Trade tensions fuel a global equities “retweet”

Brian Nick

The last week’s market highlights:

Quote of the week:

“If you drive a car, I'll tax the street,
If you try to sit, I'll tax your seat.
If you get too cold I'll tax the heat,
If you take a walk, I'll tax your feet.”
– “Taxman,” The Beatles
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

Trump’s tweets: Third time’s a bombshell

President Donald Trump often tweets on Sundays, and May 5 was no exception. First, he announced a new head of U.S. Immigration and Customs Enforcement. Then he objected to the disqualification of Maximum Security as the winner of the Kentucky Derby. So far, nothing overly dramatic or out of the ordinary. 
His third tweet, though, was a shocker. Seemingly out of the blue, the president promised to increase tariffs on $200 billion of Chinese goods, from 10% to 25%, on May 10, and threatened to impose a 25% tax on an additional $325 billion “shortly.” Investors were caught off guard, as the administration had repeatedly stated that the trade talks were going well, fueling hopes for an imminent resolution and supporting a “risk-on” market environment. In the wake of tweet number 3, however, global equities and emerging market currencies tumbled, while safe-haven assets rallied.
Why the sudden turnaround?
The White House asserted that China had reneged on previous commitments, including spelling out the laws it would change regarding the protection of U.S. intellectual property rights and the forced transfer of technology. Also, Trump may have believed the U.S. economy could withstand another round of tariffs following strong first-quarter GDP and April employment data. Lastly, he was apparently convinced that China wants to make a deal.
For their part, the Chinese seemed to be gambling that the president cares more about the U.S. trade deficit with China and less about economic reform in Beijing. That could explain why they offered more modest concessions, such as increasing U.S. imports. And they may well have interpreted Trump’s repeated calls for the Federal Reserve to lower interest rates as a sign that he thought the U.S. economy was not performing as well as advertised. Improving Chinese economic data likely hardened their position. The Caixin Composite Purchasing Managers’ Index, a measure of China’s service-sector and manufacturing activity, remained comfortably above the 50 mark (52.7) in April. (Readings above 50 indicate expansion.) Lastly, China was reportedly convinced that Trump wants to make a deal.
Although the two sides renewed negotiations on May 9, the higher 25% tariff rate on the $200 billion of Chinese goods went into effect on Friday, May 10, as scheduled. So what’s next? One outcome that is not in the cards for the immediate future—and may never come to pass—is a  comprehensive deal in which China lowers barriers to entry for U.S. businesses and promises to honor U.S. intellectual property rights. That leaves two possibilities, as we see it:
  • “Small” or “weak” deal (55% chance): This could include China’s promise of reforms with little or no enforcement mechanisms, or an agreement that brings the two sides back to the pre-2018 status quo.
  • No deal (45% chance): U.S. maintains the current tariffs and eventually imposes a 25% tariff on the remaining, untaxed $325 basket of goods, and China retaliates.
Last year, U.S. consumers and producers paid an extra $15 billion in taxes on Chinese imports. But increasing the rate from 10% to 25% doesn’t mean they will necessarily be on the hook for the full amount of the higher tariff. They may simply opt to buy products made elsewhere, or China may lower prices to preserve U.S. market share. What seems certain, though, is that Beijing will retaliate by further limiting U.S. imports, even if its counterpunch won’t be as effective. That’s because China buys far less from us than we do from them.
In our view, these tit-for-tat measures could shave 0.3%-0.4% from U.S. GDP. Fortunately, that doesn’t represent a significant recession risk for an economy growing at a 2%-2.5% annual rate. The bigger concern is the contagion risk to the economy through deteriorating consumer and business confidence.  

Government bonds help soothe nerves    

Currency and equity markets closest to the “line of fire” slumped last week amid the escalation of trade tensions:
  • The Chinese yuan fell about 1.3% versus the U.S. dollar, pulling down the broad JPMorgan Emerging Markets Currency Index. In contrast, safe-haven currencies such as the Japanese yen rallied.
  • Shares in China and the emerging markets (EM) lost 6% and 4.3%, respectively, according to MSCI indexes.
  • In the U.S., trade-sensitive sectors such as information technology and industrials declined 3.5% and 2.7%, respectively, lagging the S&P 500 Index (-2.2%).
  • Europe’s STOXX 600 Index, which contains many export-dependent companies, slipped 3.4% (in local currency terms). 
Meanwhile, U.S. and other developed market sovereign bonds benefited from the risk-off mood, although the decline in yields was relatively contained considering last week’s growing sense of unease. (Bond yields and prices move in opposite directions.) Already low yields helped keep the rally in check. 
For example, the yield on the bellwether 10-year Treasury note, which began the week at 2.53%, closed at 2.47% on May 10, down 6 basis points (bps). And Germany’s 10-year bund concluded the week 7 bps lower, at -0.04%. We doubt rates will fall much further unless financial conditions tighten as they did in December 2018, when risk aversion boosted the dollar, upended stock markets and flattened the yield curve.   
Other fixed income asset classes also performed fairly well last week. In particular, investment grade corporate bonds shrugged off trade-war fears by delivering a 0.1% total return. U.S. high yield corporate debt (-0.5% total return), which often performs in sympathy with U.S. equities, held up reasonably well. On Tuesday, high yield issuance exceeded $5 billion, the most for a single day since February, according to Bloomberg. That’s quite a contrast from December, when not a single high yield company came to market. 
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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