Escalating Trade Tensions Weigh On Investors

Week of May 20-24

Despite risk appetite improving, market waits for further trade clues

Global markets continue to weather some erratic turbulence now that the U.S and China have hit each other with increased tariffs and ended their latest round of trade negotiations without a resolution. But the prices of relatively risky assets have mostly stabilized, and stocks are still within touching distance of their all-time highs.

Measures of confidence have also held up, suggesting worries about the Sino-U.S trade fight have yet to really dent investors’ outlook. Even gold prices have barely budged for the month. Nevertheless, there are a number of signs of fear in the bond market. The U.S yield curve has inverted a couple of times this year, including today as yields fall. But the spread between three-month and 10-year Treasury yields has failed to hold below zero for more than a few sessions, which suggests that dealers are not fully convinced that the U.S economy is heading towards a contraction just yet. And despite lower yields, the US dollar remains the currency of choice.

PM May’s short lifeline

Sterling’s record losing streak combined with the growing risks that Brexit will see a hard exit, is making fund managers abandon long-term ‘bullish’ bets. Just a few months ago, the base case was that Brexit would be delivered by PM May and that it would be a soft exit. Now expectations are running high that PM Theresa May will give up pushing her Brexit deal and possibly quit on Friday (May 24) or in early June.

However, if we do see Boris Johnson, the current oddsmaker favorite, become Theresa May’s successor, we could see the ‘hardest’ Brexit occur. The pound (£1.2645), which is currently atop of its four-month lows, could see further pressure to target the psychological £1.2000 level and eventually the 2016 lows. A no-deal Brexit and a general election risks are likely to keep the pound under pressure.

But a weaker than expected showing for the Brexit party in the EU elections could potentially provide some relief for sterling, particularly if the Liberal Democrats perform strongly. A new Tory leader that is less of a Brexiteer than the likes of Boris Johnson could also see a modest bounce in the pair.

Support for Nigel Farage’s “no-deal” supporting party is at +37%, according to a recent survey, compared to +19% for the pro-remain Liberal Democrats and just +7% for PM May’s Conservatives.

Central Banks

According to the published minutes of the April 30 – May 1 meeting, the Federal Open Market Committee (FOMC) has signalled that it is in no rush to change policy rates even if there is an improvement in global economic conditions. The combination of Fed patience, lingering concerns about relatively sluggish inflation and persistent global economic uncertainty, continues to support both investors and dealers’ “dovish” assessment of the Fed rate path.

Meanwhile, a plethora of strong Canadian data lately has many revising their rate expectations for the Bank of Canada (BoC). Data for April showed headline inflation was “in line” with target, retail sales for March surprised higher, while manufacturing sales for March and existing home sales for April also surprised. Thrown into the mix Canada’s April record month for job gains has fixed income pricing out a rate cut over the next 12-months.

Down -under, there has been a sharp “dovish” shift in market-implied policy rate probabilities after RBA Governor Philip Lowe stated “…at our meeting in two weeks’ time, we will consider the case for lower interest rates”. A June cut is now fully priced in, with a second cut pencilled in for September.

On Thursday, South Africa Reserve Bank (SARB) left interest rates unchanged at +6.75% as expected. The vote was 3-2 to keep rate on hold, two members voted for a -25 bps cut. “Based on recent short-term indicators and negative growth in mining and manufacturing, GDP is expected to contract in Q1 of 2019. Policy makers also see the Rand as slightly undervalued.

Economic events

On the Economic Calendar, results for the European Parliamentary elections will be announced this Sunday evening (May 26).

European parliamentary elections exit polls on Sunday begin around 12:00 EST (6PM Germany time) with results for all EU nations expected at 5pm EST (11pm Brussels time).

Market concerns

• EU parliament election – rise of Eurosceptics
• UK leadership scramble & Brexit fallout
• US-Sino – China standing firm against US
• Trans-Atlantic trade tensions to intensify
• OPEC, Saudis, Venezuela, Libya & Trump
• Iran is threatening to close the Strait of Hormuz
• Venezuela/Russia/U.S tension
• Geo-political concerns in Iran, Russia, Ukraine & France
• U.S ramps up trade talks with India and Turkey

Next week: GBP retail sales & US durable goods (May 24), European Parliamentary Elections Day 4 (May 26), UK & US Bank holiday (May 27), UK inflation hearings, NZD financial stability report, ANZ Business confidence, RBNZ Gov. Orr speaks (May 28), BoC monetary policy announcement, AUD private capital expenditure & NZD annual budget release (May 29), CH, Fr. & DE bank holiday, US preliminary GDP & CNY manufacturing PMI (May 30), CAD GDP (May 31).

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