Trade tensions alive and lurking; rates brace for more volatility

Trade tensions alive and lurking; rates brace for more volatility
Philip Wee, Eugene Leow13 May 2019
    Photo credit: AFP Photo

    FX: Trade tensions alive and lurking

    Trade tensions will continue to keep the US dollar firm against Emerging Asian currencies. US President Donald Trump made good his threat to lift, on May 10, the tariff rate on USD200bn worth of Chinese goods to 25% from 10%. Markets reacted calmly on signs that negotiations were carrying on following the decision. Both sides, however, failed to break the impasse. China continued to resist US pressures for stronger enforcement. It is uncertain if negotiations will resume to get the trade deal back on track. White House economic adviser Larry Kudlow said that Trump and Chinese President Xi Jinping will probably hold direct talks at the G20 Summit in Osaka, Japan, on June 28-29. Meanwhile, the US has started preparations to hit the remaining USD300bn of Chinese goods with a 25% tariff.

    Europe and Japan are, meanwhile, bracing for Trump’s decision whether to impose US tariffs on car and auto part imports to safeguard national security. Trump’s deliberation ends on May 18, ninety days after the Commerce Department submitted its Section 232 investigation report in February. Trump may, however, delay announcing tariffs. Unlike last Friday’s tariffs on China, auto tariffs lacked the support of the US Congress. This, however, will not stop Trump from using tariffs to hasten a bilateral trade deal with Japan ahead of his trip to the country this month and next. On the other hand, US and Europe have been talking about holding negotiations but have yet to announce any. The Eurozone economy has not weathered the last round of trade tensions well. The start of new friction could dry up the green shoots and undermine the European Central Bank’s expectations for a second half recovery.

    Rates: Brace for more volatility

    There will be little sentiment reprieve when Asian markets open today. At last week’s close, the market was still hopeful that the weekend would bring some positive narrative. Unfortunately, those have been lacking. Instead, tensions appear to have ratcheted up with Trump threatening to impose tariffs on all Chinese imports if a deal is not concluded within a month. Accordingly, the next few weeks would be volatile across all asset classes as the market brace for the possibility of no-deal. In the immediate term, we would be watching to see if China retaliates against last Friday’s tariff increase. The performance of the equity markets would also be critical. Thus far, the selloffs in China and the US indices have been minor. A more serious decline could prompt more urgency by both sides to reach a deal.

    Against this backdrop, haven demand will keep USD yields lower than they otherwise would have been. We think this will manifest largely in the front of the curve. Notably, Fed funds futures have priced in close to two cuts by end-2020. If trade war escalates further and threatens the US’s growth outlook, it is reasonable to assume that the Fed would ease policy rates. We doubt that the bump up in core inflation (that would arise from higher tariffs) would be a deterrent.

    Meanwhile, we do not like duration risks. While protracted trade tensions could nudge 10Y and 30Y yields lower, the curve has been steepening as 30Y yields appear to be sticky in the 2.8-2.9% range. Over the longer term, the US’s fiscal position is a concern and it is unclear if the likely increase in US Treasury supply could be digested if haven demand ebbs.

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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