Another trade war salvo ahead of BoE

Summary

Investors aren’t waiting for official confirmation that the trade conflict is dragging on economic growth and corporate earnings.

China leads stocks lower

A sea of red in global stock markets is led by the main Shanghai and Shenzhen gauge which posted its biggest one-day drop since February. A committed-looking increment higher in September VIX futures confirms Wall Street does not expect to escape fallout from the latest trade war salvo. The proposal to turn the pain level of duties on $200bn in Chinese goods published last month up to 25% from 10% had already been floated on Wednesday. It is Beijing’s direct response on Thursday that’s new.

Encouragement falls flat

The White House’s top trade official, Robert Lighthizer, framed the proposal as further ‘encouragement’ for trade policy changes from Beijing. Ostensibly, the lines of official and unofficial communication remain open, but with China’s foreign ministry characterising Washington’s new twist as “blackmail”, any thaw in relations still looks distant. Instead, “China will inevitably take countermeasures”, the ministry said. Meanwhile, the list of U.S. industrial bellwethers with globally entrenched supply chains willing to pin rising costs on tariffs is getting longer. Investors are beginning to price the effect of forecast downgrades in the event that resolution isn’t found for another quarter.

Barclays’ strong quarter picked apart

The FTSE 100 is among stands out on the downside again. Its idiosyncratic mix of oil and minerals is close to the worst possible set of assets with China the biggest consumer of the world’s industrial metals. Barclays also anchors the index. In line with this earning season’s pattern, investors pick apart what appears to be one of the bank’s best quarters for years. Profit tripled to £1.9bn whilst the interim dividend was 2.5p. Both were higher than forecasts. But the dividend is still a disappointment to some. The sum foreseen in the full year is unchanged. Long-suffering investors anticipated a faster increase. The chance that this may now be on the cards is improved but persisting low visibility on pay outs keeps investors wary. After all, profit growth was largely due to the absence of penalties and other impediments rather than stepped-up underlying gains.

Siemens avoids GE moment

Germany’s DAX fares worst in a broadly lower Europe. The index is predictably led lower by car shares. Investors understand little is certain despite Washington’s undertaking to hold off from higher duties whilst discussions continue. A near 5% drop by Siemens can also be partly attributed to potential supply chain disruptions that could undermine its attempts to right size. A 54% automation revenue advance is further evidence that Siemens could yet avoid a GE moment. But slow overall growth and the negative offset from Power and Gas are a reminder that, like GE, the key execution risk is lack of urgency.

Fed tweaks “solid” to “strong”

The monetary and currency backdrop from the dollar’s extended rise ought to supportive risk-taking, in Europe at least. But what was set to be a pedestrian Federal Reserve statement turned out to be hotter than expected. The new inflection added was that “economic activity has been rising at a strong rate” compared to a “solid” one before. In the absence of detailed new projections and forecasts, the switch was a clear enough pointer that tightening will be crystalized at 25 basis points per quarter. Coinciding with deepening trade animus, the perception is that countries with current account deficits face even tighter dollar financing. After the Bank of Japan let its yield genie out of the bottle, the yen continues to lead one of the few dollar pairs on the backfoot. ‘Risk-off’ is the icing on the cake for the yen.

BoE could set sterling on a tear

In context, sterling’s retention of the $1.30 handle implies more underlying backing than its sluggish recent progress may suggest. Traders have given up trying to square current prices with high $1.43s seen immediately before the Bank called off a prior rate rise, under almost identical conditions. Still, the suspicion is that warranted or not, the onus is now on the Monetary Policy Committee to transmit something tougher than precisely calibrated caution. True, Brexit is not agreed, with just 8 months to go, and there’s no guarantee the current PM will oversee it. Wage growth is not where the MPC said it would be in May; underemployment is also just as entrenched. The gap between all key business surveys and historic norms during normal tightening cycles borders on surreal. Signs of stressed personal credit, whilst nowhere near ‘crisis’ levels are at their highest for  6 years. The Bank’s new “neutral” (or “equilibrium” or “natural”) rate could partially come to its rescue. If fresh guidance offers more evidence that the economy’s “speed limit” should now be as low as 1.5%, Governor Mark Carney could push the case for further rises with more confidence and less circumlocution. With futures markets pricing the next full 25 basis point rise no sooner than August 2019, policymakers may only need to flash their working out to put a firm floor under sterling.