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Trading  | March 23, 2018

“The equity markets are getting clobbered, which is not that surprising with fears of a trade war breaking out”  – Paul Fage, TD Securities 

Global equities are melting as they take the full brunt of a break out in trade wars after China announced it plans $3BN in tariffs on US imports in retaliation to the $50BN in US sanctions, while the latest personnel turnover in the White House (with both Dowd and McMaster out) adds to fears of rising political uncertainty.

World stocks are down 3.4% since Monday, are on course for their worst week since early February, when a spike in volatility sent markets into a tailspin.

In the US, S&P futures are trading in the red, down 9 ticks as VIX make a trip back to the 25 handle, although they have since rebounded from the session’s worst levels.

Trade Wars

Overnight, China announced it plans tariffs on USD 3bln of US imports, in which it plans 15% tariffs on US steel pipes, wine and fruits, while it also plans tariffs of 25% on US pork and pork products. Furthermore, there were also comments from Mofcom that China doesn’t want a trade war but is not afraid of one, while the ministry added it hopes US will be prudent in its decisions and pulls back from the ‘brink’. Some tangential events:

  • Russia’s Ministry of Trade and Industry said they are preparing restrictions on US imports as a response to US aluminium and steel tariffs.
  • EU’s Tusk states that EU leaders have called for a permanent exemption from US tariffs.
  • The US launched a WTO complaint over China’s “discriminatory technology licensing requirements”.
  • Source reports indicate that China intervened overnight to support its stock market after tariff announcements triggered losses.

Asian stocks saw hefty losses amid trade war fears with ASX 200 (-2.0%) led lower by miners as Chinese metals prices slumped on steel demand and tariff concerns, while Nikkei 225 (-4.5%) was the worst performer and briefly fell over 1000 points as selling pressure was magnified by a firmer JPY. Elsewhere, Hang Seng (-2.5%) and Shanghai Comp. (-3.4%) conformed to the sell-off as Chinese stocks felt the pinch from the US trade offensive, while the PBoC refrained from open market operations for a net weekly drain of CNY 320bln

European stocks tumbled at the open, down 2% to the lowest level since February 2017, although they since cut the drop in half, with the Stoxx 600 currently down about 1%; basic resources (-1.9%), auto & parts (-1.9%) and banks (1.6%) are the three worst performers; there’s one bright spot: the telecom sector is up on the day.

As Bloomberg notes, it has been a miserable week for higher-risk markets globally, as a trade war edged closer, the tech sector was roiled by Facebook Inc.’s privacy scandal and data showed European growth sputtering. Traders had already been bracing for the possibility of slowing expansion as the Federal Reserve reiterated its commitment to further interest-rate increases after Wednesday’s hike.

“The window from coming back from an all-out trade war is still open, but closing fast, and obviously leaves a lot of uncertainty over the next two to three weeks,” said Kay Van-Petersen, a Singapore-based global macro strategist with Saxo Capital Markets. It is “classic risk-off for equities today and potentially over the next few days.”

In FX, the USD/JPY slides below 105, a level not seen US election night, and has been holding in tight range, while in China the USD/CNH retraces half of yesterday’s rally; the TRY spikes considerably lower in Asian trading with officials blaming thin liquidity. BBG summarizes some of the key FX moves below:

  • The euro comes off session highs in early European hours before resuming its advance; U.S. 10-year Treasuries pare gains after the yield earlier tested a near-term support around 2.80%
  • GBP/USD steady around 1.41; heads for weekly gain buoyed by Brexit transition deal and BOE signal that investors can expect another rate hike; EU leaders will sign off on the Brexit negotiating guidelines and transition deal at the second day of a summit Friday, after U.K. PM Theresa May praised the deal Thursday
  • Scandinavian currencies tumble amid the wider risk-off mood; Swedish krona was also weighed down by a continued dovish repricing of Riksbank and a central bank survey which showed concerns surrounding the housing market persisted
  • USD/JPY breaks below 105 for the first time since November 2016 as Nikkei 225 tumbles to a 5-month low, breaking the 200-DMA; Japan’s 10-year yield falls 1.4bps to ~0.02%, lowest since November
  • Australian and New Zealand dollars rose against the greenback, pares earlier losses versus the yen amid cross-related demand by Tokyo funds; Aussie also buoyed by news that U.S. will exempt Australia from tariffs

There has been some stability in core fixed income which has rallied further, although not with the same momentum as yesterday, with the 10y bund yield close to 50bps; even as peripheral EGBs continue to selloff.

