A rapidly escalating U.S.-China trade war drove the worst stock sell-off of the year Monday. Trade watchers warn it may only mark the opening scene of a dark new chapter in the conlfict.
Leaders of the world’s two largest economies continued ratcheting up their confrontation after U.S. markets closed: The Treasury Department designated the Chinese a currency manipulator. And Beijing confirmed it is canceling purchases of American farm goods in response to President Trump’s latest tariffs — 10 percent duties on $300 billion of Chinese imports set to hit in September.
After all three major stock indexes dove Monday — the Dow Jones industrial average was off 961 points at one point, before closing down 767 points, or 2.9 percent — stock futures pointed to another rout before recovering overnight. That owes to the People's Bank of China moving today to set a higher-than-expected level for the yuan, suggesting Chinese leaders may be reluctant to launch headlong into a currency war. At press time, futures for the major indexes were up around 1 percent.
But the market’s recent slide has returned the S&P 500 to its level in January 2018, when Trump first launched the trade wars by leveling tariffs on imports of washing machines and solar panels.
From Liz Ann Sonders, chief investment strategist at Charles Schwab & Co.:
“...full of sound and fury, signifying nothing” may be what Shakespeare would say if he fell asleep in January 2018 and woke up today pic.twitter.com/XsPmSlNJm7— Liz Ann Sonders (@LizAnnSonders) August 5, 2019
And the wider threats remain. Indeed, the danger now is the conflict could spiral well beyond the one-day carnage on Wall Street, with economists and market watchers pointing to the possibility of a global currency war, the permanent delinking of decades-old U.S-China supply chains, and a rising specter of recession.
Trump on Monday morning reached for a familiar villain as stocks started their slide. He again blamed the Federal Reserve for failing to back him up after Beijing allowed their currency to slide past what had been an important psychological threshold of 7 yuan to the dollar. That marked an 11-year low for the currency, a development that will make Chinese exports cheaper, thereby mitigating some of the effect of Trump’s tariffs.
China dropped the price of their currency to an almost a historic low. It’s called “currency manipulation.” Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!— Donald J. Trump (@realDonaldTrump) August 5, 2019
Federal Reserve chair Jerome Powell last week pointed to rising trade barriers as a menace to growth when the central bank cut its benchmark interest rate by a quarter point, to a range of 2 percent to 2.25 percent. And after Monday’s action, bond market investors are now assigning a 100 percent probability to Federal Reserve officials further cutting interest rates at their September meeting, with half projecting cuts between three-quarters of a point and a full point by the end of the year.
But the risks posed by the widening conflagration may overwhelm the Fed’s limited ability to mount an effective response (a subject former Obama administration economist Austan Goolsbee explores more here). Yields on government debt plunged around the world Monday as investors sought haven from the possibility of a more severe slowdown in economic growth. In the U.S., rates on 10-year Treasuries hit a low not seen since Trump’s election.
Another landmark: the 10-year Treasury yield has dropped below its level on election day in 2016, for the first time. Fear re trade war at last cancels out optimism re tax reforms: pic.twitter.com/i27lkGkCZH— John Authers (@johnauthers) August 5, 2019
And the spread between yields on three-month bonds and those longer-term notes hit their widest point since before the 2008 financial crisis — a phenomenon known as a yield curve inversion, considered a reliable predictor of a looming recession.
Former Treasury Secretary Larry Summers was one among many sounding alarms about the peril of the situation:
Markets are now suggesting the highest risk of recession since 2011. Only slightly less than half over the next year. The collapse in medium and long term interest rates is ominous.— Lawrence H. Summers (@LHSummers) August 5, 2019
In the shorter term, continued escalation between the U.S. and China could pitch the global economy into recession in as little as nine months, Morgan Stanley chief economist Chetan Ahya predicted in a note. “As we view the risk of further escalation as high, the risks to the global outlook are decidedly skewed to the downside,” he wrote, per CNBC. "Global central banks, in particular the Fed and [the European Central Bank], will provide additional monetary policy support. But these measures, while helpful in containing downside risks, will not be enough to drive a recovery until trade policy uncertainty dissipates.”
