U.S. Highlights
Effective today, the U.S. increased tariffs to 25% on $200bn worth of Chinese imports. The threat to extend a 25% tariff to virtually all Chinese imports “shortly” remains. This comes even as the two sides continue negotiations to reach a trade deal.
The U.S. overall trade deficit edged higher in March to $50bn, even as the bilateral goods trade deficit with China declined to a five year low.
Consumer price inflation continues to show little signs of accelerating, with both headline and core inflation around 2%. Things could change however, as tariff hikes filter through the economy.
Canadian Highlights
Today’s Labour Force Survey release took the spotlight with an above-expectations net job gain of 106.5K that left the unemployment rate a tick lower at 5.7%.
Canadian international trade bounced back to life in March. Unfortunately, this was eclipsed by substantial downward revisions to the prior month, resulting in an overall poor Q1.
The economic calendar was also heavy on housing data. Starts surprised on the upside, whereas delayed home sales data from TREB showed encouraging signs of demand in Toronto.
U.S.
LATE GAINS HELP STOCKS AVOID WORST WEEK OF 2019
A rally Friday afternoon pulled back the major indexes from their worst weekly declines since late December as the U.S.-China trade dispute escalated. The technology-heavy Nasdaq Composite Index performed worst, but the small-cap Russell 2000 Index stood out for being the only major benchmark to temporarily move back into correction territory, or down over 10% from its August 2018 highs. Within the S&P 500 Index, information technology shares performed worst, dragged lower in part by a decline in Apple. Industrials and materials shares were also weak as investors worried about rising trade barriers. The typically defensive consumer staples sector held up best. Volatility, as measured by the Cboe Volatility Index (VIX), spiked to its highest level since late January.
The trading week was also notable for Friday’s initial public offering (IPO) of Uber, which valued the ride-sharing company at around $75 billion. The amount raised by the offering—approximately $8.1 billion—made it one of the 10 largest IPOs in history and the biggest since Chinese Internet giant Alibaba Group’s debut in 2014.
WHITE HOUSE HIKES CHINA TARIFFS
Trade fears hampered sentiment throughout the week. Stock futures fell sharply after President Donald Trump tweeted on May 5 that the tariff rate on Chinese imports would go up to 25% at midnight Thursday. T. Rowe Price traders noted that shares quickly recouped losses after trading began Monday, suggesting that investors viewed the tweet as a negotiating tactic. Geopolitical worries in a different form dealt another blow to sentiment on Tuesday after Secretary of State Mike Pompeo canceled important talks with German leader Angela Merkel and suddenly flew to Baghdad in an apparent response to a rising military threat from Iran.
Markets took another leg lower at the end of the week, as it became clear that the White House would, in fact, follow through on its tariff threat. At 12:01 a.m. on Friday, the tariff rate increased from 10% to 25% on $200 billion in Chinese goods, joining another $50 billion in strategically important Chinese products already taxed at the higher rate. China immediately vowed to retaliate but did not immediately specify how it would respond.
NEGOTIATIONS CONTINUE, AND TARIFF IMPACT LIKELY TO BE DELAYED
The market’s reaction to the tariff hike was not as drastic as some had feared, with stocks rebounding Friday afternoon from their lows of the morning. The president did not extend the tariff to all Chinese imports, as he had previously threatened, and Treasury Secretary Steven Mnuchin may have also calmed investors’ fears by stating on CNBC that talks continued and negotiators were making progress. A suggestion from a Federal Reserve official that rising tariffs might persuade the central bank to cut interest rates may have also boosted sentiment.
The week’s relatively light economic data calendar did not appear to sway markets, with most reports coming out in line with expectations. Earnings season also began to wind down, with 57 S&P 500 companies expected to report first-quarter results, according to Thomson Reuters.
BONDS: TREASURY YIELDS FALL, BUT AUCTION SEES WEAK DEMAND
U.S. Treasury yields decreased amid reduced risk appetite as trade tensions between the U.S. and China ratcheted higher. (Bond prices and yields move in opposite directions.) In a development that may signal impending upward pressure on yields, however, a Wednesday auction of benchmark 10-year Treasury notes was met with markedly weak demand—Bloomberg reported that the so-called cover ratio of submitted bids relative to bonds for sale was the lowest since March 2009.
