How worried should investors be about Trump’s latest tariff move?

How worried should investors be about Trump’s latest tariff move?

How worried should we be about Trump’s latest tariff increase on Chinese goods?

Global markets ended the week reeling from the latest escalation in trade tensions between the US and China, after Donald Trump slapped a 10 per cent tariff on $300bn worth of Chinese goods. Equities, US bond yields and oil prices all tumbled, while China’s renminbi weakened to its lowest level this year.

Few had expected last week’s round of trade talks — the first since a fragile truce struck in Osaka between Mr Trump and Xi Jinping — to yield immediate results. But investors were caught flat-footed by the suddenness of the tariff rise, with markets still digesting the implications of the Fed’s landmark cut earlier in the week.

Investors clearly think the news will raise growth worries at the Fed — expectations for a rate cut at the bank’s September meeting zoomed from about 60 per cent to more than 95 per cent, according to Bloomberg data.

Analysts at UBS said that while most businesses should be able to survive the escalation, the uncertainty created could weigh on investment, business confidence and hiring. But they added that “the aggressive change in tone by major central banks, and the hope of a deal to forestall implementation before September 1, may help to soothe some of the sting of this announcement”.

Others speculated that markets might be in for a long period of trade war-related uncertainty, at least until the US election in late 2020.

“We believe China’s strategy in this trade war escalation will be to slow down the pace of negotiation and tit-for-tat retaliation. This could lengthen the process of retaliation until the upcoming US presidential election,” said Iris Pang, economist at ING. “It won’t have escaped the authorities in China’s attention that a full-blown trade war is unlikely to help President Trump’s chances in the election.” Siddarth Shrikanth

Will Boris Johnson’s ‘boosterism’ capsize the gilt market?

With Boris Johnson in Number 10, austerity is well and truly over. The new prime minister has promised a spending spree to help the economy navigate Brexit — a strategy he has labelled “boosterism”.

This shift in Conservative priorities away from fiscal restraint is already showing up in the market for UK government bonds, known as gilts. In general, gilts have rallied over the past two weeks as risks of a no-deal Brexit rise. The thinking among investors is that leaving the EU without a deal will hurt the economy, forcing the Bank of England to cut interest rates — the same logic that has seen sterling tumble.

But the rally has been uneven, with longer-dated gilts lagging behind. The gap in yield between a 10-year bond and a 30-year bond widened last week to the most in two years.

The reason is investors are gearing up for increased gilt issuance as the government increases borrowing to pay for Mr Johnson’s pledges of more police officers, hospitals and railway lines, according to Peter Schaffrik of RBC Capital Markets.

“The balance of supply and demand plays a much greater role in longer-dated gilts, whereas the short end reacts to interest rate expectations,” Mr Schaffrik said.

Despite the relative weakness of 30-year UK debt, outright borrowing costs have still fallen. That is likely to continue as long as Brexit concerns trump the shifting supply-and-demand dynamics in the market. In fact, the most bearish scenario for gilts of all stripes would be a sudden reduction in Brexit tensions. “If Brexit was somehow cancelled, that would be a big blow for gilts,” Mr Schaffrik said. Tommy Stubbington

Will the US service sector spring back?

Data on US service industries, out on Monday, will offer investors a glimpse into the effects of slowing global growth on the sector, a vital cog of the US economy.

The Institute for Supply Management’s non-manufacturing purchasing managers’ index is a proxy for the health of services businesses — spanning agriculture, mining, construction, transport, communication and retail. The data relate to July and are anticipated to touch 55.6, according to a survey of economists by Bloomberg, where a score above 50 indicates growth.

Recent data have revealed a softening across the sector. June figures disappointed, coming in at 55.1 compared with expectations of 56. This marked the lowest reading since July 2017 and indicated a slowdown in purchasing activity. The poor showing deepened concerns that the US is feeling the effects of slowing global growth and the trade stand-off with China.

The data follow the US Federal Reserve’s interest rate cut last Wednesday, which clipped the benchmark lending level 0.25 percentage points, as the central bank looked to boost inflation in the face of a dimming outlook for the global economy. The Fed was the latest central bank to ease monetary policy following a wave of dovish moves in Europe and Australia.

“Our economists assign a low probability to recession in the near future,” David Kostin, chief US equity strategist for Goldman Sachs, said. “The current economic expansion is now the longest on record, but the growth in nominal GDP has actually been smaller than most other cycles and a few imbalances stand out at the moment.” Richard Henderson

How will the BoJ respond to slowing growth?

Japan’s central bank kept monetary policy on hold at its July meeting, but indicated it would boost easing measures on any new evidence of economic weakness or signs that it is further drifting from its long-elusive inflation target.

Such signals are percolating in Asia’s second-biggest economy. Japan has cut its growth forecast for 2019 as the fallout of the US-China trade war takes its toll, while business sentiment among large manufacturers is at a three-year low. Meanwhile, inflation, excluding fresh food, was just 0.6 per cent year on year in June, its weakest in two years.

This Friday Japan will issue preliminary second-quarter GDP figures, with Bloomberg forecasting that growth will slow to 0.2 per cent from 0.6 per cent in the first quarter. An expected October sales tax rise could put pressure on the economy later in the year.

Global developments could also weigh on the Bank of Japan. The Fed’s interest rate cut for the first time in more than a decade last week comes ahead of the European Central Bank’s likely move to embark on renewed stimulus in September. Lower interest rates overseas would make Japanese assets relatively more attractive for investors, which could push up the yen, harming the export economy. “The real moment of truth for BoJ policy will come in September,” said Barclays economist Tetsufumi Yamakawa.

The bigger debate is what the BoJ will do. Lowering interest rates deeper into negative territory from minus 0.1 per cent will further squeeze profitability at banks and could destabilise the financial system. The central bank is also a dominant force in ownership of government bonds and exchange traded funds after years of quantitative easing, and has been reluctant to expand asset purchases further. Daniel Shane

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