Equity investors doubting trade truce

4 December, 2018

The relief rally led by the US-China trade war truce didn’t last long. Investors in Asia were seen taking profits from Monday’s bounce in equities. The Nikkei 225 fell by more than 1.6% with all ten sectors in the red. The ASX 200 and Kospi 200 declined by 1%. Meanwhile, Chinese stocks, which are the most closely watched by traders due to the associations with the trade tensions were flat by the end of the Asia morning session.

The bullish spirits faded so quickly amid rising doubts and conflicting messages received from top officials in the Trump Administration. Trump Tweeted that China has agreed to reduce and remove tariffs on cars coming into China from the U.S. However, neither Treasury Secretary Steven Mnuchin nor Trump’s top economic adviser Larry Kudlow were able to confirm the news. Such inconsistent messages will leave markets guessing and struggling to reach a conclusion, thus leading to volatile price action in financial assets.

Is the U.S. Treasury yield curve indicating a near recession?

While equity markets are likely continue to be driven by updates on the U.S.-China trade agreement, something of interest happened on Monday that also caught the attention of investors. The U.S. 2-year and 5-year yield curve inverted for the first time since the global financial crisis in 2007. Meanwhile, the 2-year and 10-year curve is 13 basis points away from inverting. Historically, inversions of the yield curve have preceded many of the U.S. recessions, and that’s likely to keep investors alert over the next few weeks. Although we do see signs of U.S. economic slowdown, I don’t think we’re near hitting a recession yet. What we are experiencing at this stage is expectations that the Fed is near the end of tightening policy while price inflation remains on or below target. Yesterday’s manufacturing ISM data showed activity in the sector remained strong with the index rising to 59.3 in November, well above analysts’ expectations. However, the price component of the index declined by 10.9 points, which may explain why the longer end of the yield curve is getting pressured.

Sterling out of sync

While most major and emerging market currencies rallied against the Dollar on Monday, Sterling didn’t find the needed support. GBPUSD dropped briefly below 1.27 testing its October lows. The Pound weakness reflects increasing uncertainty over whether the British Parliament will approve the proposed Brexit deal.

This ongoing uncertainty is likely to keep the currency under pressure until December 11.

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