Suddenly, we’re back in the teeth of the global slowdown narrative.
In the south, they’d say Donald Trump has “gone and done it now”.
While March’s growth scare felt a bit contrived, the May sequel feels less so. The imposition of 25% tariffs on the entirety of Chinese exports to the US was deemed highly implausible (if not unthinkable) just 11 months ago, but now, it seems like a foregone conclusion. Again, the worst-case scenario is rapidly becoming the base case.
In retrospect, I suppose we should have listened to Trump when he insisted he was ready, willing and excited to go “all in”.
Read more: The Worst-Case Scenario Is Now The Base Case
In addition to the signal bonds are sending, don’t forget that while monthly losses for many developed market global equity benchmarks were relatively tame headed into this week, you didn’t have to look very far to find evidence of trade angst. Every time you look at the SOX it gets worse. The monthly loss there is up to 17% now, and semis are teetering on the brink of a bear market.
Unsurprisingly, the Kospi is having its second worst month since 2011. Wednesday’s selloff (which coincided with 10-year yields in South Korea falling below the BOK rate), erased the benchmark’s gain for 2019.
There’s no mystery there. “Now that investors are belatedly registering the severe negative shift in the US-China trade war, it makes sense for the Kospi to be at the forefront of Asia pain”, Bloomberg’s Mark Cudmore wrote Wednesday, adding that it’s “not only particularly exposed to both global trade and the tech industry, but it’s also a country with idiosyncratic vulnerabilities.”
With markets now seemingly awake to the reality of the trade war and also to the read-through for global growth, we’re back to familiar questions about the efficacy of monetary policy when it comes to blunting the impact.
“Our US current activity indicator (CAI) points to growth of 1.7% in May, down 50bp from February levels [and] as a result, our CAI innovations, which track macro surprises relative to statistical forecasts, have decreased materially across regions”, Goldman writes, in a note dated Tuesday evening.
The bank then makes a critical, if self-evident point. To wit:
Strong risky asset performance earlier this year was driven by the Fed pivot and fading recession concerns. This supported the ‘goldilocks’ environment, with equities and bonds rallying together and the negative correlation between equities and real yields (Exhibit 3). However, as breakeven inflation closely follows market measures of global growth, it has now taken the lead for the recent decline in US rates, which moved lower alongside equities.
In other words, growth concerns have now overwhelmed the support equities were getting from the Fed’s dovish pivot. If the bond rally is driven by falling breakevens, stocks will “catch down” to nominal yields.
Goldman goes on to warn that “support from easier monetary policy is seldom a reason for a sustained pick-up in risk appetite if a pick-up in growth does not follow.”
So, while the coordinated dovish pivot from policymakers was enough to catalyze the best start to a year for equities in decades, the sustainability of that run is in jeopardy without an improvement in growth. Recent trade escalations cast considerable doubt on the prospects for such an improvement.
“Currently the YTD recovery in risk sentiment is following the typical historical path where a global growth improvement does not follow monetary easing”, Goldman goes on to say. “Similar to 2015, with little support from the structural and business cycles, we think risk appetite is likely to remain in negative territory until growth picks up.”