Retreat, retreat.

The title pretty much sums up how markets and, in particular, stock and commodity markets, are reacting. Risk assets fell amid concerns that the trade war may take some time to resolve and then unravel, with some economists touting that it may take until 2035 for tensions to ease.

Goldman’s, for instance, sees a stalemate.  Nomura Holdings, which knows a thing or two about trade wars after being caught in 80’s in trade war between the U.S. and Japan, sees an escalation of tit for tat tariffs being increasingly waged. Trump and his administration have opened Pandora’s box.

Markets are now starting to price in the harsh reality that trade issues will linger and are not quickly resolved. The farmers will benefit from welfare to the tune of $16 bio to offset trade war losses. Meanwhile, soy farmers will need to find new markets and that could be difficult. The farmers will receive $14.5 bio in direct trade payment as part of the $16 bio package. Farmers were a key supporter base for Trump in 2016 and before the trade dispute, sold 60% of their crop to China.

The economic data released today show some impact on growth is underway. For instance, house sales fell to an 11 ½ year low.  And manufacturing activity is the lowest level in a decade. In addition, new home sales fell 6.9%. Moreover, an inventory overhang is hampering manufacturing with the U.S. manufacturing PMI declining to a read of 50.6. (Released earlier in the month). The slowdown is spreading from the manufacturing into the service sector.

The trade war is becoming the lexicon of the central bankers. Today, four Fed presidents on a panel spoke about the trade war.  San Francisco Fed President Mary Daly and Atlanta Fed President Raphael Bostic commented on the uncertainties of trade and how it could hurt growth. Richmond Fed President Thomas Barkin discussed a slowing resulting from trade barriers. And Dallas Fed President Robert Kaplan expressed concerns but in turn suggested it was too early to determine if the economy was slowing because of trade.

This was all too much on the day for stocks to digest. The defensive sectors performed today with utilities and real estate both showing gains. The rest of the indices were down and that tells the story. Technology and industrials slumped 1.7% and 1.6%, respectively. Financials and energy fell with energy falling 3.1%.  A 5% plunge on the oil price was the culprit for the decline in energy stocks. Volumes were high as the stock market eased into the Memorial Day long weekend. The day saw 7.61 bio shares traded on the exchange versus a 20-day moving average of 6.99 bio shares.

Bonds did what bonds do when risk is being taken off the table and rallied. Yields plummeted as risk appetite has faded with the 30-year at 17-month lows. The 10-year is at the lowest level since October 2017. Traders are now expecting that 10-years could fall to 2.2% and 2% for the 2-year.

The inversion between the 2s/5s is almost in mini panic mode given its recent movements. And the inversion is causing concerns both elsewhere in bond land and also stocks. The probability of a rate cut by October 2019 is now around 66.7% and by December it is now at 82.2%. The front end of the U.S. market is now pitching heavily for a cut.

Across the pond it’s not a lot different. In the UK, investors sought solace from the Brexit woes by accepting record low returns in exchange for protection from British inflation over the coming decade by purchasing index bonds at Thursday’s auction. The concerns are that with May’s exit, a new leader could be more aggressive in dealing with the EU.

The auction generated a negative real yield of -2.326%, the lowest levels since the UK sold index linked gilts since 1981. This means investors will receive a coupon of 2.236% below the retail price inflation, which currently stands at 3%.

German 10-year bunds also collapsed to a 2 ½ year low. A fresh dose of sluggish economic data added to concerns about the harmful impact of trade wars.

The Rant.

Inflation or the lack of inflation is affecting asset pricing and causing consternation for the central banks. Inflation has remained persistently low despite record low levels of interest rates and accommodative policies.

In the U.S. market, inflation linked bonds are losing appeal with investors starting to sell out of TIP ETF’s.

For the policy makers, sagging inflation prices increase pressure to cut rates, something we are seeing across many developed countries. There are concerns that central banks have become anchored to a point and that a 2% objective may be too high given the current level of interest rates. Perhaps in the new world the neutral rate and hence the neutral inflation rates need to be lower.

One obvious distinction coming out of the latest round of movements associated with the U.S./ China trade war is that those companies with a dependency on China or who have big sales to China are being penalised.

Market Recap.

Equities: The S&P 500 fell 1.19 and the Dow fell 1.11%.  The Vix closed at 16.92 while the Stoxx Europe 600 Index fell 1.4%.

Currencies: The Bloomberg Dollar Index was flat. The euro rose 0.3% and the pound fell 0.1%  while the yen gained 0.7%, its largest move in 2 months.

Bonds: (as at 4.30pm). The ten-year is trading at 2.322%. The 2-year is trading at 2.15% and the 30-year is at 2.757%. The U.S. curve closed on the day with the following closes 2/10 at 17 bp, 2/30 at 60.5 bp and the 10/30 closed at 43.3 bp. The U.S. 5-year closed at 2.117% and the 2/5 spread is now -3.6 bp. The ten-year bund closed at -0.12% and the British gilt closed at 0.957%. The 10-year yen gilt is trading -0.06%.

Commodities: WTI fell 5.4% while gold gained 0.8%.

Bitcoin is trading around $7,841.

Aussie Market Today.

Given the offshore movements, Aussie shares are likely to decline. Commodities are also under pressure and this won’t help the miners, a major portion in the weight of the ASX 200.

Bonds look set to open stronger. Bonds are already bid on Sycom and that trend looks likely to continue as risk off weighs heavily on markets.  The credit index will be wider on the day.

Demand for credit in the shorter terms appears to be well bid. This trend should continue for a little while as investors prepare for the RBA’s June Board  meeting and whether monetary policy will be adjusted.