Understandably, spot gold underpinned consistently, Dalian iron ore futures close -4.3% and crude futures grind lower from overnight highs.

For those who missed them, here are the key events in the turbulent overnight session, courtesy of Bloomberg:

  • China is slowly hitting back after Donald Trump fired the first shots in what may be an extended trade war, with President Xi Jinping making it clear he’s going to wait before unleashing his country’s formidable arsenal in response
  • China announced plans for reciprocal tariffs of $3 billion in response to Trump’s steel and aluminum tariffs, while the Commerce Ministry said it has a plan to act further on the planned levies on $50 billion worth of Chinese imports announced Thursday
  • In Europe, there are signs Mario Draghi’s success in reviving the euro-area economy could, ironically, delay the European Central Bank’s exit from extraordinary stimulus
  • The bloc’s broadest expansion in history is drawing workers back to the job market and spurring companies to invest to replace aging equipment, increasing the degree of slack in the economy
  • Russia cut rates on Friday, as the central bank kept to its slow but steady pace of monetary easing. The one-week auction rate was lowered to 7.25 percent from 7.5 percent in a fifth consecutive cut — a move predicted by all but four of 38 economists surveyed by Bloomberg
  • Japan’s key inflation gauge has finally reached half of its 2 percent goal, even as a strengthening yen and global trade battles threaten to curb that progress

US 10Y yields fell almost 8 basis points on Thursday, were set for their biggest two-week fall since September; on Friday they briefly dipped below 2.8%, before steadying above that level. In Europe, benchmark issuer Germany’s 10-year bond yield hovered close to 10-week lows struck a day earlier at around 0.52 percent and was on track for its biggest two-week drop since August, down 13 basis points.

Oil prices climbed amid worries that Bolton would pursue a hard-line stance against Iran. Safe-haven spot gold rose 1 percent to $1,341 an ounce, highest since Feb. 20. Copper and iron prices both fell, as investors bet demand for the metals would suffer in a trade war.

Economic data on Friday include durable goods orders and new home sales data

Market Snapshot

  • S&P 500 futures down 0.2% to 2,637.00
  • STOXX Europe 600 down 1.1% to 365.04
  • German 10Y yield fell 1.0 bps to 0.519%
  • MXAP down 2.6% to 172.06
  • MXAPJ down 2.2% to 565.65
  • Nikkei down 4.5% to 20,617.86
  • Topix down 3.6% to 1,664.94
  • Hang Seng Index down 2.5% to 30,309.29
  • Shanghai Composite down 3.4% to 3,152.76
  • Sensex down 1.2% to 32,627.04
  • Australia S&P/ASX 200 down 2% to 5,820.73
  • Kospi down 3.2% to 2,416.76
  • Euro up 0.3% to $1.2334
  • Brent Futures up 0.7% to $69.39/bbl
  • Italian 10Y yield fell 4.6 bps to 1.63%
  • Spanish 10Y yield fell 0.8 bps to 1.284%
  • Brent Futures up 0.7% to $69.39/bbl
  • Gold spot up 0.9% to $1,340.34
  • U.S. Dollar Index down 0.2% to 89.65

Top Overnight News

  • China said it doesn’t fear a trade war and announced plans for reciprocal tariffs on $3 billion of imports from the U.S. in the first response to President Donald Trump’s ordering of levies on Chinese metal exports
  • Trump signs order to exclude the EU, Argentina, Australia, Brazil, Canada, Mexico and South Korea from steel and aluminum tariffs through May 1
  • The U.S. president is replacing White House National Security Adviser H.R. McMaster with John Bolton, a former U.S. Ambassador to the United Nations famed for his hawkish views, in the latest shakeup of his administration.
  • Senate passes $1.3t spending bill to fund govt for rest of fiscal year and avert a partial govt shutdown, sending the measure to Trump for his signature.
  • Investors withdrew $19.9b from equity funds this week following last week’s record inflow, analysts at Bank of America Merrill Lynch write in research note citing EPFR Global data for week ending March 21
  • Japan won’t retaliate on U.S. tariffs as it could lead to the collapse of the free-trade system, Japanese Trade Minister Hiroshige Seko said
  • EU leaders will discuss trade on Friday after they were left in limbo on Thursday awaiting confirmation from President Trump that the bloc was indeed exempt from the new levies
  • ECB interest-rate hike expectations have been retreating after a series of dovishly perceived central bank speakers and softening data, though interest to fade the move via put ladders has emerged via Euribor options