Municipals generated positive total returns as the technical backdrop remained strong. In Illinois, higher-than-expected revenues for the month of April prompted Governor J.B. Pritzker to set aside a proposal to lower the state’s near-term contributions to its pension systems and re-amortize liabilities over a longer period. News of the reversal was greeted positively by ratings analysts.
BUSIEST MONTH FOR IG ISSUANCE IN FIVE YEARS
The investment-grade (IG) corporate bond market was largely focused on the primary calendar, with May shaping up to be the busiest month for IG issuance in the last five years. Bristol-Myers Squibb and IBM accounted for the majority of the week’s issuance with deals of approximately $20 billion each. Credit spreads—the additional yield offered over comparable-maturity Treasuries and an inverse measure of the sector’s relative appeal—widened across most IG sectors, partly due to economic and political concerns.
Meanwhile, the high yield sector saw its busiest week of issuance since August 2018. The market was resilient despite equity volatility and heavy levels of new supply. High cash balances continued to drive buying activity, although below investment-grade funds reported outflows. The automotive and commodities-related segments experienced weakness amid growing U.S.-China trade tensions, and energy-sector bonds also significantly underperformed the broader market.
Europe
STOCKS HIT BY GLOBAL RISK AVERSION TRADE
Risk aversion swept across European markets, which followed global stocks lower after increased global trade tensions overshadowed solid corporate earnings and some improved economic data. The pan-European STOXX Europe 600 Index lost 3.5%, the UK’s FTSE 100 Index was off 2.4%, and the German DAX index was down about 2.9%. Volatility for the EURO STOXX 50 Index of blue chip companies rose to a five-month high.
BRITISH POUND SLUMPS UNDER DUAL PRESSURES OF RISK AVERSION AND BREXIT UNCERTAINTY
The British pound also took a hit from the global risk-off trade emanating from increased U.S.-China trade tensions. The British pound tumbled 1.3%, as risk aversion and Brexit uncertainty pressured the currency. Hynes believes it will be difficult for the pound to gain ground as long as Brexit talks between the UK government and opposition Labour party remain at an impasse.
EURO GAINS EVEN AS EUROPEAN COMMISSION CUTS REGION’S GROWTH FORECAST
The euro dropped earlier in the week but managed to gain 1.6% against the U.S. dollar by week’s end. On Friday, Germany reported an unexpected rise in March exports. Exports rose 1.5% from February and 1.9% from a year earlier, a sign that Europe’s largest economy may be in better shape than previously forecast. German industrial output also unexpectedly increased in March. However, the European Commission (EC) cut its eurozone growth forecast to 1.2% in 2019 from its previous forecast of 1.3%, noting that the region’s economy has been weighed down by the U.S.-China trade fight and Brexit uncertainty. The EC added that Italy’s budget deficit is on pace to reach 3.5% in 2020, above the 3.0% ceiling set by the European Union’s fiscal rules.
Japan
The Japanese stock market was closed on Monday, May 6, the last day of a 10-day extended Japanese holiday closure. The Nikkei 225 Stock Average fell 914 points (4.1%) for the week and closed on Friday at 21,344.92 but is still ahead 6.7% for the year to date in 2019. The broader measures of the Japanese market, the large-cap TOPIX Index and the TOPIX Small Index, posted similar-size declines. At the close on Friday, the yen stood at ¥109.72 per U.S. dollar, significantly stronger over the past two weeks, but it was virtually unchanged versus the ¥109.69 level at the end of 2018
JAPANESE PMI RETURNS TO GROWTH, WHILE EXPORTS DECLINE
The preliminary reading of the Markit/Nikkei Japan Flash Manufacturing Purchasing Managers’ Index (PMI) rose to a seasonally adjusted 50.2 in April (barely above the neutral 50.0 level separating expansion from contraction) from March’s final reading of 49.2. The improvement in Japanese manufacturing activity represents a three-month high. Companies hired workers and grew more optimistic about the business outlook, according to the survey taken earlier this week. However, the survey also highlighted a decline in new export orders—Asia’s exporters continue to be hurt by the U.S.-China trade dispute and by weak global demand for semiconductors.
