Main Themes: US-China trade relations continued to hurt sentiment overnight, as a war of words between Chinese and US officials intensified and deepened investor anxiety. This anxiety resulted in big losses in European and US share markets and sharp declines in US government bond yields. Weak purchasing managers’ index (PMI) surveys in Europe and the US also contributed to the poor mood among investors.
Share markets: The deepening trade and technology war between the US and China has sent global stock markets sharply lower and prompted a warning from the International Monetary Fund (IMF) of the increasing risks to the global economy. The Dow Jones closed 286 points weaker (or -1.1%) and the S&P 500 slumped 163 points (or -1.0%). The Dow Jones had been down by as much as 451 points during the overnight trading session.
Interest Rates: US bond yields fell across the yield curve, as investors worried about the outlook after a batch of weak PMI surveys and the trade war heated up. US 2-year and 10-year yields closed 8 basis points and 6 points weaker respectively with the 10-year yield falling during trade to its lowest level since October 2017. The chance of a rate cut this year from the US Federal Reserve rose from 100% to 130%, according to interest-rate futures.
Foreign Exchange: The US dollar index depreciated overnight, as worries about the US-China trade war hurt the greenback. EUR/USD initially feel to a two-year low of 1.1107 after weak PMI surveys were published in the eurozone, but then recovered to 1.1187. USD/JPY fell from 110.40 to 109.46, as the safe-haven yen benefited from investor anxiety about the outlook. The AUD/USD bounced from 0.6865 to 0.690 with the rise reflecting USD weakness. The AUD/USD remains under pressure amid speculation the Reserve Bank will have no choice but to cut the cash rate at its June meeting. A follow-up rate cut this year is likely. Furthermore, global growth concerns traditionally hurt the AUD.
Commodities: Oil prices fell sharply and gold prices rose overnight, reflecting the rise in risk aversion overnight and worries about the world growth outlook.
Australia: There was no major economic data locally yesterday.
China: The US Secretary of State Mike Pompeo accused Huawei’s chief executive of lying overnight when he said the company had no links to China’s communist government. In a marked toughening of its rhetoric, China demanded that Donald Trump’s administration change course. Moreover, China’s charge d’affairs in London said the UK could suffer “substantial” loss of investment if Huawei were banned from involvement in Britain’s 5G network. China’s commerce ministry spokesman Gao Feng said “if the United States wants to continue trade talks, they should show sincerity and correct their wrong actions”. Gao Feng added that “negotiations can only continue on the basis of equality and mutual respect” and indicated Chinese authorities will “closely monitor relevant developments and prepare necessary responses”.
Europe: A host of PMI surveys pointed towards a clear slowdown in Europe. The biggest concern in Europe lies with Germany. The manufacturing PMI in Germany fell to 47.7 in May, which is the fourth consecutive month this reading has registered below 50. A reading below marks contraction in activity.
International Monetary Fund (IMF): The IMF published a blog overnight warning US consumers are “unequivocally the losers from trade tensions”. IMF researchers have analysed price data from the Bureau of Labor Statistics on imports from China and discovered that tariff revenue collected has been borne almost entirely by US importers. The blog also warns that the existing US-China trade war has already caused damage and will probably knock 0.3 percentage points off global growth. The IMF further said that a failure to resolve trade differences and further escalation in other areas, such as the auto industry, could further dent business and financial market sentiment, negatively impact emerging market bond spreads and currencies, and slow investment and trade.
Japan: The Nikkei manufacturing PMI fell from 50.2 in April to 49.6 in May, back into contraction territory. It was the third reading this year below 50, suggesting contraction. Headwinds for the outlook have increased with global trade tensions. Domestically, a sales tax hike later in the year further adds to the uncertainty.
United Kingdom: Overnight Britons were voting in a European election in which pre-poll surveys suggested Prime Minister May’s Conservatives would be thrashed by Nigel Farage’s Brexit Party. The chairman of the powerful Conservative 1922 Committee, which can often make or break prime ministers, has said May would meet him on Friday to discuss her leadership. There is widespread media speculation May would then announce she would step down on June 10, after the state visit by US President Donald Trump.
United States: The Markit PMI “flash” survey of manufacturers fell to a 9½-year low of 50.6 this month, from 52.6 in April. The softer reading was led by new orders, which fell below 50. Trade tensions were no doubt a factor in the decline.
The Markit survey of service-oriented companies also slipped, to a 39-month low of 50.8 in May, from 52.7 in April. Any number above 50.0 signifies that companies are growing, but the sharp fall in the indexes this year suggests the US economy could slow in the months ahead.
New home sales dropped 6.9% to an annual rate of 673,000 in April while March’s sale pace was revised up to 723,000 units, the highest level since October 2007, from the previously reported 692,000 units. On a year ago, new home sales are 7.0% higher. Demand for housing remains underpinned by falling mortgage rates and a tight labour market.
Finally, initial jobless claims continued to hover at generational lows for another week with a reading of 211,000 in the latest week.
Today’s key data and events:
NZ Trade Balance Apr exp NZ$450mn prev $922mn (8.45am)
JN National CPI Apr y/y exp 0.9% prev 0.5% (9.30am)
UK Retail Sales Apr exp -0.3% prev 1.1% (6:30pm)
US Durable Goods Orders Apr exp -2.0% prev 2.6% (10.30pm)
Times are AEST. All data forecasts are m/m or q/q and seasonally adjusted unless otherwise specified. Forecasts for Australian data are our forecasts and for other countries they are consensus forecasts.
Besa Deda, Chief Economist