Asian stocks saw hefty losses on trade war fears after the US announced USD 50bln of tariffs on China and with the latter planning tariffs of USD 3bln in retaliation, while it was also reported that National Security Advisor McMasters was replaced by policy hawk John Bolton. The intensified trade tensions triggered a bloodbath across stock markets with ASX 200 (-2.0%) led lower by miners as Chinese metals prices slumped on steel demand and tariff concerns, while Nikkei 225 (-4.5%) was the worst performer and briefly fell over 1000 points as selling pressure was magnified by a firmer JPY. Elsewhere, Hang Seng (-2.5%) and Shanghai Comp. (-3.4%) conformed to the sell-off as Chinese stocks felt the pinch from the US trade offensive, while the PBoC refrained from open market operations for a net weekly drain of CNY 320bln. Finally, 10yr JGBs traded higher to track the gains in T-notes amid a safe-haven bid and with the BoJ present in the market under its massive bond buying program. This helped 10yr JGB prices back above 151.00 and saw the 10yr yield slip to below 0.025% which was its lowest since November.

European equities are suffering heavy losses across the board with the Eurostoxx (-1.4%) hitting its lowest point since August 2017, continuing to remain hampered by the risk-off sentiment seen in US and Asia, after US announced USD 50bln tariffs on China triggering a retaliation of USD 3.1bln on US imports. Taking a closer look at sectors, materials (-1.8%) and industrials (-1.6%) are lagging behind due to their vast exposure to the Chinese market and are immediately followed by IT (-1.9%), financials (-1.6%) and consumer discretionary (-1.3%). On the flip side, Next (+7.5%) is leading the FTSE100 after maintaining its profit guidance this morning and against the recent backdrop of the retail sector whilst GSK (+3.6%) is the outperformer in the index after it officially announced its withdrawal for its takeover of Pfizer’s health unit, following its rival Reckitt Benckiser who ended talks over the acquisition of the unit yesterday. Elsewhere, Indivior sank more than 20% at the open after the US court turned against the co. and is said to favour its competitor Alvogen. In the DAX, Deutsche Bank is down 12.7% for the week, extending losses over the widening LIBOR – OIS spread which is believed to provide a headwind for the bank.

FX markets continue to be swayed by the prospect of ongoing ‘trade wars’ which have adopted more of a bilateral dynamic over the past 24 hours with exemptions for Argentina, Australia, Brazil, Canada, Mexico, South Korea and EU. In terms of the follow through for FX markets, the DXY is softer and back below 90.00 but largely a by-product of the safe-haven bid into JPY which knocked USD/JPY (temporarily) below 105.00 after the pair breached the YTD low at 105.23 during yesterday’s trade. From a technical perspective, some analysts are pointing towards 103.64 as a key level which marks the 76.4% Fib from the 99.00-118.66 recovery seen in 2016; a view held by IFR. Elsewhere, the USD softness has provided a modest lift to EUR/USD holding onto 1.2300, however GBP/USD gave up the 1.4100 handle. For EUR/USD, barring any major macro developments and amid a light data docket for the EZ, 2.3bln in expiries between 1.2250 and 1.2300 could act as a guiding force for prices. Back to GBP and amid the fallout of yesterday’s BoE release, focus for the UK will likely be on developments in Brussels at the EU council meeting (albeit seen as somewhat of a rubber stamp process). N.b. BoE Vlieghe to speak at 1230GMT. Elsewhere, AUD has also benefited from the softer USD despite the risk environment, albeit the pair may struggle to make any meaningful progress above 0.7730-40. Interestingly, despite concerns over potential faltering demand from China (Australia’s major trading partner), some suggest AUD could benefit if China opts to use Australian goods as a substitute for US ones. Moving forward, CAD will likely come into focus later today amid domestic CPI and retail sales releases. Traders will be looking to see if today’s releases conform to the recent slew of soft data whilst NAFTA concerns linger in the background. If this materialises, USD/CAD could make a firmer reclaiming of the 1.3000 level to the upside but would still have some way to go to hit the 2018 high around 1.3125.

