TRADE FRICTION TAKING A TOLL

The major stock market averages opened lower again today on trade tensions (Dow -278 pts; SPX -.9%). All eleven market sectors are down, led by Energy, healthcare, consumer discretionary, and communications (all down about 1%). European stock markets closed down over 1% as well, and most Asian markets closed lower last night. The one exception seems to have been the Shanghai Composite, which closed slightly higher on the session. Commodities are mixed today. Corn futures surged as flooding threatened crops. Copper rose .9% today after falling about 8% so far this month. WTI crude oil fell 2.7% to trade around $57.50/barrel. Bonds are trading mostly higher, especially safe-haven Treasuries. The 10-year Treasury yield fell to its lowest level since September 2017.

As we have pointed out in recent months, the yield curve is fragile. This morning, the 10-year Treasury yield dipped to 2.22%, which is lower than the yield on the 3-month Treasury Bill. This is of course unusual. Typically, investors snap up long-term safe-haven bonds when the future looks more uncertain. Higher demand for these bonds drives down long-term yields and historically when the 10-year yield falls below the 2-year yield investors begin to worry about the possibility of economic recession within one year. And whereas usually the 10-year yield is more than 1.0% higher than the 2-year yield, that gap has recently shrunk to just .15% (or 15 basis points). Bond traders are beginning to wonder if the Federal Reserve will be forced—by slower economic growth and lower inflation expectations—to cut short-term rates some time later this year. Such a move would potentially prevent the 2s-10s curve from inverting.

At a meeting of the World Trade Organization (WTO) China accused the Trump Administration of violating WTO rules when it placed sanctions on Huawei Technologies Co. The US Commerce Dept. added Huawei to a list of foreign firms that US companies need specific permission to do business with. This, more than trade tariffs, has incensed the Chinese government. WTO rules are intended to promote fair global trade, but offer an exception where national security concerns are present. China’s view is that the US is abusing that exception and is unfairly targeting an innocent private Chinese firm. The US military & intelligence community (as well as the Canadian government) suspect Huawei’s telecommunications equipment and cellphones are used to spy for China. And the US government is now urging its allies to avoid Huawei. This is a big deal because global wireless networks are preparing to upgrade to 5G and Huawei is positioning itself to do the work. One can imagine the “How dare you!” from Xi Jinping as he realized Mr. Trump had stolen a page from his playbook (i.e. banning Google & Facebook for their deleterious effect on China’s national security). Mr. Xi is considering retaliatory moves. A state-owned media outlet cautioned, “We advise the US side not to underestimate the Chinese side’s ability to safeguard its development rights and interests. Don’t say we didn’t warn you!”


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