Surprise.

As always with Trump, things are never as they seem. Friday’s movements were bullish. The twitterverse and White House commentary indicated that the U.S. was making ground on trade talks with China. There was a reason to be optimistic. Whatever markets did Friday is now largely irrelevant, as yet another tweet from Trump over the weekend appears to have elevated trade tensions.

Where the market at the end of last week was looking for constructive dialogue, it is now destructive. Currency markets have opened weaker for the AUD, yuan and Kiwi Dollar whilst demand for yen has surged. Not that much happens early in the day in the Pacific markets but no doubt the FX markets will be setting the trend.

Just where are the markets set? It’s hard to gauge. Does this mean escalating tensions need to be priced in? Or does this mean that a trade deal can be reached in the near term? Is it brinkmanship? Is it folly? Or are we about to step into a full-blown trade war? These scenarios are not priced into the markets in my view.

The FX market has priced in tensions,not a trade war and so too the bond markets. What we now see are weakness in emerging currencies, gains in haven assets such as yen and U.S. treasuries and increased volatility. With the Hong Kong market closed today it will be interesting to see how Asia reacts. The expectation is that Chinese corporates will look to buy dollars as they have about $840 bio of foreign exchange loans and with a falling yuan they will look to act pre-emptively.

For the stock traders, the tweet will have come as a surprise and their problem will be to figure out where the market is heading. One can look at balance sheets and review income statements, but at the end of the day they have to look at Trump’s twitter account for the daily direction.

Friday saw stocks rally on optimism and those expectations are likely to be dashed by the day’s end. It’s worth thinking about where the U.S. market is at present and it looks a little overvalued with P/Es around 16.8 times for the S&P 500 with a historic average of 15.1 times. Bond yields rose on the back of a buoyant stock market but today that trend is likely to reverse.

For the Fed there was a little good news. The CPI on Friday rose 0.4% and provides a 2.1% yoy. Weekly earnings rose 0.1% for April.

The Rant

Just when the Fed thought they had the market under control, Trump has set markets awry with yet another tweet. Markets are now positioned such that any sign of a spill over from the negotiations that causes slowing economic data or market distress will be seized upon.

Declines in stocks will lead to falling bond yields and a widening in credit spreads. The broader market appears to believe that the trade negotiations won’t drag on when realistically trade negotiations take time to agree.  That’s months and years not weeks.

If tariffs start to bite, bond yields could fall dramatically and traders appear to have forgotten Powell’s comments about a strengthening economy. Higher tariffs have simply not been priced in yet. And let’s not forget that this is just one of Trump’s trade spats. Trump still has to negotiate a trade deal with Europe.

Business confidence and consumer confidence could erode quickly.

If the bond markets are right and the Fed has to ease because of easing economic conditions, these circumstances will pave the way for other central banks to ease as well. The global economy looks and feels a little shaky at present, and a misstep could plunge the global economy towards a recession.

Remember Trump is now entering re-election mode and has already warned the Chinese that if they are waiting for him to lose, watch out as the negotiations in a second term will be more onerous.

Market Recap.

Equities: The S&P 500 rose 0.37% and the Dow rose 0.44%.  The Vix closed at 16.04 while the Stoxx Europe 600 Index rose 0.32%.

Currencies: The Bloomberg Dollar Index was flat while the euro rose 0.2%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.473%. The 2-year is trading at 2.272% and the 30-year is at 2.89%. The U.S. curve closed on the day with the following closes 2/10 at 19.7 bp, 2/30 at 61.7 bp and the 10/30 closed at 41.8 bp. The U.S. 5-year closed at 2.268%. The 2/5 spread is now -0.7 bp. The ten-year bund closed at -0.046% and the British gilt closed at 1.13%. The 10-year yen gilt is trading -0.047%.

Commodities: WTI was down slightly and WTI fell 0.5% for the week.  Gold rose 0.2%.

Bitcoin is trading around $7,114.

Aussie Market Today.

It does not matter what the markets did Friday as today will be a risk off day in all probability. Equity markets are likely to be weak in Asia unless we see yet another tweet. With Hong Kong out, volumes may be low.  And we may not see the full reaction to the weekends’ comments. The FX markets have already started to adjust.

Bonds, following Trump’s comments, will rally. A risk off sentiment is prevailing and this should continue through the day. Credit will be a little wider on the day.

The RBA will be watching with interest. And if this trend continues, the RBA could ease in June and that would be in line with falling bond yields and interest rates for bank bills. Later dated bank bills are pricing a cut and the 3-year bond future is already trading around 1.27%.

The yield curve is inverted between 1 and 5 years. The curve could flatten sharply in the long end if fears over recession in Australia increase. It looks likely that whoever wins the weekend’s election could be in for a fun period trying to wrestle the economy back into shape