In commodities , WTI (+0.1%) and Brent Crude (+0.3%) are underpinned by the latest comment from Saudi Energy Minister Al-Falih stating that there is still time to go before OPEC+ supply cut oil inventories to “normal levels” adding that OPEC/Non-OPEC will still require coordination in 2019. Additionally, the latest White House replacement of National Security Adviser HR McMaster with hardliner John Bolton, ahead of a key decision on May 12th regarding whether to maintain the Iran nuclear deal, raises the prospect of sanctions against Iran’s oil sales. Something to be aware of, with driving season edging closer, refineries are stocking up on crude oil to meet the seasonal demand for the summer driving season commencing in a few weeks. Moving onto metals, Gold (+1.0%) prices hit highs last seen in early February, boosted as investors flock into the traditional safe haven following the eruption of a trade war between US and China. Furthermore, a softer dollar this week has been supporting the yellow metal. Base metals on the other hand have fallen amid escalating trade concerns. Chinese steel futures fell more than 6%, hitting their lowest level in more than eight months while Dalian iron ore also shed over 6% hitting lows last seen in June 2017

Looking at the day ahead, the most significant data comes in the US with preliminary February durable and capital goods orders data, along with February new home sales. A number of Fed speakers are also scheduled to speak including Bostic, Kashkari, Kaplan and Rosengren, as well as the BoE’s Vlieghe.

US Event Calendar

  • 8:30am: Durable Goods Orders, est. 1.6%, prior -3.6%;
    • Durables Ex Transportation, est. 0.5%, prior -0.3%
    • Cap Goods Orders Nondef Ex Air, est. 0.85%, prior -0.3%
    • Cap Goods Ship Nondef Ex Air, est. 0.47%, prior -0.1%
  • 10am: New Home Sales, est. 620,000, prior 593,000; MoM, est. 4.55%, prior -7.8%

DB’s Craig Nicol concludes the overnight wrap

If there is one positive that we can take from 2018 so far, it’s that it is at least a lot more interesting. While you’d be hard pressed to find anyone who thought that we’d see even less volatility this year compared to 2017, the frequency or extent to which we’re having these mini shocks in markets right now is a surprise. Yesterday was seemingly a perfect storm for this. While markets were already awaiting Trump’s tariff announcement, the fact that it came post a Fed which had already made it known that the direction of trade policy was a concern, and then after optimism about global growth took a hit post the softening flash PMIs, seemed to be the trigger that markets needed to sell anything risky in a hurry.

Indeed, by the end of play the S&P 500 closed down an eye watering -2.52% for the biggest one-day decline since February 8th. That’s also the 7th time in the last 9 sessions that the index has fallen and it also notches up the 17th  time that the index has moved by at least 1% up or down since the start of February. As a reminder, there were only 10 such occasions in the 13 months to January. The Dow (-2.93%) and Nasdaq (-2.43%) also capitulated (the Dow is actually down over -4% from the pre-FOMC highs), while in Europe the Stoxx 600 and DAX finished -1.55% and -1.70% respectively. European Banks (-2.27%) are also now the lowest in 11 months. Meanwhile the VIX rose 5.5pts and closed above 23 for the first time in over 5 weeks. Credit markets also felt the pain with CDX IG over 4bps wider and iTraxx Main nearly 2bps wider. In a nutshell, these are the biggest moves that we’ve seen since the vol shock last month.

Those following bond markets were focused on whether or not Bunds might crack 0.50% and Treasuries 2.80% to the downside. Yesterday they tested that with Treasuries briefly touching an intraday low of 2.797%, however they are holding just above that this morning. Bunds fell 6.3bps by the closing bell yesterday to 0.524% and are now at the lowest since mid-January. Other European bond markets were down a similar amount although Gilts stood out with benchmark 10y yields rallying 8.8bps post the BoE (more on that later).

Moving onto the tariffs, for those that missed it President Trump has authorised US Trade Representative Robert Lighthizer to impose 25% tariffs on as much as $60bn in annual imports from China. It’s expected that 10 key sectors will be targeted which were identified under President Xi Jinping’s ‘Made in China 2025’ plan. A detailed list is expected in the coming days. In addition to that, the President has also ordered the US Treasury to start plans for imposing restrictions on Chinese investments in certain sectors. Adding fuel to the fire, Trump said that “this is the first of many”. China’s ambassador to the US said that while “we don’t want a trade war” we “are not afraid of it” and “we will certainly fight back and retaliate”.

This morning, China retaliated with the Commerce Ministry announcing plans for reciprocal tariffs on $3bn of imports from the US, including a 25% tariff on US pork and recycled aluminium as well as 15% tariffs on US steel pipes, fruit and wine. The general feeling is that China’s response has been relatively contained and measured. Markets in Asia are extending the sell-off however with the Nikkei in particular down -4.41%, while the Hang Seng (-3.02%), Shanghai Comp (-2.98%), Kospi (-2.25%) and ASX 200 (-1.95%) have also been hit hard. S&P 500 futures are also down -0.60%. Gold (+0.70%) and the Yen (+0.45%) are the assets benefiting from the flight to safety while bond markets across the board are stronger with 10y JGBs in particular down at 0.015% and the lowest since November.

