Trade war ratchets higher, the Brexit battle intensifies while Italy looks to form a new government
The US/China trade war ratcheted higher over the weekend, with further tariff increases imposed on Sunday.
The US introduced tariffs of 15% on around $115bn of Chinese exports, including footwear, clothing and certain technology products. The US has forestalled an increase on remaining Chinese exports until 15 December but is then expected to target around $150bn of goods including consumer electronics i.e. laptops and mobile phones. Both swathes of tariffs are expected to have an increasingly visible impact on US consumer prices over the coming months. China carried out its promised retaliation, increasing levies on around $75bn of US goods, including pork, beef and chicken exports - and raising the tariff level on soya bean exports by a further 5% to 30%. If the US raises tariffs again in December, China will reintroduce 25% auto tariffs. President Donald Trump stated that the US was still in talks with China but would not continue to be “ripped off” by the nation. Chinese State media said that China would weather the tariff storm and that the impact of this fresh round would increasingly be felt by US consumers. US businesses are continuing to argue for a negotiated settlement - indeed, trade talks between the US and China are still scheduled for September but it is increasingly difficult to see how the two economies can de-escalate the current tensions. Meanwhile US business confidence shows increasing signs of softening as trade uncertainties mount, while the latest consumer sentiment measure retraced to levels last seen in 2016. In terms of this week’s economic updates - the latest US ISM manufacturing index arrives on Tuesday, while on Wednesday, the Federal Reserve publishes its Beige Book. Fridays sees the latest payroll report come out.
Italy’s new government negotiations are underway.
Following Deputy PM Matteo Salvini’s withdrawal of Lega’s support for the government, last week Prime Minister Guiseppe Conte accepted a new mandate to form a government between the Five Star Movement (M5S) and the Partito Democratico (PD). Discussions are ongoing on both the programme and the composition of the cabinet - and the situation remains fluid. M5S party members are expected to vote on a potential government deal tomorrow, on the online platform Rousseau. We believe that M5S and PD will manage to form a government and that elections will be avoided for now. But this coalition could be a fragile one, not only because it would have a slim majority but also because it could be undermined by internal divergence within the two parties. On the political front, two state elections took place this weekend in Germany. There was a clear shift to the right, with the anti-immigration Alternative für Deutschland party posting strong gains and coming second in Saxony and Brandenburg. But the CDU (32.4%) in Saxony, and the SPD (26.2%) in Brandenburg did slightly better than projected by polls, probably buying some time for the grand coalition. The next political events to watch - to gauge the life-horizon of the grand coalition - will be the Thuringia state election on 27 October, the election of the new SPD leader in the Autumn and the SPD half-term review party conference in December.
In the UK, Parliament returns from its summer recess tomorrow.
Controversially this will only be for around a week until Parliament is prorogued at some point next week until 14 October – a period of around five weeks, which would include the usual three-week break for the Party conference season. The coming week promises to be eventful, with anti-no dealers aiming to pass legislation to prevent the UK from leaving the European Union without a deal on 31 October. Such a short time scale is challenging to pass such legislation, even assuming Parliament has the numbers to do so - although this appears likely. The government will obviously try to prevent such passage, by perhaps threatening to withdraw the whip (de-select) MPs that vote against the government. It will likely implement other tactics, including delaying mechanisms to run the clock down in the Lords. While financial markets would likely enjoy a significant relief rally, should such legislation be passed, we do not think it will be that easy. The Boris Johnson government claims that any attempts to prevent a no deal exit merely weakens the UK’s negotiating hand before the 17 October EU Summit. However, we see little prospect of a revised deal before 31 October. We continue to expect a UK General Election to be held after 31 October. Indeed, this week’s hastily scheduled 2020-21 Spending Review and the desire to pass a Queen’s Speech, which can subsequently be used as an election manifesto, both appear to be the latest steps in pre-election planning. Critically, we expect an extension of Article 50 to be enacted to allow for a UK election, but this remains the key uncertainty. However, we are not banking on any certainty around this outlook much before the October deadline itself.
Argentina policy makers fighting to reduce financial instability.
The primary elections which took place on 11 August revealed an unexpected wide advantage of opposition candidate Alberto Fernandes (leader of Frente Todos movement) over incumbent President Macri (leading Juntos por el Cambio). In addition, financial instability has increased significantly as the economic environment remains highly vulnerable. The sharp depreciation of the currency and the strong derating of the financial markets triggered renewed instability. This prompted the government and central bank to introduce new emergency measures, among which was the reprofiling of the country’s debt repayment schedule - and more recently the imposing of FX controls via limits and restriction on FX use for households and corporates. These controls aim at reducing US dollar demand over the short term, and restore some confidence in the currency market. However, the success of these measure in the medium term depend on the ability of the government to achieve the reprofiling of its future debt payments. Otherwise, renewed currency depreciation is likely to push inflation rates higher, trigger tighter fiscal and monetary policies, dampen further economic growth and automatically propel debt-to-GDP ratio to unsustainable levels.
The Bleak House of global fixed income yields:
Markets traded with a risk off bias in August as presidential tweets about the US/China trade war and ongoing deterioration in manufacturing PMIs globally, kept investors on edge. Corollary to that, the inexorable march in rates lower only got worse in August, with 10-year US Treasury yields dropping by over 50 basis points from just over 2% and 10-year German Bunds fell by more than 25bp from -0.44%. This leaves global fixed income investors in the unenviable position of facing vast swathes of the fixed income spectrum at forbiddingly low, if not outright negative yields. This problem is particularly acute for euro-based investors where over two thirds of the fixed income universe, including government and credit debt, is trading with negative yields - and the same holds true for US dollar fixed income hedged back to euro. This is forcing investors either down the quality curve in search of spread pick or further out on the maturity curve in search of incremental yields. Either option carries a heightened risk. The former, in case recession fears in the US escalate repricing higher beta spreads wider. The latter, in case downside risks vanish, that could lead to a sudden correction with rates moving higher, which will prove particularly painful for longer maturities/durations.
US: ISM manufacturing Index (Tuesday), Trade balance (Wednesday), ADP employment change, ISM non-manufacturing index (Thursday), Non-farm payrolls, Unemployment, average earnings (Friday)
Euro Area: Euro Area PPI (Tuesday), Euro Area Composite PMI, Euro Area retail sales, Italian and Spanish Services PMI (Wednesday), German new manufacturing orders (Thursday), German Industrial Production (Friday)
UK: Manufacturing PMI (Monday), House of Commons returns from summer recess, Construction PMI, BRC retail sales monitor (Tuesday), Chancellor Javid delivers Spending Review for 2020/21 fiscal year, Services PMI, BoE’s Carney, Haldane, Haskel and Vlieghe give evidence on the Inflation report and Carney gives evidence on the UK’s economic relationship with the EU to the Treasury Select Committee (Wednesday)
China: Caixin Manufacturing PMI (Monday)
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