Trade headwinds blow stock markets over again

Summary

The week has inevitably kicked off on the wrong foot as deteriorating trade relations between the U.S. and just about every large economy in the world depress appetite for risk.

Sentiment trips on tariffs

Equity markets are lower in Europe and the U.S. as they were in much of the Asia-Pacific region. VIX, the market’s anxiety proxy, is simmering again and gold is also firm. China’s rapid retaliation after the U.S. pushed ahead with $50bn in tariffs linked to intellectual property and technology continues to rattle global markets as other major investment challenges build: chiefly, full-steam-ahead Fed policy exacerbating dollar liquidity issues for emerging markets just as the greenback/Treasury yield ascent puts EM assets under increasing pressure.

When, not if

Regardless of The U.S. administration’s intended dollar stance—which is largely a mystery after numerous contradictory statements—a hard-line on trade favours dollar strength against currencies dependent on exports and undermined by a weak current account balance. So, dollar impacts will remain a major watch point this week. Comments late last week by former National Economic Council Director Gary Cohn confirmed that dominance of White House trade strategy by hawks had been a long-time coming. His more moderate approach now seems to have been doomed well before he threw in the towel in April. As such, Washington’s threatened counter retaliation looks more like a matter of time rather than probability. At this point there’s every chance that the move will deepen pressure on shares, increase volatility further whilst rekindling a Treasury yield rebound.

Oil greases the sell-off

China’s surprise inclusion of U.S. energy imports among possible new tariffs also trains the spotlight on oil. The decision was out of the blue as energy products were not on a list of potential duties China previously announced. Hence the move triggers fresh price uncertainty, just as OPEC and other producing countries are expected to agree an end to their 17-month production cut this week. Having recently become joint top importer of U.S. oil, a threat by the world’s second-largest economy to levy duties on crude oil, natural gas and imports of other U.S. energy products could quicken the price slide off last month’s three-and-a-half year high. Brent-WTI divergence is also holding at the widest in three years, reflecting fully utilised pipeline capacity. This stresses the precarious nature of prices further, particularly when events threatening Libyan supply ease. The bounce by shares of oil majors like Royal Dutch Shell after Friday’s slump, is likely to be limited, by the timing of escalation.

Add immigration showdown to euro challenges

The euro, already wounded by last week’s ECB blindsiding, is back at a three-week low as the trade outlook adds further pressure. Angela Merkel’s preference of a more centrist immigration line is another factor. Close coalition partner CSU could defy the Chancellor for the first time in years by backing a “masterplan”, limiting immigration. The final decision has been left to the CSU chairman a staunch opponent of Merkel’s refugee policy but wary of internal CSU divisions. A potential fudge is possible. Neither possibility nor fact may lift the euro above an entrenched psychological level of $1.16, though. It was the high before last Friday’s data-driven sell-off. The dollar index has also seen a new 7-month high already. Flailing sterling helps; recent short covering exhausted. It’s unlikely the Bank of England’s statement on Thursday changes hike readiness to live, from neutral. Trader attention thus moves on to potential breaks under late-May lows. 29^th May’s $1.3203 will be the first watch if Friday’s $1.3209 goes. The yen’s 12-pip recoil at last look was aligned with other risk-off bids. Attempts to get below much below 110.30 have quickly been quelled though. Buyers may take such moves more seriously if they break the 200-day average, currently at 110.24.

BoE central this week

Only NAHB’s Housing Market Index remains today amongst ‘medium market impact’ releases. There are slightly more pivotal U.S. housing-related data in coming days: permits, starts and sales. But the only events that will be universally watched this week are Bank of England policy decisions, and even these will have an element of ‘damp squibbery’, due to lack of a press conference and economic forecasts. Friday will bear the week’s back-end loaded focus with Eurozone and U.S. PMIs and Canadian inflation. The dearth of much scheduled top-tier economic news will keep attention firmly focused on trade developments; fast market reactions are likely.