A further slowing in growth
In the US new tariffs on Chinese imports kicked in over the weekend,.
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Cause everybody cries, And everybody hurts sometimes – REM
We had a quiet end to the week with the market wary ahead of the expected US-China tariff announcement over the weekend while China and US data releases showed signs of strain from trade tensions (Everybody hurts!). US equities ended little changed on Friday, but with solid gains for the week. 10y UST yields closed unchanged at 1.496% and USD indices edged a little higher, largely reflecting EUR weakness- soft inflation, Italian woes and month end flows the main culprits. The AUD and NZD have given up their small Friday gains at the open, reflecting a mild risk off tone at the start of the new week.
As expected, on Sunday the US imposed a new round of tariffs on Chinese imports. A 15%duty now applies to $110bn Chinese imports hitting consumer goods ranging from footwear to technology gadgets such Apple watch. At this stage the remaining $160bn of Chinese imports not yet subject to any duties will be hit by a 15% tariff on December 15 ( laptops and mobile phones are the main component of the latter group). China has responded with its own batch of tariffs expected to hit about $75bn of US good, including an extra 10% on American pork, beef, and chicken while soybeans will get an extra 5% tariff on top of the existing 25%. China’s tariffs have been aimed at the core of Trump’s political support, namely factories in the Midwest and South of the US.
Ahead the weekend tariff imposition, President Trump remained as defiant on Friday, tweeting “We don’t have a tariff problem (we are reining in bad and/or unfair players), we have a Fed problem. They don’t have a clue!”, and in another tweet saying “Badly run and weak companies are smartly blaming these small tariffs instead of themselves for bad management”. Notwithstanding the escalation in trade tensions, China and US trade representatives are still expected to continue to talk with president Trump confirming that “as of now” face-to-face talks between Chinese and American trade negotiators are still expected to take place in Washington sometime in September.
On Friday night there were mixed economic reports out of the US. Personal spending growth was solid in July, indicating a strong start to the third quarter after the very strong June quarter. By contrast, the University of Michigan’s final consumer sentiment survey showed the largest monthly drop in nearly seven years, falling to a near 2-year low. Tariffs were flagged as a concern by one-in-three consumers. A stronger Chicago PMI allayed some fears of the ISM manufacturing index falling to fresh lows when it is released early this week. The core PCE deflator was in line with expectations at 1.6% y/y, suggesting moderate inflationary pressure despite being ten years into the economic expansion.
That said, US data releases didn’t have a material impact on markets with month end flow playing a more dominant role instead. In FX, the euro was the big mover, dipping below the 1.10 an in the process helping DXY briefly trade above the 99 mark.
EUR fell below 1.10 for the first time since May 2017, reaching as low as 1.0983. In Italy the new (prospective) coalition between Five-Star and the Democrats got off to a rocky start with some public disagreement on the policy agenda and the threat of new elections by Di Maio, leader of Five-Star. Euro area inflation remained subdued, with annual headline CPI inflation for August at 1.0% and the core rate coming in a weaker-than-expected 0.9%, suggesting little progress has been made by the ECB in driving higher inflation through negative interest rates and its massive bond-buying programme. Against this backdrop Germany’s ECB executive board member Lautenschlaeger joined fellow hawks Knot and Weidmann in pushing against a large stimulus package at the September 12 ECB meeting, in particular it seems that norther European central bankers are not too keen on the idea of restarting QE. It looks like a coordinated message to markets and Draghi that we should not take it as a done deal the ECB will deliver a big bazooka this month, as was hinted by Finnish ECB member Olli Rehn a couple of weeks ago.
In a similar vein, Austria’s Nowotny said there was room for tweaks to policy settings, but there isn’t room for new measures. These comments gel with our view that from a timing perspective, we will likely get lower rates at the next ECB meeting and some tiering of the deposit rate, but any further QE policy may have to wait.
USD/CAD had a volatile Friday, but ended the day little changed. (1.3310 +0.17%). CAD jumped on the stronger than expected Q2 GDP headline, but details of the report were not as flattering, with the CAD reversing its initial move. The breakdown of the data showed strong growth was driven by net exports, with soggy domestic demand growth. This keeps alive the expectation that the Bank of Canada will join the club of central banks easing this year – not this week when the Bank next meets but almost a full cut remains priced by December.
US-China trade uncertainty and a soft commodity back drop barring oil and gold, kept the AUD and NZD under pressure in August and the outlook for September is not looking that much brighter. AUD and NZD small gains on Friday have been reversed this morning as the market begins to digest the implications of the increase in US-China trade tension. NZD lost 1.49% over the past week and now it is toying with the idea of making a sustain break below the 0.63 mark. AUD has been a little bit more resilient, only down 0.86% for the week and now trading at 0.6727, after recording an overnight low of 0.6706 on Friday.
On Saturday, China’s August Manufacturing PMI fell to 49.5 from 49.7, marginally below the 49.6 consensus. The softness in manufacturing is being seen in ongoing subdued reads for New orders (49.7) and Employment (46.9), while Production is a little more healthy (51.9). More worryingly though is that softness in the manufacturing sector may now be starting to spread to the larger services side of the economy. The Services PMI (a sub-sector of the Non-manufacturing PMI) fell to 52.5, its lowest level since December 2018. The overall Non-manufacturing PMI though did rise slightly to 53.8 from 53.7 previously, being boosted by a lift in construction activity. Combining Manufacturing and Non-manufacturing, the Composite PMI fell slightly to 53.0 from 53.1.
GBP fell 0.2% to 1.2155, but outperformed the soft euro. A Scottish judge refused to block Boris Johnson’s plan to suspend Parliament. This was the first of three judicial reviews that have been launched to try to overturn Johnson’s plan. None of them are expected to succeed and focus turns to the reopening of Parliament early this week after the summer recess. Meanwhile, the EU’s lead Brexit negotiator has rejected Boris Johnson’s demands for the controversial Irish backstop to be scrapped.
The bond market ended the week on a fairly lacklustre note, with little change in yields across the US and Europe. The 10-year US Treasury yield traded as high as 1.54% but ended the session flat at 1.50%. The market value of negative-yielding bonds in the Bloomberg-Barclays Global Aggregate Index hit the $17 trillion mark.
Domestically, partial indicators suggest that growth will again disappoint the Reserve Bank, likely leading to a further downgrade to the outlook in the November Statement on Monetary Policy. We currently estimate GDP grew by 0.5% in Q2 with a slight downside risk to this forecast, while the bank had forecast a 0.8% increase. Recent data show that residential construction is falling at a much faster rate than the bank had expected, while business investment also seems to have disappointed.
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