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Investors react to fears of trade tariff escalation

By David Morrison  |  26/06/2018 15:32

Global indices took a tumble on Monday on concerns that a global trade war is looming and as central banks tighten monetary policy
Monday saw significant selling across global equity markets following comments from Treasury Secretary Steve Mnuchin. Mr Mnuchin said that there would be limits to foreign investment on “all countries that are trying to steal our technology." This pointed to a serious escalation in the current tariff tit-for-tat with the prospect of unknown negative consequences for trade and global growth. Equities made back some of their early losses after White House trade advisor Peter Navarro downplayed the remarks, insisting that any restrictions would be aimed solely at China. However, White House press secretary Sarah Sanders then insisted that fresh trade limits would apply to “all countries that are trying to steal our technology”. These comments come ahead of a new clutch of tariffs and restrictions due to be unveiled by the Trump administration this weekend.

Of course, the US tariffs aren’t just aimed at China. On Friday, President Trump warned of a 20% tariff on all car imports from the EU, to counter the duties levied on vehicles imported from the US. So, despite getting warnings from all sides about the dangers of triggering a full-blown trade war, the president appears determined to push ahead. It could be argued that if Trump is using the relative moves in countries’ stock markets to measure the success of his actions so far then he may feel that his tariffs are working. While US indices have lost ground over the past few weeks, the sell-off in China’s key index has been severe.

The Shanghai Composite is now officially in a bear market (its fourth in three years) having fallen over 20% since its January high. Last night it closed at its lowest level in over two years, despite the People’s Bank of China cutting its Reserve Requirement Ratio again over the weekend. The index remains over 50% below the all-time high hit in 2007 before the financial crisis.

In contrast, as measured by Monday’s close of 24,253, the Dow Jones Industrial Average is down 9% from its January high although it has lost around half of that over the past fortnight. The index is now trading below its 50, 100 and 200-day Simple Moving Averages (SMA) with the next support coming in around 24,000. This marks the 23.6% Fibonacci Retracement of the 29th Jan-6th Feb sell-off and a break below here opens the possibility of a retest of the February low just above 23,100.

Now we’re used to seeing traders rush in to buy dips and no wonder. This is a play that has proved extremely profitable over the past few years, particularly since early 2016 when markets steadied after a second yuan devaluation by China in less than six months.

But there are concerns that things may be different this time. For a start, the US Federal Reserve looks set to tighten monetary policy further with the expectation of another two 25 basis-point rate hikes this year. At the same time, the Fed is continuing to reduce its balance sheet as it no longer reinvests the proceeds of maturing bonds. It also appears that the current chairman Jerome Powell is of a somewhat different type to his post-financial crisis predecessors, Ben Bernanke and Janet Yellen. The US central bank has a dual mandate to maximise employment and ensure price stability (in other words, control inflation). Mr Powell made it clear at this month’s meeting that he also takes financial stability seriously as well. It appears that the new Fed Chair feels monetary policy has a role to play in keeping markets anchored. In other words, loose monetary policy must not contribute to asset bubbles. It also may suggest that tightening monetary policy can be used to take some heat out of overcooked markets, particularly those driven by monetary and fiscal stimulus. The big question is what measures would the Fed use to decide when financial markets are unstable? Even if we can’t be sure of this, it does sound as if Chairman Powell won’t be put off from raising rates further by a stock market sell-off.

Moreover, the euro remains under pressure, meaning a firmer dollar for now, as the European Union (EU) faces a political crisis over immigration. This is proving particularly troublesome for German Chancellor Merkel. She not only has to deal with a new government in Italy, anxious for other EU members to share the immigration burden, but also her CSU coalition partners who are pushing for controls. All this ahead of Thursday’s EU summit.  

In the meantime, it’s likely that daily market moves, whether up or down, will be triggered by tweets from Trump and his team, even though there seems to be considerable confusion amongst members of the administration. Prepare for another pick-up in volatility.  
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