Today’s podcast

https://soundcloud.com/user-291029717/possible-volatility-ahead-as-us-china-trade-dispute-intensifies?in=user-291029717/sets/the-morning-call

Overview: The heat is on

• No trade deal and the increased 25% rate will apply within weeks
• US putting together the paperwork for tariffs on the other $300bn
• Kudlow hopeful that there’ll be a Trump-Xi meeting at the end June G20 Summit in Japan
• Markets waiting on China response (currency?); non-tariff trade barriers?  Promised but not yet announced
• Limited reaction in early APAC time; AUD, NZD only marginally lower (10-15 pips)
• Markets still pricing for a deal
• Housing finance today and a big week for local economy/labour market news

It’s early days as far as market reaction is concerned, but if the initial reaction from the AUD and the NZD is any guide, markets have reacted in a relatively calm manner to the ending the US-China trade talks on Friday in the US without any deal and with more tariffs “on the way”.  The AUD and the NZD are both sitting just below 0.77/0.66 respectively, both having closed Friday in New York at the figure for each.  Markets appear to be pricing for a deal yet to be done, attractive for both sides.

The absence of trade deal also didn’t stop the CAD from rallying after a super-sized employment report released on Friday, employment up nothing less than a record-high 106K, blowing expectations of a more normal +12K out of the water.  The unemployment rate also was loser by a tenth to 5.7% from 5.8%, and despite the participation rate up two tenths to 65.9%.  The Canadian labour market continues to perform relatively well.

With news Friday APAC time that the US tariff rate on the $200bn of Chinese imports would be forthwith raised from 10% to 25%, offshore markets finished last week with equities and bond yields both closing higher.  The S&P 500 closed 0.37% higher on Friday, the Eurostoxx 50 ending the week 0.31% higher.  US Treasury yields closed 1-2 bps higher.

It remains to be seen how the markets will react this week once they are back in full swing, but the news on the trade-tariff front is anything other than reassuring.  The trade talks have ended without any deal, the US has increased its existing tariff of 10% on the $200bn to 25%, to apply to Chinese exports leaving from the end of last week, and the US is putting together the paper work for tariffs on the remaining $300bn of Chinese imports.

China responded that it would be forced to retaliate, although it hasn’t yet specified how.  China has already applied tariffs to nearly all US imports, in response to Trump’s previous tariffs, but it could use non-trade countermeasures, including making business more difficult for US firms operating in China and potentially allowing the CNY to depreciate.

After finishing talks on Friday, Chinese Vice Premier Liu said that in order to reach an agreement, the US must remove all extra tariffs (the US had reportedly argued for the tariffs to be removed in stages, as part of an enforcement mechanism), set realistic targets for Chinese purchases of US goods, and ensure the text of the deal is “balanced” (the Chinese had reportedly reneged on a prior agreement to implement aspects of the deal into Chinese law).

As my BNZ colleague Nick Smyth has also observed this morning, the relatively sanguine market response so far probably reflects market hopes that a deal can still be reached between the two sides.  The 25% tariff rate won’t apply to goods already in transit from China to the US, creating a two-to-four week window for negotiators to come to an agreement before the economic impact begins to bite.  Trump tweeted on Friday that the talks had been “candid and constructive” and maintains that he has a good relationship with Chinese President Xi.

Over the weekend, White House Economic Advisor Larry Kudlow said that Treasury Secretary Mnuchin and Trade Representative Lighthizer had been invited back to Beijing to continue talks.  Importantly, Kudlow mentioned that there was a “strong possibility” that Trump and Xi could meet at the G20 summit in Japan at the end of June (the two leaders agreed to a ‘ceasefire’ when they met at the G20 late last year).

Trump has released a barrage of trade-related tweets over the weekend, ranging from his approval for tariffs (“love collecting BIG TARIFFS!”), saying it’s in Chinese interests to agree to a deal before his second term, and floating the possibility of buying agricultural goods directly from farmers and sending this as aid to poorer countries, at least half-expecting more retaliation against US far exports to China with US farmers already facing low grain prices, is come cases multi-decade lows.

In economic news, the US CPI for April was released on Friday and again it was on the soft side.  Both headline and core inflation were a tenth below consensus, with another sizeable decline in apparel prices (-0.8% after -0.9% in March) and declines in used auto prices to blame.  Core CPI was 2.1% in year-terms.  Analysts were suggesting this fall in apparel prices could still be the methodology/measurement changes introduced last month spilling over into April.  Also, lurking behind the scenes is an emerging uplift in US rent inflation in recent months with the vacancy rates very low.  Rent is nothing less than 40% of the US CPI.  Some service sector inflation reading also seem to pushing a little higher.  This is all before higher tariffs come into effect.

Fed President Bostic mentioned Friday that should the tariffs eat into household purchasing power and crimp consumer spending, then that could lead the Fed to ease.

The UK released it Q1 GDP and it met expectations, despite the Brexit train wreck.  Growth rose 0.5%, annual growth up to 1.8% from 1.4%, matching the consensus.  Also, Manufacturing production in March rose 0.9%, annual growth increasing from 1.2% to 2.6%.  EUR/GBP drifted lower after the release before reversing course again.

Coming up

• It’s going to be pretty much a focus on the trade issue.  Is there any prospect of a deal before G20 (it sounds not), retaliatory from China, the other $300bn of Chinese imports not (yet) subject to tariffs and market/trade/economy fallout.  Lots of focus on USD/CNY today too.
• Housing finance approvals for March is out today (11.30 AEST) with NAB and the market looking for a 0.5% decline in the headline number of owner-occupied loan approvals.  There’ll also be close attention to the investment lending approvals that after a run of negatives since last August actually managed a modest 0.9% rise in February.  A return to a decline is expected, down 1.5% in value.  Housing investor credit growth has stalled, annual growth now sub 1% and still easing, already at the lowest ever.
• RBA Deputy Governor speaks this afternoon on a panel discussing ”The End of Libor and the Impact on Australian Financial Markets”, but will he be asked about the economy and monetary policy settings?  That to start this afternoon at 5pm AEST.
• NZ food prices are out this morning while there are more Fed speakers scheduled for tonight.
• Looking further ahead this week, there’s the April NAB Business Survey tomorrow, Q1 wages Wednesday and the April unemployment and employment reading on Thursday.  NAB looks for a rise in employment of just 5K, softer than the market’s 15K with the risk that the unemployment rate could tick up to 5.1%.
• China releases it April monthly activity indicators on Wednesday.

Market prices

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