But there’s an even more fundamental shakeup potentially under way beyond the tit-for-tat retaliation between Washington and Beijing and its shorter-term ravages, Neal Shearing of Capital Economics writes — “namely, we may be witnessing the end of globalisation.”
“There is a significant risk that the current trade war between the US and China represents the start of a wider backlash to globalisation that ultimately leads to the disintegration of the liberal rules-based system that has governed the cross-border flow of goods, capital and labour over the past 70 years. It’s even possible that this might lead to an eventual Balkanisation of the global economy, with US-, and China-led spheres of influence, each with separate payment systems, regulatory standards and technological platforms.”
Pressure from existing tariffs and the threat of new ones has already started severing U.S.-China supply chains, as firms that rely on Chinese facilities have shipped production elsewhere. Much of it has moved to Vietnam, as this Wall Street Journal chart illustrates:
But developments over the course of the last week appear primed to accelerate the trend, leaving the truce that Trump and Chinese President Xi Jinping negotiated at a G-20 summit in Osaka in late June in tatters. Trade experts now say they see shrinking hope for talks between the countries to head off intensifying hostilities.
The situation started unraveling last week after Treasury Secretary Steven Mnuchin and U.S. Trade Representative Robert Lighthizer returned from unproductive talks in Shanghai with no Chinese commitment to resume buying U.S. agricultural products. Trump responded Thursday by announcing the new round of tariffs — over the objections of his advisers in a heated Oval Office session, per the Wall Street Journal. And the Chinese in turn retaliated by letting the yuan sink, prompting Treasury’s designation of the country as a currency manipulator.
Though the designation itself is largely symbolic, Trump could use the currency manipulation label “to justify some combination of (more) tariffs, investment restrictions and export controls,” Chris Krueger of Cowen Washington Research Group wrote in a Monday note. Eswar Prasad, a professor of trade policy at Cornell University, tells my colleague Jeff Stein the morphing of a trade war into a currency war could get “very serious… This could lead the U.S. to essentially shut down all imports from China.”
Or as Bloomberg’s Shawn Donnan puts it, the U.S.-China face-off is "starting to look like a forever war — a quagmire with no end in sight, no clear path to a resolution and more potential land mines for an already weakening global economy.” Goldman Sachs economists wrote late Monday they now see both sides “taking a harder line, and we no longer expect a trade deal before the 2020 election." Part of the problem, Beacon Policy Advisors’ Stephen Myrow writes, is that there is no obvious off-ramp for either side now. Per Myrow, “The president has given no indication that he is willing to pull back on his tariff threat, and even if he wants to, Xi appears unwilling to make yet another deal that is likely to be broken.”
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— Should you buy the dip? Bloomberg's Eric Lam points to the stats that make the case: "The more optimistic among the U.S. equity trading community have no doubt just one question in their minds amid the trade-war induced stock slump -- when to buy the dip. History has a few answers. A look back at steep U.S. losses from multi-year highs does show a pattern of rapid rebounds, according to Sundial Capital Research Inc. Meanwhile, Bespoke Investment Group points to the tendency for Monday sell-offs to bounce back strongly...
"Since 1929, the U.S. benchmark has experienced such a scenario -- a slump of more than 5% within two weeks of hitting a multi-year high -- 16 times, not including its current run, said [Sundial Capital Research founder Jason] Goepfert. For 10 of those, the index jumped back to a fresh high, while it fell into a correction six times, he said. Still, the gauge never dropped into a bear market within the next six months, he added."
— Service sector growth hits three-year low. WSJ's Harriet Torry: "The U.S. service sector expanded at the slowest pace in nearly three years in July, a sign that a key segment of the economy continues to cool. The Institute for Supply Management’s nonmanufacturing purchasing managers index eased for the second month in a row to 53.7 in July from 55.1 in June, below economists’ expectations for a higher reading of 55.7. The July reading was the index’s lowest level since August 2016.
"The index topped 60 for a few months in late 2018, but has fallen over the course of this year... The data provide a barometer for the nation’s restaurants, builders, bankers and other service-providers. Consumer spending is the primary driver of the U.S. economy, and about two-thirds of those outlays are on services."
