40 (+0.70%) and the FTSE MIB (+0.79%) also advanced. Like in the US, energy stocks underperformed, with the STOXX Oil and Gas index down -1.46% and at an eight-week low. Yield curves flattened across the continent, while ten-year yields bunds were down -1.0bps to close at -0.45% – another record low. Late in the session, an MNI story got some attention, which said that support at the ECB is solidifying around a tiered deposit rate cut, but there is no consensus on new asset purchases. These anonymously sourced articles have a mixed record of accuracy and this article does contradict earlier MNI reports, from a few weeks back, suggesting that there was lack of support for tiering. Still, the potential uncertainty around new QE caused BTP yields to rise +4.0bps.
As for European data, the final July manufacturing PMIs were the highlight and showed poor momentum across the board. The final Eurozone reading was at 46.5 (vs. preliminary 46.4), while the final French manufacturing PMI was revised into contractionary territory at 49.7 (vs. preliminary 50.0), making this the first time since June 2013 that the big 4 Eurozone countries all had a sub-50 reading in the manufacturing PMIs. It was no better for the CEEMEA countries either, with Poland (47.4), Turkey (46.7), Russia (49.3) and the Czech Republic (43.1) all seeing contractionary readings. The comparative outperformer was Greece, with a 54.6 reading.
To recap the rest of the US data, the Markit PMI was revised up +0.4 pts but was still at the lowest level since 2009 at 50.4. Construction spending fell -1.3% mom in June, worse than the 0.3% expansion expected, though the May figures were revised higher. Meanwhile the latest initial jobless claims rose to 215k last week (vs. 214k expected).
Despite all the central bank, political, and data noise so far this week, things will continue to be eventful today when we get the US jobs report for July. Consensus is calling for a 165,000 print, below June’s 224,000 figure but roughly in-line with the 3- and 6-month moving averages. The unemployment rate is expected to fall back 0.1pp to 3.6%, while average hourly earnings are forecast to rise by the same pace as June, 0.2% mom and 3.1% yoy.
Apart from the US jobs report today, we’ll also get the trade balance and factory orders for June. There’ll also be the final readings for the University of Michigan’s sentiment indicator for July and durable goods orders for June. From Europe, we have the Eurozone’s June retail sales and PPI data, the UK’s construction PMI for July, and Italy’s industrial production and retail sales for June. In addition, we have earnings releases from Exxon Mobil, Chevron and RBS.