The Daily Prophet: Let's Call This Comeback the Ross Rebound

Connecting the dots in global markets.

Is it all just for show? That seems to be the message stock markets took from the escalating trade tensions between the U.S. and China. The S&P 500 Index fell as much as 1.56 percent at the open, but slowly clawed its way back to end the day higher by 1.16 percent.

Although the news that the U.S. would impose tariffs on $50 billion of Chinese goods, and the quick response by China that it would place an additional 25 percent levy on about $50 billion of U.S. imports rattled markets, Trump administration officials worked hard to sooth nerves. Commerce Secretary Wilbur Ross signaled that the door is open for a negotiated solution. National Economic Council Director Larry Kudlow suggesting the proposed tariffs on Chinese imports may never go into effect, telling reporters that the tariffs announced Tuesday are "potentially" a negotiating ploy in an effort to get China to level the playing field for U.S. businesses. "There are carrots and sticks in life," he said.

For now, the markets are willing to give the Trump administration the benefit of the doubt that it has skills needed to successfully navigate this tricky situation. “At this juncture we need to be careful," Charles St-Arnaud, an investment strategist at Lombard Odier Asset Management, told Bloomberg News. "The macro picture hasn’t changed massively yet. Growth remains robust, unless we go into a bigger trade war.”

While equities markets went haywire following the tit-for-tat tariffs imposed by the world's two largest economies, the U.S. bond market was strangely quiet. Benchmark Treasury 10-year note yields bounced around in a relatively tight range of 5 basis points, and ended Wednesday up 2 basis points at 2.80 percent. There are two explanations for this -- one good and one bad. The good news is that the small move means that fixed-income investors don't see the budding trade war, which so far covers $50 billion in goods, getting out of control and damaging global economic growth, which would cause a big rally in bonds. The bad news take on the market's lack of reaction is that the threat of China responding by slowing or cutting its purchases of Treasuries has kept U.S. debt from rallying. In a March 23 interview with Bloomberg Television, China’s ambassador to the U.S., Cui Tiankai, wouldn’t rule out that possibility, saying “We are looking at all options.” Treasury Department data show that China owns $1.17 trillion of U.S. government debt, so even a small pullback could have a big impact on the U.S. debt market. It's notable that yields on euro zone government bonds fell on Wednesday.

International trade and foreign-exchange rates typically go hand-in-hand. So how does one account for the relative calm in global currencies even as the world's two-largest economies go toe-to-toe in imposing tariffs on a slew of each other's good, threatening to upend global commerce? A JPMorgan gauge of currency volatility has barely budged in recent weeks, in contrast with similar measures for equities. It's not that traders are complacent, it's just that no one really knows how this will all play out in the $5.1-trillion-a-day current market, according to Bloomberg News' Lananh Nguyen and Ivan Levingston. The challenge is that measures aimed at the U.S. or China could wind up causing ripple effects across world economies. On Wednesday, for example, China’s retaliation against U.S. levies left the dollar little changed broadly, with gains versus about half of its major counterparts. The best performing major currency on Wednesday was the New Zealand dollar, while the worst was the Swiss franc, according to Bloomberg Correlation-Weighted Indexes. Over the past month, the U.K. pound is the strongest, while the franc is the weakest. That's a bit odd as the franc is typically a haven in times of turmoil.

There's no way that China would retaliate against any U.S. tariffs by imposing its own charges on U.S. soybeans, right? After all, China's purchases more than doubled in the past decade, bolstered by a growing herd of hogs and pork consumption and helping U.S. soybean production to rise to $40.9 billion in 2016. China would only be hurting itself. Plus, Wall Street firms such as Citigroup and JPMorgan said last week that China probably won’t impose tariffs on U.S. soybeans. Well, wrong. Commodities traders learned a painful lesson Wednesday as soybean futures for May delivery tumbled as much as 5.3 percent after China imposed tariffs on the product. The move was especially painful since hedge funds and other speculators had built bullish positions in soybeans to some of the highest levels since 2012, Commodity Futures Trading Commission data show. Even so, some Wall Street strategists such as those from Goldman Sachs said Chinese demand for pork and soybean used to make pig feed will hold up in medium term. Even so, broad weakness in raw materials dragged the Bloomberg Commodity Index down at one point to its lowest level since the first half of February before ending down 0.44 percent.

On a day when the MSCI Emerging Markets index of stocks fell to its lowest level in seven weeks, Mexico's benchmark stock index surged 1.66 percent. The nation's equities jumped after Mexico’s presidential front-runner Andres Manuel Lopez Obrador reassured investors in an op-ed in the El Financiero that he won’t confiscate assets. Energy and public works contracts such as the new $13 billion Mexico City airport project will be reviewed one by one "to avoid corruption cases," while respecting bondholders’ rights, he wrote. Mexican stocks also got a boost after Bank of America Merrill Lynch strategists wrote in a research note Tuesday that they probably won’t continue to perform as poorly relative to other Latin American equities. They cited recent positive Nafta headlines, compelling valuations and the fact that most investors are underweight the country’s equity market. Mexican stocks had fallen 5.8 percent this year while Latin American stocks gained 7.6 percent. UBS also chimed in with some positive comments, with its strategists noting in a research report that equities should rise irrespective of the election results.

It's safe to say that President Donald Trump is concerned about the U.S. trade deficit. But for all his efforts to shrink the shortfall, it keeps growing. Data out Thursday will only likely add to his ire. The Commerce Department will probably say that the deficit expanded for the sixth straight month in February, to $56.8 billion, the most since 2008. The expanding trade deficit subtracted 1.16 percentage points from gross domestic product in the fourth quarter, and was likely a drag on first-quarter growth, as well, according to the economists at Bloomberg Intelligence.

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