By Michael O’Neill
“There’s somethin’ wrong with the world today, I don’t know what it is. Something’s wrong with our eyes. We’re seeing’ things in a different way.” These are the opening lyrics from the 1993 title track of Aerosmith’s Livin’ on the Edge album.
They could be also be describing financial markets around the world in the middle of September, 2018. That’s the day President Trump launched a full-scale trade war against China. He imposed 10% tariffs on $200 billion worth of Chinese imports, effective September 24th , and said he would add tariffs on another $267 billion worth of imports if China dared to retaliate.
China did. Officials in Beijing slapped 10% tariffs on $60 billion of US imports. They are also looking at other measures including a currency devaluation, and by doing so, are thumbing their noses at Mr Trump.
Conventional wisdom suggests that a US/China trade war is bad for both nations. There are substantial contagion risks as well. China is the hub of the global supply chain, and if the supply chain is disrupted, it would have a negative impact on the economies of many nations including emerging market countries like South Korea, Taiwan, Singapore, and Malaysia. The Reserve Bank of Australia also warned that the US/China trade war was a threat to its economy. The Australian newspaper said one accounting firm (KPMG) forecast a loss of 0.3% of GDP by 2020 from lower commodity prices and export volumes.
Usually, threats to global growth and the global economy spark a movement out of riskier assets and currencies and into the traditional safe-havens of Japan, Switzerland, EU, and the USA. That isn’t happening with this trade war, yet.
Wall Street rallied. The Dow Jones Industrial Average is at levels last seen in January 2018. Prices have climbed steadily since bottoming out in May even though trade tensions were ratcheting higher. Equity traders are emboldened by the strength of the US economy, (at the moment) strong corporate earnings, and because Trump dialed back on his original threat to impose 25% tariffs. Instead, the September 24 tariff levy is 10% which some believe is an indication that he is leaving the door wide open to further trade negotiations.
The safe haven currencies are behaving abnormally as well. In times of global strife, the Japanese yen is normally in demand. A lot of it has to do with Japanese individuals and institutions repatriating assets. That is not the case at the moment, even with the onset of the US/China trade war. USDJPY traders are fixated on the strength of the American economy, the outlook for higher interest rates and rising US Treasury yields. The Swiss franc shows some recent strength, but those gains are more a factor of broad USD dollar weakness against the G-10 major currencies.
The Canadian dollar is another currency aberration. Canada is staring down the barrel of a loaded trade war cannon. The American’s are ready to light the fuse, and the Canadian dollar is strengthening.
US Commerce Secretary Wilbur Ross, interviewed on CNBC on September 18, said the United States Trade Representative office has “already filed with the Congress the notice regarding the transaction with Mexico.” He added that President Trump would like Canada to get onboard then said: “If they don’t, we’ll simply go ahead with Mexico.”
It seems that the American’s are happy with the deal they signed with Mexico and the choice for Canada is simply “take it or leave it.” Canada’s Foreign Minister Chrystia Freeland is in Washington for another round of trade talks. She is likely to face an uphill battle. Canada’s supply management program and the dispute resolution mechanism appear to be the major hurdles. Two weeks ago, Canada reportedly offered concessions on dairy supply management. That doesn’t seem to be the case today. Prime Minister Trudeau admitted on September 17 that the trade talks were not even close to decision time. Time is running short ahead of the US month end deadline and Canada risks being bumped right off the radar screen if (when) the China) trade war escalates further.
Tensions in the Middle East are heating up thanks to various militaries in action in Syria. Japan sent a submarine to challenge the Chinese Navy in the south China Sea, although Japan denies it was targeting any nation. Oil prices are high and rising still. Saudi Arabia said they could “live with oil at $80.00/barrel, implying production may not be increased to offset Iranian production lost to US sanctions. High oil prices have a history of destabilizing global growth. Traders have ignored these developments as well.
Unfortunately, Aerosmith may have been prophetic when they sang “something’s wrong with the world today.” Complacent traders may soon be facing the wrath from geopolitical tensions going off the rails. The slew of articles on the 10-year anniversary of the Lehman Brothers collapse should be required reading by all market participants, even if it is just to revisit how its bankruptcy precipitated a chain reaction of financial institution devastation. This time is not different.