President Trump announced a short while ago that he would place 10% tariffs on the remaining $300 bln of Chinese imports as of 1st September.
Global rates have fallen sharply – the 10 year Treasury yield is now at its lowest since 2016 – equities have spiked lower and the AUD has underperformed as the fragile trade war ceasefire looks to have come to an early end.
Nonfarm payrolls is released tonight.
Trump announced, via Twitter, that he was planning to move ahead with more tariffs on Chinese imports in a further escalation of the trade war. US Treasury Secretary Mnuchin and US Trade Representative had been in Shanghai earlier in the week for face-to-face trade talks with Chinese vice premier Liu, which Trump described as “constructive”. Nevertheless, Trump said “China agreed to buy agricultural product from the U.S. in large quantities, but did not do so. Additionally, my friend President Xi said that he would stop the sale of Fentanyl to the United States – this never happened, and many Americans continue to die!” The 10% tariff rate, lower than the 25% originally proposed, will take effect from 1st September, shortly before Chinese officials were expected to arrive in Washington for the next round of trade talks. Those talks must now be in doubt, and the read-across to global growth doesn’t make for pretty reading. Those with a cynical bent might think that Trump’s decision is a reaction to the more hawkish Fed message from yesterday (Trump said on Twitter that “as usual, Powell let us down”) and a desire to see more aggressive Fed rate cuts.
US Treasury yields have experienced a massive move lower – the 10 year yield is 11bps lower on the day at 1.9%, its lowest level since 2016, while the 2 year yield has fallen 15bps to 1.73%. In the immediate aftermath of Powell’s comments at the FOMC press conference yesterday that the Fed was thinking of its rate cut as a “mid cycle adjustment” and “this isn’t the start of a long series of rate cuts” the 2 year yield had briefly touched 1.96%. The market now fully-prices a follow-up Fed rate cut in September (60% priced earlier in the session) and there are now slightly more than two full rate cuts priced-in by the end of the year.
The S&P500, which had been 1% higher on the day prior to the Trump comments, is now down around 0.7% (although it has bounced slightly from its intraday lows). In a further sign that the market sees global growth being hit as a result of the tariffs, Brent crude oil prices have fallen 5%.
Treasury yields had already fallen significantly before the Trump announcement on tariffs, with a weaker than expected US ISM manufacturing survey partly to blame. The ISM index fell to 51.2 in July and there was weakness in two of the key subcomponents – production and, ahead of nonfarm payrolls, employment. The new orders sub-index nudged up but remained at a subdued 50.4 level. The 10 year Treasury yield was sitting close to 1.95% before Trump made his tariff announcement, down from 2.05% earlier in the trading session. The break below the year-to-date lows of 1.94% in the 10 year rate likely triggered stop-loss buying of Treasuries, exacerbating the moves. The 10 year breakeven inflation rate, a market-based measure of inflation expectations, has fallen 5bps to 1.7%, with the market seemingly perceiving the fall in oil prices and disinflationary impact of slower growth as likely to more than offset the direct inflationary impact of tariffs.
In FX, the safe haven Japanese yen and Swiss franc have predictably outperformed against a risk-off backdrop and sharp falls in US rates. The yen is 1.3% stronger on the day, with USD/JPY trading close to its recent lows of 107.35. At the other end of the currency leader-board, the Australian dollar – which the market views as the closest G10 proxy for China – is 0.6% lower, to 0.68. The AUD is now trading at its lowest level since 2009, with the exception of the flash-crash driven spike lower at the start of the year. The Norwegian krona and Canadian dollars sit behind the AUD, with the sharp fall in oil prices leading to 0.4% and 0.3% falls in those currencies respectively.
The offshore renminbi has dropped 0.7%, with USD/CNH approaching the psychologically important 7.0 level again. USD/CNH currently trades around 6.96, near its highest level over the past 12 months.
The weakness in the AUD and CNH alongside the sharp falls in equity markets might ordinarily have been expected to see a similarly sharp fall in the NZD. However, the NZD has held up reasonably well given the circumstances and has significantly lagged the move in the AUD. The NZD is currently down only 0.1% on the day, at 0.6550, while the NZD/AUD cross has made a fresh four-month high at 0.9630. A break above 7.0 in USD/CNY could yet trigger more pronounced weakness in the NZD given the strong correlation between the two currencies since the trade war erupted.
NZ rates increased slightly yesterday after the more hawkish comments from Fed chair Powell, although the moves were very modest (2 year swap +1bp to 1.25%, 10 year swap unchanged at 1.645%). We can expect a sharp move lower in NZ rates when the market opens this morning, in response to the overnight moves in global rates. The implied yield on the Australian 3 year bond futures contract is 11bps lower while that of the 10 year contract is 13.5bps lower.
In other news, the BoE kept rates unchanged at 0.75% but downgraded its growth forecasts (to 1.3% in 2019 and 2020, down from 1.5% and 1.6% respectively) citing Brexit uncertainty and slower global growth. The Bank sees a 33% chance that the economy could contract in annual terms in Q1 next year. Carney said the Bank’s central view was for gradual increase in rates although, crucially, this is conditioned on a pick-up in the global economy and a “smooth” Brexit, both of which are far from assured. As at the end of the UK trading day (but before Trump’s announcement on Chinese tariffs) the market fully-priced a rate cut by the BoE in March next year. There was little reaction in the GBP, with the market far more focused on the risks of a no-deal Brexit and possible new elections.
The US senate passed Trump’s budget deal, which will avert a government shutdown, lift the debt ceiling and add $320 bln of new spending. Having cleared Congress and Senate, Trump now needs to sign the bill to pass it into law.
Nonfarm payrolls is released tonight, where consensus is looking for the US economy to have added 165,000 new jobs in July. Given the prevailing backdrop, the market is likely to be more sensitive to a miss on the downside than an upside surprise.
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