Insight Multi-Asset weekly update: Interest rate cuts overshadowed by ongoing US-China trade war

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Market and economic review

This week’s economic data overshadowed by trade war concerns

While the primary driver of risk assets last week has been the escalation in US-China trade tensions, key economic data did play some part in moving the market. The US non-manufacturing ISM fell to its lowest level since August 2016. Chinese exports showed a strong increase, confounding expectations of a small decline. July European PMIs were mixed although Italy was stronger than expected. Several central banks cut interest rates with the main surprise being New Zealand’s 50bp cut to an all-time low of 1%. India cut rates by 35bp, the fourth cut this year, sending its benchmark rate to a nine year low. Central banks in Thailand and Belarus also cut rates by 25bp and 50bp, respectively.

On Twitter, President Trump raised the pressure on the Federal Reserve (Fed) to cut rates further saying “They must cut rates bigger and faster”. St. Louis Fed president, James Bullard, said that he has one more hike “pencilled in” for this year, while Chicago Fed President, Charles Evans, said that he had expected two 25bps rate cuts this year when he submitted his dot in June, but seemed to indicate that he now favours more accommodation.

China officially labelled a currency manipulator

Last Monday, the US officially cited China as a currency manipulator, the first time since the 1990s. However as this designation came under the 1988 act, it is less disruptive than the 2015 act which automatically starts sanctions. Under the 1988 act, all that is required is for the US government to seek negotiations with the accused government. However, the two countries have now been talking for over a year. A tail event could see Chinese firms being prohibited from receiving US government contracts. A more immediate concern, however, is the potential of currency intervention by the US and further tariffs.

In addition to China being labelled a currency manipulator, there were several hostile comments between the two nations, including a comment from the Global Times that said “Chinese enterprises have halted buying US farm products. The Chinese side won’t submit to the US.” In addition, the US banned the government from purchasing goods from five Chinese firms, including Huawei. The South China Morning Post was more optimistic, saying that “insiders on both sides expect September’s trade talks to go ahead” while Director of the National Economic Council Larry Kudlow said that “The president and our team are planning for a Chinese visit in September”. Separately, there was some positive news flow between Japan and South Korea, with Japan allowing some exports of semiconductor materials.

Markets whipsaw due to trade war concerns

Equity markets sank early in the week before recovering part of their losses. Government yields remained low, with the German 10-year bunds falling below -60bp for the first time. Curves continue to flatten, with the entire German bund curve falling into negative territory. There were reports that Germany was mulling a “fiscal U-turn” by issuing debt to finance climate protection programmes.

Currency moves were also substantial, with the Chinese onshore yuan breaking the key resistance level of 7 against the USD, prompting concerns of competitive devaluation against an already fragile global growth backdrop.

Oil prices slid after disappointing data on US inventories, but they slightly recovered after Saudi Arabia said they are considering all options to support oil prices.

Italian coalition could be close to collapse

Matteo Salvini, the deputy premier of Italy and the head of the League party, filed a no-confidence motion against the prime minister on Friday raising political uncertainty in eurozone’s third largest economy. On the Friday, the yield on the Italian 10-year government bond sold off by more than 20bps. It is unclear at this stage when the motion is expected to be debated as the Italian parliament is in summer recess. The League is currently polling nearly 40%, almost twice that of the 5 Star Movement. An alternative to new elections would be for the League to form a new government with the centre-left PD party.

UK threatens no deal Brexit

Dominic Cummings, Boris Johnson’s senior advisor, has reportedly told MPs that losing a no-confidence vote would not stop a no-deal Brexit as the prime minister could call an election after 31 October. Jeremy Corbyn, the Labour leader, has written to Cabinet Secretary Sir Mark Sedwill saying this move would be “anti-democratic abuse of power” and asked him to intervene to prevent a no-deal Brexit from happening during a general election campaign. Jeremy Corbyn said his party would propose a no-confidence vote at an appropriate time after parliament returns on 3 September. The GDP data release from last week showed that the economy contracted in the second quarter for the first time in more than six years. The data reflects in part an unwinding of inventory build-up over the first quarter as businesses prepared for a departure from the European Union in March. 

Outlook

While there are several economic releases this week, focus is likely to remain on trade war considerations. In Italy, Deputy Prime Minister Matteo Salvini is due to speak in Sicily, which could provide some insight regarding a new election. In Argentina, voters will decide on the candidates for president and vice president in their elections.

The main focus is likely to be the US CPI report on Tuesday, as this could impact expectations for further interest rates cuts. There are also July retail sales, weekly jobless claims and industrial production figures for the US released on Thursday.

In Europe there are several figures for Germany, including the second quarter GDP and the August ZEW survey. There will be final CPI revisions for Germany, Spain and France.

In terms of releases out of the UK, there will be employment data, retail sales and CPI releases. Regarding central banks there are interest rate decisions from Norway and Mexico on Thursday. OPEC will also release its monthly oil market report.

By Adam Kibble, Investment Specialist

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