E Markets: Mourning

The US remembers its 41st President today and markets are closed for a day of mourning, while the rest of the world reacts to yesterday’s US reversal of risk-mood and seeks understanding. There are five steps to grief – denial, anger, depression, bargaining and acceptance.The markets are somewhere in the anger and depression stages. Blame for the reversal rests on Trump’s tariff man tweet and the further inversion of the US 2-5Y curve, throw in ongoing equity market rotations from growth to value along with increased volatility and you see a market in mourning. The undoing of the Trump/Xi euphoria isn’t a surprise, but it is a disappointment – this is the slap of reality that the goldilocks narrative of benign central bankers and steady growth truly is a fairy tale. 

If you can’t have a bed-time tale, then there is always the newspapers. But, markets want to read the sports page first to celebrate the victorious and leave the front-page disasters for later. So today depends are what you read – where OPEC works on a deal to cut output by 1.3mb a day, but still needs Russia to have it work; where China is “confident” of a trade deal with the US; where Italy expects to get new budget numbers next week; where any twist on the UK Brexit leads to someone losing, either through messy politics or messy trade. The UK maybe the best place to focus on for lessons about grief as they have had two years to mourn the vote to divorce from the EU and yet no acceptance yet.  

The GBP looks noisy as the worst outcome for UK May increasing the hope for remaining in the EU and reversing the entire mess – many analysts are moving the odds for another referendum and new elections higher. All of which makes the GBP 1.2650 or 1.2850 levels look more important than usual in the context of trading risk into the weekend and next Monday’s vote.

Question for the Day: Does the US/China trade war hurt Europe? The trade war truce and the talks that follow from the US Trump and China Xi G20 dinner are still the main focus for trading markets. The ability to have any edge over outcomes seems limited given the opaque nature of the discussions. The latest research on the effects of trade wars and global economies is filled with gloom and this is part of the story behind risk-on and off market movements. The one new twist on trade analysis came from the Dutch Central Bank last month– its worth considering – here is their point - A trade war between the United States and China is set to cause serious damage to both countries. The euro area may be able to benefit temporarily, provided it does not get involved.

The figure above illustrates the macroeconomic impact of a trade war between the United States and China. We first assume that only the United States imposes a 10% tariff on all US imports from China (solid lines). In a second scenario, we assume that China retaliates by imposing an equal tariff on all Chinese imports from the United States, i.e. on all US exports to China with a three-month delay (dotted lines). Figure 1 shows the impact on gross domestic product (GDP) in each of the regions.

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