Bad medicine is what I got.

What Trump gave markets on the week was bad medicine. It just took us a while to realise just how bitter that medicine tasted. In response, China launched its own tariff increase just before the U.S. open and that set markets into free fall. The Dow over the day fell 2.38% and the S&P 500 fell 2.41%. The Vix rose to 20.55 and that really set the tone of the day. And maybe just maybe the days of Goldilocks markets has ceased.

And the bizarre thing is that with the Chinese increase, Trump has considered levying more tariffs on Chinese goods. The responses have become a tit for tat exercise, and this has become a situation where there can be no winner.

Traders today saw the Vix post its biggest daily gain of the year. Of the 11 sectors of the S&P 500 only utilities ended in the black. Tech stocks suffered the largest decline. The Philadelphia Chip Index fell 4.9% and is now down 6%.

Amongst the stocks vulnerable to tariffs, Boeing fell 4.9%, Caterpillar slid 4.9%, and Apple fell 5.8%. The recently floated Uber Technologies fell 10.8% and Lyft fell 5.8%, Tesla hit a two-year low and was down 5.2%. Volume on the exchanges was good with 8.24 bio shares trading compared to a 20-day moving average of 6.97 bio.

Trade is on the markets minds. And with Europe looking to finalise a list of U.S. goods in the event that Trump imposes levies on their cars, the situation is and can only become more complicated.

Bonds became the flavour of the day once again. The 3-month/10-year curve inverted again.  If it remains that way, it  could become a concern to investors that a recession is coming. Many investors view the yield curve as a leading indicator.

Buying of bonds was across the curve and especially so in the longer dated treasuries as shorts were being covered. The prospect of an easing by the Fed was the bet of the day. One major trader apparently has set up an option position and paying $2.5 mio for the privilege to bet that there will be more than one easing and possibly two by year end. Some traders are targeting a fall of 75bp by mid-October.

There is an interesting twist in all of this noise. As there always is a twist. The twist is that the Chinese Government has apparently asked a number of academics how it can best sell down its U.S. bond holdings. This is not necessarily a gasp moment, because if the Chinese did sell their treasury holdings the belief is that U.S. would benefit.

Here’s how. By selling treasuries, the Chinese would be repatriating cash and this repatriation would cause a weakening of the USD. This would be beneficial for both the trade gap with China and cheapen U.S. exports.

A sale of treasuries also means that rates would rise, and bond yields as well would rise. Such a rise would create demand from other sectors for U.S. debt. And for the banking system, higher interest rates and a steeper yield curve would incentivise the sector to lend. That’s the theory, would it work in practice – who knows? – as these events often end in an unexpected manner.

The net position after the tit for tat rumblings is that emerging market risk is being sold as traders derisk. Periphery debt such as the sunbelt debt is also being sold. Italian 10-years rose to 2.74% before closing at 2.7%. Over the week, Italian bonds have risen some 13bp, not all of which is trade related. Italy/ Spain 10-years is now at 172 bp. German / U.S. 2-years are now around 281bp the tightest since March.

The Rant.

Today was not the best day for stocks. Apart from the plunge in U.S. stocks, European shares lost 1.2% and emerging markets slipped 1.7% and an estimated $1 tr plus was wiped from the stock market today. The safe haven are now the popular bets with gold, safe haven currencies such as the yen and treasuries and German bunds proving to be the popular bets as risk off bets take hold of markets.

The trade spat between China and the U.S. is starting to become interesting as both parties are finding leverage difficult to source. China has run out of raw materials to target and really the only sector that can be targeted revolves around energy.

China has spared oil from tariffs and if this spat becomes heated then you could easily see China revert to purchasing sanctioned Iranian oil. Refined products such as gasoline and biofuels do attract tariffs. Chinese purchases of crude from the U.S. have dramatically reduced as refiners distanced themselves from the political imbroglio. U.S. oil does suffer from not being all that clean and that too may be a reason.

China has imposed a 25% tariff on soybeans, a necessary component in hog feed. China is now sourcing soybean from Brazil and other Latam countries.

Who wins the trade war?  It’s hard to say, but Trump’s boast that trade wars are easy to win is going to be tested. For the moment, the actual burden of tariffs has fallen on the consumer, whilst the sellers are still selling at the same price.

The higher prices on capital and intermediate goods through tariffs is making it more expensive to manufacture goods, making U.S. manufacturers less competitive. U.S. farmers have been hurt and with another $15 bio of aid being pledged by the Trump Administration it’s a burden on taxpayers. The U.S. farmer would prefer to be exporting as more money can be made compared to receiving aid.

For China, the real danger is that many multinational companies will look for other places to produce goods. There is already a noticeable slowdown in foreign direct investment. China may have to shift from exports to investment in order to sustain growth, and this would push the country towards a less productive model.

What we don’t know, however, is if Trump is using the trade war as a way of holding back China’s ascent as a world power.  A trade war would certainly harm the U.S. but the costs to China would be deep and long lasting. Geopolitical primacy being the objective.  The alternative is that Trump is playing to the beating heart of his supporter base, trying to look tough and in doing so there is less to be gained by striking a deal. If the goal is to weaken China then what we are seeing are the opening salvos for a long and protracted period.

Market Recap.

Equities: The S&P 500 fell 2.41%. The Dow fell 2.38%.  The Vix closed at 20.55. The Stoxx Europe 600 Index fell 1.2%.

Currencies: The Bloomberg Dollar Index rose 0.2%. The euro was flat. The pound fell 0.3%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.403%. The 2-year is trading at 2.19% and the 30-year is at 2.838%. The U.S. curve closed on the day with the following closes 2/10 at 21.2 bp, 2/30 at 64.7 bp and the 10/30 closed at 43.4 bp. The U.S. 5-year closed at 2.185%. The 2/5 spread is now -0.7 bp. The ten-year bund closed at -0.073% and the British gilt closed at 1.097%. The 10-year yen gilt is trading -0.048%.

Commodities: WTI fell 1.4%. Gold rose 1%.

Bitcoin is trading around $7,892.

Aussie Market Today.

The ASX will be hit with a risk off day. Unless we see some commentary out of China, the day is most likely to be a sea of red as stocks capitulate. Hong Kong is back today, so expect better volumes on the day. I cannot see how the ASX can rally without some form of support. The old adage sell in May and go away certainly appears to have been the way for stocks.

Today is risk off. Bonds will rally aggressively on the moves of last night. UST’s rallied some 6bp and we will most likely do the same. With the deterioration of trade talks, global growth becomes questionable and if that’s the case then the front end should stage a neat rally as it looks for an easing from the RBA. These events make an easing more likely and the election result will be known. Credit will drift wider on the day as the equity markets sell. The AUD is under pressure and is likely to remain that way for a while yet.