Maybe I should have used yesterday’s headline today as never a truer sentence was said in jest. That’s how one can read today’s market. Trump in one fell move has sought to impose tariffs on steel and aluminium. Thus, he set in a chain of events that will most likely have a significant impact on markets and certainly markets in the U.S.
Trump with his tariff has now not only upset the Chinese. He will also upset the Europeans and especially the Germans. We have already seen price rises in washing machines and other white goods. An increase in steel and aluminium prices will impact the input costs for car manufacturers as well as drive prices for automotive vehicles higher.
And in another twist, the U.S. Ambassador to Mexico has just resigned in the middle of a fairly testy trade negotiation relating to NAFTA. The tariffs on steel and aluminium are interesting because the U.S. does not have enough manufacturing capacity that it can draw down. Much of the excess capacity in days gone by have fallen into disrepair. They would require significant investment and time to bring them back into production.
The retaliation, however, against the U.S. may also be equally brutal. China has said it may impose tariffs on soya beans, a key feed in their pig farms. Such a move would hurt U.S. farmers. Feed can be substituted, new suppliers found. In the Chinese pig farms, there is a drive to be more efficient and automated. Automation would reduce feed wastage and increase efficiency. The U.S. will also be in for a rough ride as trade wars always result in industry losses and unintended consequences.
Political intrigue is ramping up again and at the same rate, so too, is the Vix. The one thing that equity traders loved was the low volatility that equity markets exhibited and like the frog in hot water have not anticipated this rise.
Equities sold after the tariff announcement and, strangely, bonds rallied. The only reason can be that tariffs will help the budget as anticipated tax revenues may not be realised. The fear that is missing for bonds is inflation and inflation will surge with the tariffs being imposed.
Fear of issuance has yet to be realised. But that surely won’t be too far away as that with rising inflation will cause hard decisions to be made. One of the reasons perhaps for the rally is that the Atlanta Fed, which runs a live econometric model of 15 variables, was suggesting that in early February the U.S. economy was growing at a white-hot pace of 5.2%. But that has been revised back to 2.6%, which bizarrely enough is the same as the yoy growth rate and slightly above the December number for GDP growth.
Bonds, however, won’t be a safe haven. There is now too much at stake. The Chinese may well decide to impose an investment embargo on the U.S. and such a move would be a major hazard for U.S. treasuries. China recently was the major investor in the 7 -year auction and has been a massive buyer of U.S. treasuries. Should China step aside like the Japanese have already done then the challenge will be to find investors at current levels.
Yes, bonds can rally for a little while. However, the real challenge will be to find buyers as the ECB, Fed and SNB all slow their purchases or start to sell their holdings. Combine that with a rising deficit and probably a widening trade deficit, then the U.S. bond market starts to look not quite the AAA rated economy one thought they were investing in.
Equities no doubt will be caught up in the rising rate scenario and will require a certain amount of repricing. The Vix has now risen to about 23. At this level, it starts to indicate bearish signals. For Trump, who has seemingly pinned his success as a President to the stock market, this may turn out to be not such a good idea. Equities are seeing selling pressure. Investors are starting to rotate out of the manufacturing sector into sectors such as oil which are not so affected by tariffs.
For an economy that needs to grow at 3% to pay for its future needs, a slow down in the economy could prove to be disastrous. That is something the Trump Administration will have to grapple with, probably sooner rather than later. The warning signals are now flashing. Sure, bonds rallied following Powell’s comments today that the economy was not overheating.
But to meet budget needs, the economy has to grow in excess of 3% and at excess employment this is an extremely ambitious goal. Bond investors will one day think about this. But for the moment, the hint of a slowing economy caused bond traders to do what they should do and that was to buy. They can now think a little later on deficits, funding gaps, issuance, drying up of central bank purchases and rising inflation at a later date.
Today was a buying day for investors in bond markets but not such a good day for equity investors. Europe may well end up being a better investment choice as the U.S. has a number of internal issues to grapple with. And these issues will not be easily dealt with.
Equities: The S&P 500 fell 1.28%. The Dow fell 1.6%. The Stoxx 600 fell 1.3%. The Vix closed at 22.25.
Currencies: The Bloomberg Dollar Spot Index fell 0.1%. The euro rose 0.4%
Bonds: The ten-year closed around at 2.81%. The 2-year closed at 2.22% and the 30-year closed at 3.09%. The ten-year bund closed at 0.64 and the UK gilt closed at 1.47%. The OAT closed at 0.91%. The U.S. curve closed 2/10 at 58.8bp, 2/30 at 87 bp and the 10/30, closed at 28bp. The U.S. 5-year closed at 2.58.
Commodities: The WTI fell 0.8 %. Gold fell 0.3%
Bitcoin is trading around $11,028.62.
Aussie Market Today.
Today looks likely to be a down day for equities. What should be a period of up markets looks like it may become a period of bear movements. Until sentiment changes we may see a few more down days
The AUD is likely to be a little stronger.
Bonds are likely to have a better day today. Bonds look likely to follow the lead from offshore and continue the rally. With a trade war looming, Australia looks to be in a good space compared to the U.S.. As such, bonds can probably rally or at least hold current levels until there is new information to challenge the direction.