Submitted by Michael Every of Rabobank
Weren’t we supposed to be in a bond bear market by now? I distinctly recall some famous talking heads mentioning a 4% 10-year US Treasury target, and that was at a time when we hadn’t yet broken through 3%. Instead, yet again, we see bond bears suffering Charlie Brown’s fate as Lucy pulls away the ball just before he kicks it. The 10-Y UST was at a 19-month low of 2.29% yesterday, and who is to say that we stop there given the global backdrop and the disappointing tone to key data? With oil slumping 6% on the day too, can you smell the inflation ahead?
Equities also stumbled, though hardly collapsed – and the impact was immediate. US President Trump spoke to the press and stressed that there remained a “good possibility” of a trade deal with China. Indeed, he even went so far as to suggest that Huawei, which is being hung, drawn, and quartered, could be included in that deal. You could hear the eyes rolling among the legal establishment in Canada, and among the national security establishment in the West.
So is there an olive branch being offered? Unlikely. That ship has sailed. China is battening down the hatches for a “Long March” and doesn’t even want to talk to the US. In fact, Xi and Trump might not even meet at the end of June in Osaka, in which case there is no obvious off-ramp.
Moreover, the US security establishment is finding that export controls are an incredible new economic weapon that can act against Chinese (and other nationalities’) firms no matter how deeply they have wormed their way into the global economy. Are the US really going to put down a super-straw that lets them drink China’s milkshake? That lets them suck-up global supply chains and drop them down wherever they want, saying “Damn right; it’s better than yours”? And will it do that on a Chinese pinkie swear of no more of their own milkshake stealing? And are China ever going to believe the US when they say they have put their super-straw away and won’t touch any milkshakes again, all the while humming “I know you want it, the thing that makes me”?
Just to underline that the US is still in national security = economic security mode, there are reports this morning the Commerce Department is proposing to impose tariffs on countries that undervalue their currencies: “Techniques that freaks these boys; Just know, thieves get caught” Well, for once that isn’t China – yet. It’s fighting with all it’s got to keep CNY under 7. But what if (when) that peg goes? It says US tariffs will go even higher. And who does that currency target list include today? I expect that the US will be deciding, not the IMF or other countries; and many of them should be very, very nervous – particularly if they happen to fall out with the US politically.
What about Vietnam though? There have already been suggestions that it would be in the Commerce Department’s cross-hairs….and yet it is incredibly pro-US, co-operating with the States vs. China in the South China Sea, and “doing a Mexico on fast-forward” to parts of Chinese industry, weakening the giant in the process. Is that a process the US wants to accelerate or not? And what about India, where PM Modi has just won a thumping re-election victory, receiving a belated congratulatory tweet from Trump talking about cooperation, etc.? Isn’t India the best long-term counter-weight to China in the “Indo-Pacific” region in all dimensions? These kind of clashing strategies --Make America Great Again vs. the US vs. China-- are going to have to be reconciled, and the FX markets will move appropriately. “La la-la la la. The boys are waiting.”
So will bond yields, because this is either going to be a global tariff/trade war, or it’s going to be a more carefully-targeted one that aims to ‘cage’ China. Is either outcome inflationary in the short- to medium-term? The IMF swears that the US has been paying for all the tariffs so far. Yet the Treasury market doesn’t seem to think so, and that’s despite rumblings of China selling down its holdings – perhaps the only thing happening on the US-China front that shouldn’t worry us.
Meanwhile, in the UK we have politics as usual. Which in this case means a headline in the Sun “Nigel Farage ‘trapped on Brexit bus surrounded by people armed with milkshakes’.” That really does sum things up: trapped on the Brexit Bus. At time of writing the balance of the UK press was speculating heavily that PM May will announce her resignation date today as being June 10. That will allow her the singular honour of hosting President Trump in the UK first, where he will be leaning on the Brits to lean on Huawei (which will mean China will lean on the UK, according to China). Then we will see a Tory leadership contest lasting until the end of July, and a new face in No. 10 for August. Who then has three months to avoid being drenched in milkshakes. Or, May could continue to limp on uselessly to no effect. Neither outcome says GBP looks good value, surely?