Macro 5 minutes to read

Bonds, equities sound trade war wake-up call

Eleanor Creagh

Australian markets strategist, Saxo Bank

Summary:  The likely escalation of the China-US conflict means that investors need to more into capital preservation mode.


Risk appetite has made an abrupt turnabout in the last 24 hours as investors slowly wake up to the trade war risks and potential knock-on effects to the global economy. The inversion of the three-month/10-year yield curve hit its deepest level in 12 year, sounding a warning bell for the global economy. We have warned previously that complacency in the face of escalating trade tensions would be misplaced, as the chances of a deal at the G20 are incredibly slim given the trajectory of the rhetoric.

As I write, European and US futures are following Asian equities into the red setting the stage for an ugly turn in risk appetite. It seems now that market participants are finally realising that the narrative of an H2’19 recovery is fast dissipating. At the centre of the market’s concerns is the obliteration of green shoots in global growth arising from escalating geopolitical tensions, as incoming data continue to raise concerns. Markets have been lulled into a false sense of security by benevolent central banks but could be in for a rude awakening as the H2 revival fizzles out and the outlook for economic growth is dampened.

As we wrote at the start of the month, our view remains that until we see a more robust macro environment and confirmation of a self-sustaining re-acceleration in economic growth, it’s time to move into capital preservation mode. Global markets remain vulnerable as they are yet to price in the protracted escalation and unfolding fight for technological supremacy.

Many are aware of the notion of a long and protracted battle between the US and China, but this is not reflected in positioning yet. The implications of a permanent shift in the US/Chinese relationship are hard to fathom as globalisation has profoundly entwined supply chains and economic networks. But as the probability that a tech “cold war” has increased, investors should not dismiss the notion of a splintering US/China relationship and the effect this could have on risk premiums. The impact on global growth will be pervasive, non-linear and lagging, something investors have been complacent about to date.
S&P 500 e-mini futures (source: Bloomberg)
The canary in the coal mine comes in the form of the Tasman tango, as both New Zealand and Aussie 10-year yields hit record lows. The Australian 10-year yield has fallen below the Reserve Bank of Australia policy rate of 1.5%. Forecasters are near-unanimous on the likelihood of 50 basis points of cuts from the RBA, with JP Morgan calling for 100 bps of cuts by mid-2020. As investors move to price rate cuts and trade tensions escalate, yields will continue to move lower.

Globally, yields are joining the Tasman party as Treasury yields are hitting their lowest level since 2017 and bund yields are hitting their lowest level in almost three years, closing in on the record low in 2016.

China’s calls to weaponise rare earths are growing louder; again, this may not be a new development as last week Chinese president Xi Jinping’s visit to a rare earth mining base fueled speculation that the strategic materials will soon be deployed in the trade war. But the persistent threats in Chinese media have grown more forceful and risk appetite is consequently waning.
Lynas Corp (ASX:LYC), was the top performer on the ASX 200 today, up 15.5% as the company is poised to benefit as the trade war heats up and the market realises the weapon potential of rare earth minerals. Lynas is the world’s only miner and processor/producer of rare earths worldwide outside of China. In a world of heightened geopolitical tensions, a non-Chinese supplier has a significant competitive advantage for manufacturers and businesses wishing to diversify supply chains away from China, making it a supplier of choice for non-Chinese customers.

Click here for more on Lynas, and here for Saxo Head of Commodity Strategy Ole Hansen's latest on why rare earths are a key Chinese advantage.
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