Stocks fall faster but may not fall harder just yet

Summary

The trade conflict is quickening, and the pace of stock market declines follows suit.

Over-reaction?

After a tense pause, the latest wave of U.S. tariffs threats falls. At $200bn, the detailed plans for counter-retaliatory duties on China at least suggest the White House intends to continue scaling incrementally to $500bn in total new import taxes it has said it would levy on the world’s No. 2 economy. Inevitability of the late-Tuesday announcement and Beijing’s continued pattern of restrained reactions somewhat reduce the shock factor from this latest twist. It offers the chance that the stock market may rethink its initial severe reflex. If so, Wall Street may open with a more measured fall than the up 1% losses September futures project, and declines of similar magnitude by Germany’s DAX, Britain’s FTSE and across other large European bourses may also ease later. This could provide a smoother ride in coming sessions for hardest-hit Asia-Pacific indices like Japan’s Nikkei and Shanghai/Shenzhen’s CS1300.

Watch ¥6.70

However, as per last week, in China much depends on the yuan. After last week’s 11-month low against the dollar, roughly ¥6.70 per dollar is thought to be sensitive as that was the exchange rate at which talk of various People’s Bank of China interventions reached a crescendo. The rate was at ¥6.67 a short while ago, from a high of ¥6.6784 and ¥6.6995 offshore. The latter rate looks to settle around 1% off last Tuesday’s floor, though trade weighted gauges, which Beijing appears more focused on, are closer to their own coincident lows. For these reasons, anticipation of additional monetary action is rising. Whilst a spate of such moves last week appeared to stabilise cross-market effect, asset price reaction, particularly equities, is difficult to predict.

Washington targets consumers

Whilst Chinese stock markets have been hit harder than those in Europe and the States (CSI300 is 11% over a month compared with the DAX’s 3% fall, for instance) Wall Street and EU shares will continue to face considerable downdrafts if Asia-Pacific shares remain challenged. Furthermore, with the Trump administration’s newly published list including a higher percentage of consumer-related products, raising prospects that Beijing may reciprocate in similar kind, a recent rise in large-cap value-orientated shares, many of which are listed on the Dow Jones Industrial Average could be implicated in the near term, assuming further escalation. Likewise, confirmation of continued turbulence in commodity prices, particularly industrial metals puts UK indices like the FTSE 100 and FTSE 250 much more in the frame for possible further weakness linked to their heavy weighting of resource industry shares.

Imperfect storm

The dollar’s rise against the yen and continuing weakness of gold make this risk-off phase an imperfect one. This could eventually provide another avenue for overall sentiment to lighten. On the other hand, the sheer strength of the greenback bid—all major currencies are weaker—underscores that a creeping fall in dollar liquidity in emerging markets, yield, economic and other factors exerting upward pressure on the greenback, are once again front and centre.  In simple terms, the orderly nature of global markets since the trade crisis escalated suggests more complacency than is acceptable given potential risks. What if China adopt a more aggressive attitude, perhaps hinting at its dollar-denominated debt holdings. Ironically, Treasury, bund and gilt prices though are seeing temporary relief on Wednesday, as investors once again ensure the path to safety is clear, should it be required.

BoC in focus, China data eyed

Bank of Canada is likely to raise its key rate by 25 basis points on Wednesday. With hike expectations baked, absent a major surprise, the statement will be the main news. If bullish commentary for the Canadian dollar is moderated, a soft Loonie story will back our view that the dollar’s latest intermittent uptick can gather pace. U.S. PPI is also due before a raft of European readings on Thursday, including German inflation and EU output. In the context of the last few weeks, the most pivotal releases over the next few days may well now come from China – trade on Friday and industrial output on Monday.