Back to those PMIs, after Japan was the first to disappoint early in the morning yesterday (0.9pt decline in the manufacturing to 53.2), Europe did little to boost optimism. Indeed, the Euro area manufacturing reading was reported as falling a full 2pts to 56.6 which compared to expectations for a much more modest decline of half a point. That is the lowest since July last year while the services reading also slid 1.2pts to 55.0 (vs. 56.0 expected). That put the composite at 55.3 (vs. 56.8 expected) and down 1.8pts from February, and also the lowest since January last year. Regionally, Germany’s manufacturing print tumbled 2.2pts to 58.4 (vs. 59.8 expected) which means it’s down a shade under 5pts from the December high. France (53.6 vs. 55.5 expected; 55.9 previously) didn’t fare much better with the data also overall implying a decline for the non-core.

That also means that we’ve had two consecutive months of bigger than expected declines for Germany and France with the manufacturing readings in particular suggesting that the external boost to growth might be running out of legs a bit. Our European economists noted in a report yesterday that the question is whether we are seeing some moderate rebalancing or an inflection point into a new weaker regime. The team’s view has been and remains that Euro area GDP growth will slow gradually this year. They note that having dropped the QE bias in March, the ECB has the benefit of time to assess the state of the cycle before facing the next exit step. The moderately dovish tone in ECB commentary lately already suggests risk of a short delay to their baseline exit trajectory and the possibility of moves to limit the risk to financial conditions from the ending of QE.

On the other side of the pond, there was some hope that the US data might be a little more upbeat and while the manufacturing print rose 0.4pts to 55.7 and a bit more than expected, it was notable that the services PMI tumbled 1.8pts to 54.1 (vs. 56.0 expected). As a result, the composite finished down 1.5pts at 54.3.

Away from the tariffs and PMIs, the BoE was also under the spotlight yesterday following the MPC meeting outcome. As expected there was no change in policy with the committee voting to keep rates on hold by 7-2, with McCafferty and Saunders the dissenters which came as a slight surprise. Our UK economists noted that, broadly speaking, the tone and language of the minutes was in line with market pricing for a May hike. They also note that given the prospect of excess demand over the forecast horizon, the BoE continues to reiterate its view of an ongoing tightening in monetary policy at a “gradual pace and to a limited extent”.

Before we wrap up, a quick mention that this morning our European Equity Strategy team have published a report following yesterday’s soft PMI data. Our European equity strategist Sebastian Raedler highlights that as a consequence of the sharp fall in the March Euro flash PMI yesterday, Euro area PMI momentum – the six-month change in PMIs and a key driver of European equities – has turned meaningfully negative for the first time since August 2016. His models now imply a fall in the fair-value for the Stoxx 600 to 360 by mid-year, continued underperformance by European banks and further relative downside for European relative to US equities over the coming months.

Also worth highlighting is an update by our US economists in which they have raised their 2019 forecast for the Fed to four rate hikes instead of three, putting the terminal Fed funds rates rate at 3.4% based on recent evidence that the inflation trend is firming and updated unemployment rate projections. They made no change to their 2018 forecast.

The remaining data yesterday was a bit of an afterthought to everything else that was going on yesterday but for completeness, in the US, the March Kansas Fed manufacturing index was in line at 17, while the February Conference board leading index was above market (+0.6% mom vs. +0.5%). The January FHFA house price index also beat at +0.8% mom (vs. +0.4% expected). Elsewhere, the weekly continuing claims (1,828k vs. 1,870k expected) and initial jobless claims (229k vs. 225k expected) were broadly in line. Germany’s March IFO current assessment was slightly above market at 125.9 (vs. 125.6 expected) while the expectations index fell 1pt mom but was in line at 104.4. Finally, the UK’s February core retail sales was above markets at +0.6% mom (vs. +0.4% expected).

Looking at the day ahead, the most significant data comes in the US with preliminary February durable and capital goods orders data, along with February new home sales. A number of Fed speakers are also scheduled to speak including Bostic, Kashkari, Kaplan and Rosengren, as well as the BoE’s Vlieghe.

A revolutionary initiative is helping average Americans find quick and lasting stock market success.

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