Equity markets and US rates in freefall. Trade war concerns dominate and the CNY pushes above 7. The NZD remarkably resilient but downside risks ahead

Concerns around the US-China trade war and the weaker yuan to trade at more than 7 to the US dollar have dominated the market. Global equities and US Treasury rates have shown some significant falls.

The USD has come under pressure overnight, which has helped contained any fallout for the NZD.

The fallout from Trump’s announcement early Friday morning NZ time that he would put on more punitive tariffs on Chinese imports from 1 September continues. The PBoC set the CNY slightly weaker than the market expected yesterday, down 0.33% to 6.9225. The market took this as a signal that the central bank was happy to engineer a slightly weaker currency and drove the offshore yuan, CNH, about 1½% weaker, taking USDCNH to a record high of 7.1114. The PBoC allows CNY to trade within 2% of the reference rate and the currency sits this morning just over the 7.05 mark. The PBoC has taken no action to keep CNY below the symbolic 7 mark.

Admittedly, the escalation of tensions in Hong Kong didn’t help the situation. Hong Kong protesters moved to encourage a general strike and shut down parts of the city, adding another dimension to risks overhanging markets. China’s patience towards the pro-democracy protesters is no doubt wearing thin and threatens to escalate into a civil war.

Adding to trade war tensions, not long after CNY breached the 7 mark, Bloomberg reported that the Chinese government has asked its state-owned enterprises to suspend imports of US agricultural products after Trump ratcheted up trade tensions last week. China’s state-run agricultural firms have now stopped buying American farm goods, and are waiting to see how trade talks progress.

Amidst the “cracking of 7”, a PBoC spokesman gave an interview with the FT to offer some perspective and last night PBoC Governor Yi issued a statement on the RMB exchange rate that reiterated that message. He said that China will remain committed to the market-based exchange rate regime and refrain from competitive devaluations. He recognised the changed market expectations “amid new developments in the global economy and trade frictions” and reiterated that the Bank would keep the RMB exchange rate “basically stable at an equilibrium and adaptive level”.

Trump has fired off a barrage of four tweets overnight directed at China with one of them being “China dropped the price of their currency to an almost a historic low. It’s called “currency manipulation.” Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!”.  Interestingly all four tweets mention the words “currency manipulation”, a not-so-subtle signal that he wants the US Fed (or Treasury) to intervene to weaken the US dollar. Trump has previously said he hasn’t ruled out currency intervention, while his economic advisor Kudlow, as recently as Friday, said that there were no plans for intervention. A unilateral intervention – without the support of other major central banks like the ECB and BoJ – would prove to be futile, with an impact on the day from shock value, but likely little sustained impact.  Ironically, the PBoC has been manipulating its exchange rate over recent years but it has been to contain weakness and prevent capital flight, than trying to weaken the yuan.

The trade war escalation has had a significant impact on the market. A prevailing view is that the escalation of the trade war might be enough to tip the global economy into recession.  The Euro Stoxx 600 index fell 2.3% following on from Friday’s 2.5% fall.  The S&P 500 is currently down 3.4%, backing up the 3.1% fall seen last week.

The global rates market has seen some big moves as well, but largely confined to the US. Market expectations of easier Fed policy have ramped up, with the Fed Funds rate currently priced at a low of 1.03%, so that’s at least four cuts, with half a chance of five further rate cuts by the end of next year – the market taking a clear view that the so-called “insurance” easing will morph into a full-scale easing required to ward off a US economic recession. Ramped-up easing expectations have seen a steepening of the yield curve, with the 2-year rate down 13bps to 1.58% and the 10-year rate down by “only” 11bps to 1.74%.

Much of this price action was forewarned by the futures market, so the US 10-year rate has only effectively lost a few basis points since the level prevailing at the NZ close. This should limit downside pressure in the NZ rates market, which yesterday saw fresh lows emerge – with 2-year swap closing down 2bps to 1.18% and 10-year swap down 6bps to 1.49%.

In currency markets, EUR has outperformed, reflecting a closing of carry-trades, with EUR widely seen as the preferred funding currency for these. EUR is up 0.9% to breach the 1.12 mark. The big falls in US rates alongside Trump’s currency intervention tweets have seen the USD under a little pressure. So remarkably the NZD has made a small gain overnight and trades this morning at 0.6540, having fallen to as low as 0.6489 during local trading hours yesterday.  We’ve previously noted the strong link between CNY and the NZD since the trade war began, so this might only be a short-term reprieve for the NZD if, as we expect, pressure on CNY will remain. In our weekly note on the NZD yesterday we flagged downside risk to our NZD forecasts.

The AUD hasn’t escaped the full onslaught of the weaker CNY and is trading not far off its lows seen yesterday near the 0.6750 mark.  Thus, NZD/AUD has pushed up to 0.9665.  NZD/JPY fell to a multi-year low of 68.66 yesterday afternoon but has recovered back up to 69.30 this morning.

Economic data releases are only a secondary consideration for the market at present, while it assesses the likely future damage from the worsening trade war. The US non-manufacturing ISM index fell by more than expected to a near 3-year low, consistent with the slowing in the US economy seen in other indicators. The UK services PMI recovered compared to expectations of a flat result, but remains below average and consistent with sluggish growth.

The economic calendar over the next 24 hours is fairly full. NZ labour market data are expected to show employment growth remaining soft and the unemployment rate ticking higher. Wage inflation is expected to pick up, but still be broadly consistent with the 2% inflation target. The RBA meets this afternoon and is expected to stand pat after two consecutive 25bps rate cuts, likely preferring to sit on the sidelines for a few months to see the impact of its rate cuts on inflation and the labour market.