The last week’s market highlights:
Quote of the week:
“Gratitude is riches. Complaint is poverty.” – Doris Day
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2Q 2019 Outlook :
- U.S. economy: Late cycle but no recession
- Global economy: Slower this year than last
- Policy watch: A dovish turn for global central banks
- Fixed income: Rates likelier to rise than fall
- Equities: Get defensive, stay invested
- Asset allocation: Still favorable to emerging-market assets
Wanted: Strong stomachs to tolerate a weak currency
The abrupt end of the détente in the U.S.-China trade war has rekindled equity market volatility over the past two weeks, with steep intraday and day-to-day moves. On May 10, for example, the S&P 500 Index fell by 1% out of the gate, surged 2% during afternoon trading and then slipped again to finish with a modest gain. Then, on May 13, the index tumbled 2.4%—its worst day since early January—before rallying over the next three days. May 17 saw U.S. stocks swing between gains and losses to finish the day down 0.6%.
A major source of investor unease has been a drop in the Chinese currency (the renminbi, or yuan), from 6.69 per U.S. dollar on April 17 to 6.92 on May 17. Unlike other major currencies, the renminbi doesn’t trade freely. Instead, China’s central bank, the People’s Bank of China (PBoC), allows it to drift as much as 2% above or below a daily midpoint, based partly on the previous day’s close.
Should the PBoC allow further weakening? Such an approach might be tempting following April’s unexpected 2.7% drop in Chinese exports. A softer currency would make China’s products more competitive in overseas markets and help offset the effects of U.S. tariffs.
On the other hand, devaluing the currency can have unpleasant consequences for investors, as in 2015, when China’s economy showed signs of slowing in the first quarter, and exports plunged in July. In August, the PBoC carried out its biggest one-day devaluation in more than 20 years. Amid evaporating risk appetite over the next two weeks, the S&P 500 Index shed 10%, and U.S. Treasuries saw their prices surge and yields plunge as investors flocked to safe-haven assets. China’s currency devaluations have been also been associated with, if not explicitly blamed for, U.S. equity downturns in 2016, 2018 and now 2019.
Whether engineered by the PBoC or not, significant declines in the renminbi’s value may cause collateral damage. Central banks in other countries might be pressured to lower interest rates. While that could boost those countries’ exports thanks to weaker currencies, cutting rates could also spur inflation.
In our view, the direct impact of the U.S.-China tariffs will likely trim about 0.25% from U.S. GDP and 0.5% from Chinese GDP in 2019. Those are relatively modest and manageable amounts relative to the size of the world’s two-largest economies. But the potential knock-on effects of the tariffs could be substantial, coming in the form of lost business and consumer confidence, and tighter financial conditions driven by a stronger dollar, lower equity prices and wider corporate bond spreads.
Global economy: A new trade deal is no cure-all
In addition to his comedic skills, the late Marty Feldman was known for his large, chameleon-like eyes that seemingly allowed him to look in several directions at once. Investors might have coveted such an ability last week, scrolling through Twitter for President Trump’s trade-related tweets while keeping a close watch on key economic data releases.
Trump’s tweets were largely bullish for markets. On Tuesday, for example, he reiterated that China was still keen on closing a trade deal, easing concerns that talks had broken off altogether. In contrast, economic news was mostly disappointing. Among the reports:
- Retail sales fell in both the U.S. (-0.2%) and China (-1.5%, to a 16-year low) in April.
- U.S. (-0.5%) and Chinese industrial production (-3.1%) also declined last month.
- Germany’s closely watched ZEW Economic Sentiment Index slipped in May, signaling expectations for restrained growth in the eurozone’s largest economy over the next six months.
On the positive side, U.S. small business optimism and leading economic indicators both rose in April. And consumer sentiment surged to a 15-year high in May, according to the preliminary reading of the University of Michigan index. However, all three of these surveys were conducted before the latest round of the tariff war had begun.
We think renewed trade tensions have intruded on an already fragile global economy. It’s true the economic backdrop looks sturdier today than it did at the end of 2018, due in large part to China’s steady stream of stimulus and dovish policy shifts by the Federal Reserve and other central banks. But a few months ago we hoped to see economic conditions worldwide continue to improve in the second quarter. Instead, they’ve held steady at best and taken a few steps backward at worst. For these reasons, a U.S.-China trade deal—even if one were to be announced soon—wouldn't be a panacea for the global economy, in our view.