— Ex-Fed chiefs: Leave the Fed alone. In a remarkable op-ed, all four living former Federal Reserve chairs — Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen — are sending a not-so-subtle shot across Trump's bow, indicating he needs to back off his Fed bullying. "As former chairs of the board of governors of the Federal Reserve System, we are united in the conviction that the Fed and its chair must be permitted to act independently and in the best interests of the economy, free of short-term political pressures and, in particular, without the threat of removal or demotion of Fed leaders for political reasons," the four write in their WSJ piece.
"Elections have consequences," they continue. "That certainly applies to the Federal Reserve as well as to other government agencies. When the current chair’s four-year term ends, the president will have the opportunity to reappoint him or choose someone new. That nomination will have to be ratified by the Senate. We hope that when that decision is made, the choice will be based on the prospective nominee’s competence and integrity, not on political allegiance or activism."
— Walmart won't stop selling guns. The Post's Abha Bhatterai: "Walmart said Monday it will not stop selling firearms or change its open carry policies, even as advocacy groups and workers voiced concerns about shootings at two of its stores that killed 24 people in the past week. 'There has been no change in company policy,' spokesman Randy Hargrove said in an interview. 'With this incident just having happened over the weekend, our focus has been on supporting associates, customer and the El Paso community.' ...
"The retail giant sells guns in about half of its 4,750 U.S. stores, making it one of the nation’s largest sellers of firearms and ammunition. It requires store employees to undergo active shooter training every three months, and allows shoppers to carry firearms openly in cities and states where it is legal."
— Wall Street faces a pay slump. Reuters: "Many Wall Street workers will see their pay stay flat or decline this year, as big banks and money managers continue to cut costs, according to a report on Tuesday by compensation consultancy Johnson Associates. Those in equities trading and underwriting will be hardest hit, with annual pay packages down 10-15%, Johnson Associates predicted. Bond traders and traditional asset managers can expect reductions of 0-5%, with dealmakers and private bankers facing flat pay.
"The job market has generally tightened on Wall Street since the 2008 financial crisis, when market chaos and recession forced the industry to adjust. But now there is a peculiar dynamic, where pay can fall even when the economy is strong, said Alan Johnson, who runs the consultancy."
— America’s two largest newspaper chains are set to merge: “The merger announced Monday between Gannett and GateHouse Media — America’s two largest newspaper chains — comes amid turmoil for the print journalism industry and shaky times for Gannett, which fought off a takeover attempt by a hedge fund earlier this year,” my colleague Rachel Siegel reports.
“The deal also marked an uncertain new chapter for the McLean, Va.-based Gannett, a former titan of American media that boomed in the latter half of the 20th century. Its flagship publication, USA Today, introduced the country to a national newspaper that could reach millions of readers, complete with digestible coverage, color photos and eye-popping graphics.”
— Tyson discloses DOJ probe: “Tyson Foods Inc. and other major chicken companies said they received subpoenas from the Justice Department, signaling an expansion of a criminal investigation into allegations they colluded to prop up prices,” the Wall Street Journal’s Jacob Bunge reports.
— Senators demand Google do something for contractors: “Ten U.S. senators are calling on Google to take ‘immediate action’ to convert its growing number of contractors to full-time employees after six months of work,” CNBC’s Todd Haselton reports.
“The demand follows a New York Times report in May that said Google employed 121,000 contract employees and 102,000 full-time employees.”
— Wyden wants info on Capital One hack: “A Democratic senator is pressing Amazon.com Inc. for answers on its cloud-computing technology at the heart of the Capital One hack, one of the biggest-ever bank-data thefts,” WSJ’s Robert McMillan reports. “Sen. Ron Wyden (D., Ore.) on Monday sent a letter to Chief Executive Jeff Bezos requesting details about the security of Amazon’s cloud service, which stored the 106 million Capital One Financial Corp. credit-card records allegedly stolen by an accused hacker.”
— Fed to develop real-time payments system: “The Federal Reserve plans to develop a faster payments system for banks to exchange money, providing a public option to another real-time network built by big banks,” WSJ’s Lalita Clozel reports. “The new system would allow bill payments, paychecks and other common consumer or business transfers to be available instantly and round-the-clock, a change from the government’s current system that is closed on weekends and can at times take days to settle a transaction.” The Fed expects the service to debut in 2023 or 2024.
The House and Senate are on recess.
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