Unlike Trade, Markets Are Not Where We Want Them
(Bloomberg Opinion) -- Over the weekend, President Donald Trump weighed in on the state of trade negotiations with China, saying the U.S. was “right where we want to be.” Markets don’t share the sentiment. That was evident by the performance of stocks, with the MSCI USA Index tumbling as much as 2.81%, exceeding the 2.09% drop in the broad MSCI All-Country World Index. Yes, U.S. equities have outperformed this year, so they had further to fall, but it’s clear that nobody is sure where the escalation in the trade war will lead, let alone whether there will be any winners.
In fact, there’s the very real possibility that everybody loses. Even before the latest breakdown, with the U.S. imposing additional tariffs on Chinese goods and China retaliating with more tariffs of its own, global traded volumes were falling at the fastest pace since the depths of the financial crisis, according to data compiled by Bloomberg based on the trade monitor of the Dutch Bureau for Economic Policy Analysis. Now comes the news that the OECD’s Composite Leading Indicator, designed to anticipate turning points in major economies six to nine months before they happen, fell for 12th consecutive month in March, hitting its lowest level since 2009. A measure for the U.S. is also at the weakest in almost a decade, while the euro-area reading was the worst since 2013, according to Bloomberg News’s William Horobin. But when considering markets now, it’s all about whether U.S. equities only being less than 5% from their all-time highs is a reassuring sign or whether the biggest one-day tumble since early December — even with the Federal Reserve seemingly ready to cut interest rates at a moment’s notice — is a sign to run and hide.
For the former, it’s a positive that the Smart Money Flow Index, which measures action in the narrower Dow Jones Industrial Average during the first half-hour of trading and the last hour, rose on Friday to its highest since October. The thinking is that the first 30 minutes represent emotional buying, driven by greed and fear of the crowd based on good and bad news as well as a lot of buying on market orders and short covering. The “smart money,” though, waits until the end of trading to place big bets when there is less “noise.” “The question remains: is the performance pattern year-to-date a template for the rest of the year, or an aberration?” the strategists at Morgan Stanley posed in a research note. “We think the latter.”
BOND TRADERS ARE WORRIED
What’s not encouraging is that equities and other so-called risk assets took a big hit despite money markets pricing in a near certainty that the Fed will lower rates this year. Recall that it was the Fed’s dovish pivot at the start of the year that sent stocks soaring. The rate on the January federal funds futures contract implies that the central bank’s benchmark will fall to 2.075% by the end of 2019. This is more than 25 basis points below where the effective fed funds rate stood Friday, showing traders are fully pricing in a quarter-point reduction, according to Bloomberg News’s Alexandra Harris. The idea of a Fed rate cut, along with investors seeking a haven from the sell-off in stocks, sent Treasuries of all maturities soaring on Monday. The yield on the benchmark two-year note, which is more sensitive to changes in monetary policy than longer-term maturities, closed at 2.19%, the lowest since February 2018. Put another way, the yield is below the Fed’s target rate by the most since 2008. That’s a clear sign that the bond market is extremely worried about the economic outlook, so much so that traders shrugged off a tweet by the editor-in-chief of the Global Times, which is an English-language organ of the state media, that Chinese scholars were looking into ways for China to dump its $1.13 trillion of Treasuries. Then again, maybe the bond market doesn’t think a mass sale would happen. And even if it did, it might not have much impact. China’s stake represents about 5% of the total amount of Treasuries outstanding, down from the peak of 9% in 2011, according to Bloomberg News’s Ye Xie.
CHINA’S YUAN IS KEY
Perhaps the market that needs to be watched closest is the one for China’s currency. The yuan tumbled 0.81% Monday to 6.8744 per dollar in its worst slide since October. More important, the currency is back on the march toward 7 per dollar, the same level that it approached in late October that many attribute to sparking the global turmoil in markets at the end of 2018. That rate, if breached, is seen as likely sparking a capital flight from China, throwing growing global markets into disarray. Conversely, its strength earlier this year was seen as bolstering confidence in riskier assets globally. The yuan has been an “anchor of stability for all markets,” Kit Juckes, a global strategist at Societe Generale SA, wrote in note to clients on Thursday. Although the yuan is weakening again, that can’t be seen solely as a referendum on China’s standing in the trade wars. It could be that China, which closely controls the yuan by allowing to move no more than 2% on either side of its daily fixing rate against the dollar, is allowing the currency to weaken to offset some of the fallout from additional U.S. tariffs. Analysts at Goldman Sachs Group Inc., Morgan Stanley and UBS Group AG joined JPMorgan Chase & Co. in slicing their forecasts for the yuan, according to Bloomberg News’s Livia Yap. “Higher tariff rates and a re-ignition of the trade conflict necessitates a weaker (yuan) forecast profile,” JPMorgan strategists including Jonathan Cavenagh wrote in a report dated May 10.