MINISTRY REPORTS STEEP WAGE DECLINE IN MARCH
Japan’s Ministry of Health, Labor, and Welfare reported that pay in March fell 1.9%, which represents the steepest year-over-year fall since June 2015. The decline in wages far exceeded analysts’ expectations (polled by Bloomberg) for a 0.5% drop. The government said that the results may have been distorted by a slowdown in the method it uses to collect the data, but any decline hurts the central bank’s efforts to achieve its 2% inflation goal. Some analysts suggested that lower bonuses and fewer overtime hours worked were largely to blame for the falloff in earnings. However, the improvement in manufacturing activity reported in April could help to spur wages in the months ahead.
KATO SAYS THE PLANNED TAX HIKE SHOULD BE IMPLEMENTED IN OCTOBER
Senior Liberal Democratic Party Leader Katsunobu Kato affirmed that the planned consumption tax increase to 10%, slated for October, should be implemented as scheduled. He believes that, unless there is a financial crisis, the government should proceed as planned. However, he allowed that there will be a need for additional stimulus to bolster the economy, acknowledging “some domestic weakness due to external factors.” Japan’s fiscal 2019 budget already includes about ¥2 trillion (approximately $18 billion) of stimulus to offset the impact of the tax increase.
China
STOCKS APPROACH THREE-MONTH LOWS ON RENEWED TRADE TENSIONS
Mainland Chinese stocks slumped as trade-related uncertainty built up over the week, giving local investors added incentive to sell their holdings in one of the world’s best-performing stock markets this year. For the week, the Shanghai Composite Index and the large-cap CSI 300 Index, China’s blue chip benchmark, shed roughly 4.5% and 4.7%, respectively, pushing them both near three-month lows.
While Trump’s latest tariff escalation dealt a blow to investor sentiment in the short term, many analysts think it won’t have a lasting impact on China’s economic fundamentals. China’s economy is much less export-dependent than most people realize. Despite being a huge exporter, China’s net exports accounted for about 2% of its total gross domestic product in 2017, Moffett adds. Moreover, China currently trades far more with other developing countries than it does with the U.S., Europe, and Japan. In fact, the U.S. has less leverage with China today than it did 15 years ago, when trade was heavily weighted to developed markets, Moffett notes—all of which mitigates the pressure on China to capitulate to U.S. demands.
Meanwhile, trade negotiations between the U.S. and China will likely continue and offer a clear path to a possible agreement in the coming months, believes T. Rowe Price Policy Analyst Katie Deal. However, threats of escalation and of likely retaliation will increase investor uncertainty and the risk of derailment in the near term, Deal adds. Despite U.S. officials’ failure to clinch a deal, the Trump administration’s trade negotiations with China offer a politically useful tool for the president. Looking ahead, Trump will likely use tariff escalations as a way to stoke “tough on China” rhetoric ahead of the 2020 election, according to Deal.
Other Key Markets
SOUTH AFRICAN SHARES DECLINE ON FEARS OVER WANING REFORM MOMENTUM
Stocks in South Africa, as measured by the FTSE/JSE All Share Index, fell about 4.3%. Equities slipped with many world markets due to uncertainty about U.S.-China trade negotiations, but shares also declined as investors were cautious ahead of national elections on Wednesday. While the ruling African National Congress seems poised to win—ballots were still being counted on Friday—investors and analysts were preparing for the party to lose some of its representation in the legislature due, in part, to economic frustrations; lingering negativity toward former President Jacob Zuma, who is accused of corruption; and impatience with current President Cyril Ramaphosa’s efforts to boost the economy and reduce corruption.
TURKISH STOCKS FALL AS GOVERNMENT MAKES PROGRESS IN OVERTURNING ELECTION RESULTS
Turkish stocks, as measured by the BIST-100 Index, fell about 5.8%. Shares sagged, and the lira weakened on news that Turkey’s Supreme Election Council accepted the ruling AK Party’s appeal to nullify the recent Istanbul mayoral election—which was won by an opposition candidate—due to the alleged participation of 40,000 ineligible voters. The new election is scheduled for June 23. In addition to a period of political uncertainty, investors were concerned that Turkey’s plans to purchase Russian military equipment will raise tensions with the U.S. and NATO allies. There are reports that Turkish troops will travel to Russia in June to begin learning how to use the S-400 missile defense system to be delivered to Turkey later this year.
On Thursday, in an apparent attempt to stop the lira’s weakness, the Turkish central bank announced several policy adjustments, one of which was the temporary suspension of its one-week repo auctions. This change forces banks to borrow from the central bank at the overnight lending rate of 25.5%, rather than the one-week repo rate of 24%.