Take Five: The last of the summer wine
1/ TAXING TIMES
The northern hemisphere summer is ending, and U.S. President Donald Trump kicks off September by jacking up tariffs on $300 billion of Chinese imports to 15% (from 10%). A second phase of tariff hikes take effect mid-December. Targeting items such as mobile phones, smartwatches and video games consoles, the higher levies will kick in before Christmas shopping gets underway.
Consumer demand — two-thirds of U.S. economic activity — has been resilient in the face of the escalating trade war with Beijing. But retailers such as Macy’s, Abercrombie & Fitch and Best Buy are now warning of profit hits as new tariff rounds bite. Best Buy predicts full-year same-store sales will rise 0.7% to 1.7% versus a previous 0.5% to 2.5% forecast. The S&P500 index posted losses this month for the first time since May.
China has expressed hopes Washington will cancel the additional levies and continue negotiations. But it has also said it might have no choice but to impose retaliatory tariffs. Next week will show whether it follows through on that threat.
The question is, can it afford to? Demand from Chinese businesses and consumers is faltering; last month, industrial output growth cooled to a 17-year low. Official surveys this weekend are expected to show factory activity slowed for the fourth straight month in August. Weak numbers and a total breakdown in trade talks may well see the yuan — down almost 4% in August – extend its slide.
2/DOGS OF WAR
Sept. 3 brings British lawmakers back to work from their summer recess. It will be a tense return, with the opposition Labour Party planning an emergency debate to try and stop Prime Minister Boris Johnson taking Britain out of the European Union without a withdrawal agreement. Traders will be returning to their desks in force, meaning that sterling volatility, already elevated, may go higher.
Though the pound is still above two-and-a-half-year low of $1.2015 it reached this month, it could see bigger moves during the upcoming parliament session. That will last until Sept. 9-11, before a one-month suspension following Johnson’s controversial move to prorogue parliament.
Still, markets are unwilling to place large bets on where the pound will be in a month. Not only will the European Central Bank and the Federal Reserve introduce more monetary stimulus soon, many remain unsure that Johnson can actually force through a no-deal Brexit. That’s reflected in options markets, which display only a sprinkling of small barriers over the next two months between $1.15 to $1.25 – a sign investors are wary about betting big on sterling.
Instead, traders see higher volatility as a surefire bet. One- to three-month implied sterling volatility gauges — expected price swings — have zoomed to their highest levels this year and pound volatility is more than double the levels of other major currencies such as the yen and euro.
With U.S. unemployment hovering around 50-year lows, President Donald Trump has touted “JOBS, JOBS, JOBS,” and a roaring stock market as evidence of his economic stewardship.
But stocks have fallen from July’s peaks, Treasuries are on a tear as investors seek safety and the yield curve is upside down – a very different spin from Trump’s. With markets signalling SOS, investors will fixate on unemployment data due on Friday for signs the trade war is nudging the economy towards recession.
Non-farm payrolls are expected to have grown by 155,000 in August, moderating from 164,000 in July but still a healthy clip. Unemployment is seen holding steady at 3.7%.
Trump, though, loves to tout manufacturing jobs, often bragging about the nearly half-million production jobs created on his watch. That’s something to watch for in the August numbers — the last payrolls report showed manufacturers were already paring workers’ hours.
Also, the Philadelphia Federal Reserve’s index of factory employment in the mid-Atlantic region dropped this month by the most on record; the last time it fell anywhere near as much as this month was May 2006. Soon after, the Labour Department reported a loss of 23,000 factory jobs, and by the end of the year, manufacturing employment was in steady decline.
4/ALL ROADS LEAD TO ROME
Plenty of sunshine on Italian financial markets lately as erstwhile political foes 5-Star Movement and the Democratic Party (PD) managed to head off a snap election by joining hands to form a new coalition under the leadership of Giuseppe Conte. Investors reacted by pushing an index of blue-chip Italian stocks to its best weekly run in more than two years and 10-year government borrowing costs fell below 1% for the first time ever.
What next, though? The new political tie-up is fragile because the two parties are longstanding political foes. Their coalition could suffer the same fate as the government that 5-Star formed last year with the League party. Citi analysts predicted the government to last as long as “the proverbial cat on a highway”.
But Italy will continue benefiting from upcoming interest rate cuts from the European Central Bank, which is also expected to resume bond-buying stimulus. Moreover, investors appear hopeful the coalition will pursue a prudent fiscal policy and avoid confrontation with Brussels over spending. This optimism may last at least until the government budget for 2020 is presented in October. For now, Italy is enjoying its moment in the sun.
Argentina’s move to extend the maturity of its debt, raising the prospect of a full-scale sovereign default, has come at a bad time for emerging markets. Reeling from the Sino-U.S. trade battle and the prospect of a global economic recession, the “re-profiling” of some $100 billion worth of Argentine debt is the latest shockwave for the sector.
So far, the Argentine crisis impact has been felt mainly by neighbouring Brazil, a major trading partner. The Turkish lira, already weakened by last year’s collapse, has also wobbled. But demand for emerging markets was already waning — August outflows from emerging-market funds amount to $13.8 billion, the most since Donald Trump’s U.S. election win in November 2016 — and the contagion might spread.
Many EM-watchers finger Lebanon as the next hotspot. Heavily indebted and facing heightened tensions with Israel, the price of some of Lebanon’s dollar bonds have plumbed new depths and the cost of insuring its sovereign debt against default has surged.