MORE BAD NEWS FOR FARMERS
The market for raw materials suffered its worst week of the year in the five days ended May 10, with the Bloomberg Commodity Index dropping 1.47%. The new week didn’t start any better, with the Bloomberg gauge declining an additional 0.41%. Much of the loss centered on goods that China targeted for additional tariffs. Soybean futures fell to the lowest level in a decade, dipping below $8 a bushel in Chicago for the first time since 2008. U.S. Department of Agriculture data show that China has purchased about 7.4 million metric tons of U.S. beans that have not yet been shipped, and the breakdown in negotiations makes it more likely that some purchases might be canceled before delivery, according to Bloomberg News’s Michael Hirtzer. Cotton also took a big hit, with futures plunging by the 3-cent exchange limit in New York to the lowest since September 2016. China’s retaliatory tariffs threaten the demand outlook for cotton when the USDA predicts domestic inventory will reach a decade high, according to Bloomberg News’s Shruti Date Singh and Fabiana Batista. China also took aim at U.S. exporters of liquefied natural gas, biodiesel and rare-earth metals. Beijing announced Monday that it will increase tariffs on liquefied natural gas to 25% from 10% as of June 1. To be sure, Bloomberg News reports that a fatter tariff on U.S. LNG may have limited immediate impact because Beijing’s 10% duty in September dried up most of the trade. China has imported only four cargoes of American gas so far in 2019, compared with 19 over the same period a year ago, according to Bloomberg analysis of vessel-tracking data.
MIDDLE EAST ‘SABOTAGE’
Emerging markets certainly didn’t take the escalation of the U.S.-China trade war very well, with the MSCI EM Index dropping as much as 1.79% to its lowest since January. The fallout was widespread, but the reason behind one of the biggest losers had little to do with trade. Saudi Arabia’s benchmark index tumbled 3.55%, the most since the crisis surrounding the killing of journalist Jamal Khashoggi in October, after the kingdom said two oil tankers were damaged in a “sabotage attack” on Sunday. “The timing of the recent events in the region is not ideal when you consider the investor anxiety in global markets,” Jameel Ahmad, global head of currency strategy and market research at FXTM in Limassol, Cyprus, told Bloomberg News. The tankers were damaged off the United Arab Emirates coast on Sunday, state-run Saudi Press Agency reported. The vessels were approaching the Strait of Hormuz, the world’s most important chokepoint for oil shipments. The U.A.E. foreign ministry on Sunday reported an attack on four commercial ships. No one has claimed responsibility. Two of the targeted tankers were registered in Saudi Arabia, one was flagged in the U.A.E. and the other in Norway, according to a U.A.E. government official. The U.S. deployed an aircraft carrier, bomber planes and defense missiles to the region last week amid worsening friction with Iran, Saudi Arabia’s regional rival. Attacks on oil tankers in the turbulent Gulf have been rare since 1991, according to Bloomberg News’s Anthony DiPaola and Abbas Al Lawati. Saudi Arabia continued shipping through the Strait of Hormuz during the so-called tanker war, a phase of the 1981-88 conflict between Iraq and Iran when both foes attacked vessels in the Gulf. Oil exports flowed also during the first Gulf War in 1990-91.
The National Federation of Independent Business’s monthly index of sentiment among U.S. small-business owners had fallen for five straight months through January before showing back-to-back small gains in February and March. So, were those increases the start of a new upswing or a just a pause on the way to a deeper slide? Markets will get some answers Tuesday when the report for April is due. The median estimate of economists surveyed by Bloomberg is for another minuscule rise, to 102 from 101.8 in March. But that would still keep the gauge a long way from the 35-year high of 108.8 in August. Bloomberg Economics is in the camp expecting a small gain, given the improvement in hiring plans among small-business owners. According to the April NFIB employment survey, hiring plans rose to 18 from 16, building on a 2-point increase in the prior month. The rise in tariffs to 25% from 10% on $200 billion of Chinese imports will not affect the April result but could weigh on sentiment next month, Bloomberg Economics says.
Bond Traders Can’t Wait to Bet on Fed Rate Cuts: Brian Chappatta
Company Bottom Lines Can’t Escape Trade War Pain: Stephen Gandel
China Loses More From a Trade War With the U.S.: Tyler Cowen
How Congress Can Help the Fed Fight Recessions: Bill Dudley
Fed Can Avoid Traps of Average-Inflation Target: Ramesh Ponnuru
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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