Investors eye implications of wider, longer trade war on interest rates

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Tense calm pervaded the markets on Tuesday as investors eyed the implications of wider, longer trade war. Market participants weighed the geo-political risks as buyers cautiously returned to the equities markets.

U.S. stocks rebounded a bit from Monday’s losses. The Dow Jones Industrial Average was up by about 242 points at 3 p.m. New York time. Treasury yields moved higher, with the 10-year yielding about 1.74% and the 30-year yielding around 2.27%.

Amid trade tensions and the tit-for-tat responses from China to the imposition of U.S. tariffs, and a Chinese monetary devaluation countered by U.S. charges of currency manipulation, some analysts speculated a tilt toward further interest rate cuts in the U.S. to counter slowing global growth.

“As we try to gauge the impact of new tariffs upon Chinese exports, we would expect the haven bias to dominate the investment narrative over the near-term as the trade story encourages the market doves seeking enduring momentum towards lower rates and calling upon the Fed to respond aggressively to the global uncertainty," said Jeffrey Lipton, head of municipal research and strategy at Oppenheimer & Co. Inc. "This dynamic should bolster muni performance.
“With the conclusion of July’s FOMC meeting, we were expecting munis to break free from their tight trading range, but we signaled caution on the asset class’s ability to extend outperformance over [U.S. Treasuries],” Lipton wrote in a Tuesday market comment. “Beyond August, reinvestment needs are expected to taper, giving rise to a weaker supply/demand dynamic, yet we still believe that continued retail interest will drive performance through Q3 and into the fourth quarter of 2019.”

Fed Chairman Jerome Powell pledged appropriate accommodative actions would be taken to sustain the recovery cycle as necessary, Liption said, but did not indicate the Fed was done cutting.

“As anticipated, muted inflation and a slowing global economy with widening optics on the complexities and ramifications of an extended trade conflict have not only rationalized the move to easier policy, but this backdrop, in our view, provides sufficient flexibility to lower rates again,” Lipton said. “In our opinion, the threat and very real possibility of expanded tariffs on Chinese goods likely alters the calculus for not only the financial markets, but for the Fed as well.”
Subadra Rajappa, head of U.S. rates strategy at Societe Generale, said the Fed may be heading into a series of gradual rate cuts this year and next.

“The Fed delivered a hawkish rate cut at the July FOMC meeting, the effects of which soon dwindled amid fears of fresh tariffs on Chinese imports. Against the backdrop of growing trade and currency war fears, and speculation that the Treasury might intervene to devalue the US dollar, it is very unlikely that the Fed will stop at just one cut,” Rajappa said. Therefore, a general decline in yields steered by the belly has been seen across the curve. What seemed earlier an insurance cut now appears to be the beginning of an easing cycle. The Fed is expected to deliver at least one further cut this year (markets are pricing in more) and more again in 2020 as the U.S. economy heads into recession.”

The FOMC next meets in September.
"In our view, the intensifying trade conflict has made its job more difficult,” Lipton said. “Through the balance of the year, we suspect that the wager will point to one or more additional rate cuts, and now we have to find the confidence that the Fed will give proper consideration to fundamental data here in the U.S. as well as to a weakening and politically-challenged global economy.”

Labor says job openings little changed
The number of job openings was little changed at 7.3 million on the last business day of June, the U.S. Bureau of Labor Statistics reported Tuesday.

Hires and separations were little changed at 5.7 million and 5.5 million, respectively. Within separations, the quits rate was unchanged at 2.3%, and the layoffs and discharges rate was little changed at 1.1%.

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