US equities fall sharply. UST yields fall. China threatens UST demand but options limited. Local focus shifts to arrival of RBNZ governor Orr and the new Policy Targets Agreement

By Nick Smyth

US stock indices fell sharply again on Friday, with the S&P500 down over 2%, bringing its loss on the week to around 6%.  The S&P500 is now down around 5% for the year, and almost 10% below its record highs reached in late January.  The Nasdaq was down 2.43% on the day and over 6% on the week, with the ongoing Facebook / Cambridge Analytica scandal contributing to the underperformance there.   The VIX increased to 25, its highest level since the market turbulence in mid-February. 

Growing concerns about US-China trade tensions were probably behind the move lower in US stocks, although the bulk of the move happened in the last few hours of trading in the US and most of the trade measures had been seemingly well flagged in advance. On Friday, China announced that it was implementing tariffs on $3b of US exports, in retaliation for the recently announced steel and aluminium tariffs by the US.   We now await the details of Trump’s more recent China-specific trade measures (tariffs on up to $60b of Chinese imports, related to intellectual property abuse), and the Chinese response to that. Over the weekend Treasury Secretary Mnuchin said the two sides were having “productive conversations” and he was “cautiously hopeful we reach an agreement” (to avert the full $60b in tariffs).  To date, the Chinese response has been very measured, but the market is clearly nervous that these tit-for-tat measures could morph into a broader trade conflict. 

Earlier on Friday, Trump announced the appointment of foreign policy hawk John Bolton as his new National Security Advisor, replacing HM McMaster, the latest in a raft of changes at the top of the US administration.  Over recent months, Trump has removed a number of the more moderate, and pro-free trade, members of his administration, which has also arguably weighed on sentiment towards equities. 

Moves in other asset classes were reasonably well contained.  In FX, the USD was generally weaker on Friday against this backdrop of escalating trade tensions.  The Bloomberg DXY was around 0.3% lower on the day and near one-month lows.   The JPY was unsurprisingly the outperformer amidst the risk-off tone in markets; USDJPY fell below 105 for the first time since November 2016.  

Similarly, volatility in bond markets was reasonably subdued. The US 10 year Treasury ended the day around 1bp lower, at 2.81% (having earlier reached 2.85%). The 10 year Treasury sits just above the lower end of the 2.80% - 2.95% range it has traded for the past month and a half.  On Friday, China’s ambassador to the U.S. said “we are looking at all options” if the situation were to escalate further, including cutting back purchases of US Treasuries.  China holds over $1 trillion of US Treasuries, making it the largest foreign holder, although realistically there aren’t many alternative bond markets have the same degree of liquidity and credit quality as the US. 

At 9am today, Finance Minister Grant Robertson and incoming RBNZ Governor Adrian Orr will hold a press conference to reveal the new Policy Targets Agreement (PTA), along with the outcomes of phase-1 of the RBNZ Act review.  There will be a question and answer session with this, with the market likely to pay close attention to what Orr has to say.

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