Drifting before the terms of trade are set
FT subscribers can click here to receive Market Forces every day by email.A sense of drift characterises markets at the moment, but that will change should the pattern of previous China-US trade negotiations swing back and forth between hope and frustration.
Trade tension has been animating financial markets for some time, with talk of a trade truce between the US and China flickering on the radar ahead of formal talks resuming next month.Here’s how global trade has deteriorated via data (as of June) from the CPB World Trade Monitor:
Where the rubber meets the road for the trade war is its harm to business confidence, which results in the deferment of capital spending. As shown below courtesy of UniCredit: “The growth of capital goods orders in the US and euro area — a closely-watched proxy for business investment plans — has now turned slightly negative.”
The case for optimism over trade is that both the US and China need to reach some kind of truce before the damage becomes too grave for either side. Recent easing by central banks and the summer collapse in bond yields show some nascent signs of life as Citi’s Global Economic index has climbed to its best level since April 2018, at a reading of plus 6, up from minus 32 in March. But the Surprise index for China has recently eased back below zero. When it comes to trade negotiations, expectations of a truce heading into the G20 meeting in June proved hollow and this remains a risk, no matter the hopes for some kind of detente. Mark Dowding, chief investment officer at BlueBay Asset Management, says:“A protracted ceasefire, avoiding ongoing escalation, would seem to us to be the most likely outcome from a political point of view, but further conflagration cannot be ruled out. Meanwhile, economic activity in China continues to weaken based on our analysis.”So as US and Chinese negotiators gather in Washington early next month, stand by for more volatility and whether the talks act like a barrier capping the recovery seen in equities from their August nadir. The FTSE All-World index has climbed more than 6 per cent from its depths of mid-August, while the S&P 500 index is just shy of its record territory set back in late July.
Looking back to early 2018 shows the FTSE All-World has effectively gone sideways in nominal terms, up 2.5 per cent, while the inclusion of reinvested dividends produces a total return of 7 per cent. The area around 350 points has been a significant peak (previously tested this July) since the market peaked in January of 2018 at 363.83. Such a period of sideways trading is seen by some as marking time before an eventual acceleration. This was the pattern for equities between late 2014 and the summer of 2016, when the slump in oil prices and China’s growth scare dominated market sentiment. But a push beyond the 350 point and even a test of the January 2018 peak, in the wake of any agreement between the US and China, must be weighed against whether such a deal holds water over time. That raises the next potential headwind for risk assets. Central bank easing and bond yields still within sight of recent lows have driven equity valuations higher. Removing trade as a source of tension (even for a short period) entails higher yields and pushes the bar for additional easing by the likes of the Federal Reserve only higher. It will be interesting to see how the equity market fares, particularly should current earnings growth suggest next year’s still-high expectations for profits look lofty and in need of a haircut. Another test of market sentiment is the risk that any interim deal between the US and China opens the door to the next trade battleground. A weaker euro from here may well prompt US tariffs on European goods from a White House that fails to appreciate the virtues of comparative advantage from trading with other countries.Quick Hits — What’s on the markets radarThe New York Fed is ready for the end of the third quarter, a time when funding stress can flare up. The markets desk at the NY Fed will conduct daily overnight repurchase operations until October 10, rolling over the $75bn it began injecting earlier this week. There are also term repos for a period of 14 days and up to $30bn of that will be conducted next Tuesday, Thursday and Friday. In a statement on Friday, the NY Fed said:“After October 10, 2019, the Desk will conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined.”The liquidity fire hose is wide open. Sterling’s climb abruptly paused on Friday after the Irish government warned a deal was “not close”. That reversed a rally in the pound that earlier touched a two-month high of $1.2583. Buyers of sterling were encouraged after Jean-Claude Juncker said he was open to British suggestions that a hard Irish border could be averted by conducting customs and regulatory checks elsewhere and by aligning Northern Ireland with EU agriculture and food rules.The ball remains in Boris Johnson’s court. As of yet the UK prime minister has not produced a proposal that solves the Brexit conundrum. India’s BSE Sensex index surged more than 6 per cent and closed up 5.3 per cent on Friday, with the equity market very receptive to the news of a big corporate tax cut and other measures designed to boost the Indian economy.Here’s an explanation for why equities are climbing from Mizuho’s Vishnu Varathan:“The equity market exuberance is understandable as ~5% annual ‘cash bonus’ from tax saved will boost corporates’ free cash flow; in turn corresponding to equity valuation gains of a somewhat greater order on a discounted cash flow model.”But these measures will pile further pressure on India’s budget deficit, while the issue of non-performing loans within the country’s financial system has yet to be tackled.Oil prices were a touch firmer, with the market consolidating after a volatile week. Brent crude around $65 a barrel sat roughly between last week’s close of $60 and Monday’s peak of $71.95. The question is just how much of a risk premium remains in the price, given the broad range of $56 to $66 a barrel from the end of May until this week. Your feedbackI’d love to hear from you. You can email me on email@example.com and follow me on Twitter at @michaellachlan.