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Trade Deal Talk Gives Markets Unequal Hope
Reports that the U.S. and China are close to announcing a trade deal sent stocks soaring around the world on Wednesday. If true, it would alleviate one of the biggest risks — if not the biggest one — hanging over global markets. It doesn’t matter that nobody outside of the negotiators knows the full details (news broke near the close of trading that Washington would give Beijing until 2025 to meet commitments on commodity purchases and allow American companies to wholly own enterprises in the Asian nation), but investors have already decided on a winner, and it isn’t the U.S.
Although U.S. equities rose, with the MSCI USA Index rising as much as 0.64 percent, that gain was effectively more than cut in half by the close of trading. Meanwhile, the MSCI All-Country World Index excluding the U.S. and the MSCI Emerging Markets Index held their gains, rising 0.94 percent and 0.74 percent. Of course, this was just one day, and the case could be made that the other markets are just catching up to the U.S., which has outperformed this year. Even so, the evidence suggests that the trade war has been more painful for countries outside of the U.S., which benefits from a highly diversified economy. In January, the International Monetary Fund left its U.S. economic growth forecast for 2019 unchanged at 2.50 percent even as it lowered its global outlook by 0.2 percentage point to 3.5 percent. More recently, the World Trade Organization this week slashed its global trade growth projection for 2019 to the lowest in three years, citing the impact of rising commercial tensions and tariffs. World merchandise trade growth will slow to 2.6 percent this year after gaining 3 percent in 2018, the WTO said. In September, the WTO said trade would increase by 3.9 percent in 2018 and 3.7 percent in 2019.
And just because the U.S. and China may beabout to reach a deal, it doesn’t mean the markets are in the clear. The Trump administration has set its sights on overhauling trade with the European Union, which raises a similar set of risks for markets. As Bloomberg News’s Viktoria Dendrinou and Nikos Chrysoloras report, EU governments are struggling to reach consensus on a mandate to begin trade talks with the U.S., risking a delay that would further provoke President Donald Trump’s ire after the bloc’s refusal to include agriculture in the negotiations.
PUTTING THE FED BACK IN PLAY? The other thing about a U.S.-China trade deal is that it potentially puts a Federal Reserve interest-rate increase back in play. That helps explain the sell-off in U.S. Treasuries, with yields on benchmark 10-year notes rising to as much as 2.52 percent, their highest since March 22. While that’s still low, considering that yields were above 3.20 percent as recently as November, the risk for bond traders is clearly shifting. As recently as last week, money markets were pricing in odds of almost 80 percent that the central bank would cut rates this year. That now seems extreme given that the most recent data show the economy is doing fine, just not going gangbusters. For example, the Institute for Supply Management said Wednesday that its non-manufacturing index for March fell to 56.1, the lowest level since mid-2017. The important thing to remember is that the measure is a diffusion index, meaning readings above 50 denote expansion and those below 50 signal contraction. Plus, March’s reading is right in line with the average over the past five years. Plus, the Federal Reserve Bank of Atlanta’s GDPNow Index, which aims to track growth in real time, has risen to 2.07 percent from a “stall speed” level of 0.17 percent just three weeks ago.
COMMODITIES DON’T CARE WHO WINS The commodities market is agnostic about who wins the U.S.-China trade war. It’s just happy that that it may soon be back to business as usual. The Bloomberg Commodity Index rose on Wednesday, led higher by industrial metals copper, aluminum, iron ore and nickel. The gains in iron ore — the key ingredient in making steel — are notable because futures topped $90 a ton as spot prices rose to their highest in two years. Although that isn’t due solely to optimism tied to the trade talks, it doesn’t hurt. Regardless, the outlook for commodities is brightening amid signs that the manufacturing sector is picking up in China and elsewhere. The economists at JPMorgan said in a report on Wednesday that its global all-industry output PMI rose for a second straight month in March, as did the new orders portion of the index. The gains suggest that growth in global gross domestic product is tracking at a 2.9 percent rate, which is above the 2.7 percent potential rate. “China has been more aggressive than other countries in stimulating its economy and this may have had a bigger impact that we anticipated,” the economists wrote in the report. This is significant because Bank of America’s monthly investor survey found that an economic slowdown in China is the biggest risk facing markets, followed by an intensifying trade war.
THE DOLLAR IS A LOSER, RELATIVELY SPEAKING It looks as if the currency market is also weighing in on the winners and losers, and the results seem to ratify what’s happening in the equities market. The Bloomberg Dollar Spot Index fell as much as 0.29 percent in its biggest decline in two weeks. Then again, that makes sense because demand for havens like the dollar would drop if the global outlook became less uncertain, which helps to explain the broad weakness in the yen and Swiss franc. One big winner is the Australian dollar. It jumped as much as 0.52 percent against a basket of major peers in its biggest rally since January. Australia is also a play on China, which is its largest trading partner, and on industrial metals, because it’s a leading producer of iron ore. But that’s not all driving the so-called Aussie. February retail sales rose 0.8 percent from January, better than the 0.3 percent gain forecast by economists. Also, the government said the trade surplus widened to A$4.8 billion ($3.42 billion), compared with the A$3.7 billion that was expected. “There is no doubt that the Australian economy is facing serious headwinds,” the strategists at Brown Brothers Harriman wrote in a research note. “However, we think some market calls for two rate cuts this year overstate the dovish case.”
THE BRIGHT SIDE OF EARNINGS It’s not all doom and gloom for U.S. equities. If the U.S. and China reach a deal soon, it would come just in time for earnings season. In that case, it would give company officials something optimistic to talk about, which would generally be good for stock prices, especially because earnings don’t look to be as bad once feared. In contrast to a relentless cutting of earnings estimates this year for S&P 500 companies, Wall Street analysts have had a change of heart in April, according to Bloomberg News’s Andrew Cinko. Their earnings-per-share estimate for 2020 jumped by $1.04, or 0.56 percent, since the start of the month, while this year’s estimate increased by 44 cents, or 0.26 percent. Cinko reports that a similar trend is underway for small-cap stocks in the Russell 2000 Index. While it’s not immediately clear which industry is driving the change — energy is a possibility — should the trend continue, bulls have one more reason to press stocks toward record highs, Cinko notes. “Trade matters because it could impact corporate earnings,” said Alec Young, managing director of global markets research for FTSE Russell, according to Bloomberg News.
TEA LEAVES India’s stock market has been a star performer since mid-February, with the benchmark S&P BSE Sensex index gaining 9.97 percent to a record high. That compares with a gain of 4.28 percent for the MSCI EM Index of equities. Even with that lofty performance, it would be foolish to bet that Indian stocks are ready for a breather for a two reasons. The first is that the Reserve Bank of India is widely expected to cut interest rates by 25 basis points in Thursday, thanks to a slowdown in inflation. That should give the economy, which the Asian Development Bank expects to expand 7.2 percent this year, an added boost. The second reason is that based on the most recent polling, India’s business-friendly Prime Minister Narendra Modi looks increasingly likely to win a second term when elections are held over the next month.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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