Whilst these topics are important, Tump’s tweet at 6pm UK time on Thursday stole the limelight and sparked a risk-off move, which is the focus of this update.
First to the Fed, which delivered the 0.25% cut investors had expected it to deliver on Wednesday. However, the cut was deemed by many to be ‘hawkish’ – dialling down expectations of further interest rate cuts. Investors who had already begun to price-in a second cut were surprised and forced to re-think their expectations. This caused the S&P 500 to post its first 1% loss in two months, whilst the dollar rallied some 60 basis points. Markets opened on Thursday to weaker than expected US manufacturing data. Traders took this as a cue that the Fed may be a little more accommodating than it had implied the day before so by the time European markets had closed, the S&P had recouped almost all the loses from the previous day.
The tweet in question announced tariffs of 10% on the remaining $300bn of imports from China, effective from 1st September. It came out of the blue for most investors – when the official word was that talks were progressing well – and so hit risk assets. US equities ended the day some 1% lower whilst the Semiconductor index, the ‘Sox’, which is especially sensitive to trade war escalation, fell twice as much, down 2% on the day. Meanwhile, gold rallied along with government bonds. The US 10-year bond yield fell to 1.84%, the lowest level since November 2016.
The majority of imports affected by the new tariffs will be consumer goods (roughly some $200bn of the $300bn). As a result, it is likely that these tariffs will be unpopular politically and Trump’s challengers will attack the President for harming American consumers.
Hu Xijin, a commentator considered to have an inside track on the Chinese administration’s thinking, said the new tariffs will make a trade deal further away as the Chinese will now prioritise planning for a prolonged trade war, not controlling it.
So why has Trump done this? Well he has used the tactic of ‘the stick’ before – with mixed success. However, it is known that the more Trump ratchets up the ante on trade, the more likely it is that the Fed has to ease. It is also well known that Trump wants lower interest rates. After the Fed said Wednesday’s rate cut was justified by global developments over trade, it makes sense that Trump would use trade to help push the Fed into cutting interest rates again. Chances of a cut to interest rates have risen, helping fuel the rally in bonds and gold and a weaker US dollar.
The question is now: how will China respond? With retaliatory tariff options limited, one option is to allow the Yuan to weaken against the dollar. The key Dollar/Yuan FX rate to watch for is 7 – which is symbolically significant. Currently it is 6.93.