On Wednesday, markets were pleased to learn that Donald Trump will, for now, hold off on the imposition of auto tariffs pending negotiations with Europe and Japan.
Markets also learned that the administration is on the verge of cutting some manner of deal with Canada and Mexico that will lift metals tariffs and pave the way for the ratification of the USMCA.
All of that appears designed to allay fears that Trump is prepared to forge ahead with a multi-front trade war, on the way to making everyone’s worst protectionist nightmare a reality.
The news was good enough to carry the day for US equities, which logged a second consecutive day of gains Wednesday, even as growth jitters and what looks like convexity flows drove yields lower in a (possible) repeat of what transpired in late March during the last growth scare/hedging activity-driven bond rally.
Obviously, China’s April activity data was poor and a pair of disappointing prints stateside (retail sales and industrial output) underscored concerns. The market is on edge about the outlook now that the prospect of an all-out trade war between the world’s two largest economies threatens to spray Roundup on whatever “green shoots” you might have observed over the last month or so. 2-year yields fell to the lowest since February 2018 on Wednesday.
At one point, the market was pricing 45bps of Fed cuts between now and June of next year. Swap spreads legged lower as yields fell on Wednesday morning suggesting the rates rally was being exacerbated by convexity hedging, akin to what played out following the March Fed.
That potentially sets the stage for another “false optic” effect, wherein market participants have a hard time separating what part of the bond rally is a “genuine” growth scare and what part is a something of a mirage, created by the sheer scope of the convexity hedging impact on rates.
This is complicated immeasurably (literally – because it’s subjective, you can’t measure it) by the psychological impact of the most recent trade escalations and the worsening situation in Italy. Both the threat of Trump flying off the handle and the notion that Salvini is prepared to instigate another budget battle with Brussels are troublesome for the macro narrative, which makes it even more difficult to discern what’s driving an apparent safe-haven bid for DM bonds and/or fueling rate cut bets.
Speaking of things that are troublesome for the macro narrative, on Wednesday evening, Trump went ahead and signed an executive order that sets the stage for the US to effectively ban Huawei (and ZTE, I guess) from selling telecommunications equipment to American firms. The move was expected, but it’s likely to irritate Beijing at a sensitive time.
The excuse, of course, was “national security”. “This administration will do what it takes to keep America safe and prosperous and to protect America from foreign adversaries”, Sarah Sanders said.
The order was described by the White House as “agnostic”, where that means no country or company was singled out. But make no mistake, this was clearly aimed at Huawei.
“The order, which applies only to future transactions, left many questions unanswered, including how the Commerce Department will define foreign adversaries and establish criteria to ban companies from selling equipment to the United States”, the New York Times writes, adding that “the executive action did not address concerns by rural carriers that the order would hit them particularly hard [as] some rely on equipment that already contains parts by Huawei and other Chinese companies.”
For months, the US has sought to turn the screws on Huawei and the arrest and detention of Meng Wanzhou (who is basically a political prisoner) has cast a pall over the trade negotiations. Wednesday’s executive action will bring Meng back into the limelight (although she was never far from the minds of market participants given her connection to the Sino-US dispute). Meng is still under house arrest, and to say relations between Canada and China have suffered from the ordeal would be to grossly understate the case.
Later Wednesday, the Commerce Department said it has determined that Huawei engages in activity that may be a national security threat. Therefore, Huawei has been put on a list that requires US entities trying to do business with the company to obtain a license. “The sale or transfer of American technology to a company or person on the Entity List requires a license [which] may be denied if the sale or transfer would harm US national security or foreign policy interests,” the Commerce Department said, in a statement.
So, you can consider this blackballing of Huawei just another aggravating factor in the now highly contentious negotiations between Washington and Beijing.
All of that creates safe haven demand for Treasurys (the cost of currency hedging be damned, apparently) and, relatedly, these macro concerns ostensibly argue for a precautionary Fed cut, Jerome Powell’s efforts to push back on those expectations notwithstanding. When you throw in the hedging dynamics/convexity flows mentioned above, you’ve got a recipe for difficult-to-decipher rates moves.
Remember, all of this can turn on a dime, as it did in April, when yields snapped back higher on better data and trade optimism.