Insight multi-asset weekly update: Government bond yields fell to multi-year lows, more Trump tariffs

Adam Kibble

Market and economic review

Government bond yields fell again to multi-year lows and risk assets were on the back foot as growth fears intensified

In a holiday-shortened week with relatively little macroeconomic data to absorb, risk appetite remained firmly on the back foot. Continued concerns that escalating trade tensions might tip a fragile global economy over the edge were at the forefront of investors’ minds, with the US threatening further tariffs on both China and Mexico. The rally in core government bond yields intensified, with the 10-year Treasury yield falling to its lowest level since September 2017. Meanwhile, the US yield curve (3-month to 10-year) inverted to -13bp, a level not seen since 2007. Similar moves were evident elsewhere. For example, the 10-year German bund yield fell to -0.21bp, through the previous all-time low in 2016. 

Moves in other asset classes followed this risk-off tone with credit spreads widening and equity markets continuing their recent sell-off. The re-ignition of US-China trade concerns and, specifically, the intensification of the dispute over industry heavyweights – most obviously Huawei – are an additional complication in a conflict that is becoming more entrenched. In our view, the path to compromise is looking increasingly hard to find. In May, the MSCI All Country World Index has given back around 5%, while the MSCI Emerging Markets Index has lost closer to 8%.

Economic data released last week, particularly out of the US, were reasonable, with consumer confidence for May beating consensus with both the ‘present situation’ and ‘expectations’ measures improving. In addition, US Q1 GDP growth was revised marginally higher, helped by a rise in personal consumption. The prices component within the GDP report was revised marginally lower – continuing to point to a lack of inflationary risk.

At the end of the week, Chinese data provided the first insight into how the latest escalation in US-China tensions might be affecting the underlying economies. China’s official manufacturing PMI fell back below 50 (into contraction territory) to 49.4, with new export orders and new orders particularly weak. The services PMI was stable, which helped keep the composite PMI above 50, but given trade tensions, manufacturing data is the market’s focal point. To the extent that we have characterised the year-to-date rebound in risk as a battle between ‘policy hope’ and ‘economic fragility’, the escalation of geopolitical risk represents a material challenge to the tentative signs of stabilisation we have witnessed in recent months.

On Friday, President Trump added more uncertainty into the mix by announcing a 5% tariff on all Mexican goods (effective 10 June) and that these tariffs would move higher if illegal immigration were not curtailed. Whether the president will go through with this threat is unclear but the potential implications could be even larger than the US-China trade dispute. To put that into context, US imports from Mexico totalled $346.5bn in 2018. If the full (25%) tariffs were applied, the $87bn effective tax in Mexican imports would be larger than all of President Trump’s other China tariffs combined.

European parliamentary elections see dawn of new era

Away from markets, the European parliamentary election results were broadly in line with expectations, which meant populist and anti-establishment parties gained support. That said, although the political duopoly between the centre-left socialists and the centre-right European People’s Party lost its traditional absolute majority, pro-European groups will still hold a majority of two-thirds of the seats in the next European Parliament. Policymaking looks set to become more complex and require broader cross-party agreements. With many key positions up for new appointments, much depends on the alliances formed in months ahead.

A taste of the challenges came on Wednesday when the European Commission wrote to the Italian government asking for an explanation on the country’s deteriorating debt position. The Italian Deputy Prime Minister Matteo Salvini’s right-wing party did well in the European parliamentary elections and a move by the Commission to restart its ‘excessive deficit procedure’ would be a blow to Salvini’s promise of a ‘fiscal shock’ to stimulate the Italian economy. Italian assets sold off in response to this renewed uncertainty, with the spread over bunds widening 24bp on the week, while the Italian equity market was the worst performer among the main European equity bourses.

The European election results in the UK did nothing to ease Brexit concerns, with both the Conservative and Labour vote taking a battering in favour of both pro-Brexit and explicitly pro-EU groups. With the country divided on the issue, the UK government’s attempt to find a new leader to navigate the path ahead looks more challenging.

Outlook

Trade headlines will continue to be a key focus over the coming week, with the US administration now taking action on multiple fronts, in China and Mexico. Meanwhile, China has made it clear that retaliatory actions will follow. 

The initial Mexican reaction to the US tariff threat has been measured, with talks planned; however, officials have made clear that the tariff threat, “if turned into reality, would be extremely serious”.

By Adam Kibble, investment specialist