Trade conflict escalates further over the weekend

Arne Lohmann Rasmussen Danske Bank A/S

Market movers today

Today, we get final service PMIs (including the ISM non-manufacturing index from the US), which will tell us to what extent the manufacturing slowdown is spilling over to the more important service sector (at least in terms of overall GDP growth and jobs growth).
Also today, we get Sentix Investor Confidence for the euro area, which is probably not going to show more encouraging signs.
Otherwise, this week we are looking forward to hearing from FOMC members for any signs of whether more cuts are in cards.
Also, we are looking for any news on trade policy after Trump's escalation last week. To us, it seems like a trade deal has moved further away, see China Weekly Letter .

Selected market news

The decision on Thursday night by President Trump to levy new tariffs on Chinese imports was not received well in financial markets. Especially, the global growth and China-sensitive German Dax index came under strong pressure, closing down more than 3% on the day and overnight the Nikkei was down by close to 2.5%.

Risk-averse investors flocked to fixed income and 10Y Bund yields were pushed below -0.5% during Friday's session. In fact, the whole German sovereign curve from zero to 30-year traded below zero for the first time ever, joining Denmark and Switzerland. There are now 12 countries in Europe for which the 10Y benchmark is trading below zero. Ireland could very well be next in line as investors look for markets that offer positive yields. In the US, more than a full 25bp cut is again priced for next month and the US curve has further inverted overnight, as 10Y yields are down 7.0 bp to 1.78%. Hence, we should see another significant drop in European yields when FI markets open this morning.

If anyone believed that China would 'give in', the answer came overnight, as the Chinese government asked its state-owned enterprises to halt imports of US agricultural products. Furthermore, the yuan made a spectacular 1.5% drop this morning, pushing USD/CNY above 7.0 for the first time in a decade. According to Bloomberg, the People's Bank of China said the move was due to "protectionism". Overall, the trade situation has clearly escalated further over the weekend.

The escalation could potentially be a more fundamental game changer for risk appetite. If Trump thought that financial markets would be ready to 'accept' a trade escalation just because the Fed is lowering rates, he could very well be wrong, especially when markets take into account the simultaneously global weakening of the manufacturing cycle.

Global central banks turned more dovish in July due to the trade war concerns. After the latest development, we believe there is little doubt they will now deliver more easing. Note in that respect that USD/JPY dropped below 106 and 10Y JGB yields dropped slightly below the -0.20% lower bound yield target this morning.

The Bank of Japan and Ministry of Finance will meet this morning to discuss financial markets. In the wake of the CNY drop, markets will be wondering whether Japan will intervene in FX market and ease monetary policy further.

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Author

Arne Lohmann Rasmussen

Danske Bank A/S

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