This week provided more signs that we are likely at the peak in the global business cycle and hence that the acceleration phase is over. ISM manufacturing fell for the first time since August and US Markit PMI, ISM non-manufacturing, US car sales and US personal spending all fell short of expectations. In China, PMI manufacturing from Caixin also declined slightly and other data suggests that the Chinese cycle is heading lower from here – see China leading indicators – more signs of a peak in Q1, 4 April 2017.
Moving from acceleration to deceleration in the global business cycle has important implications for financial markets as we wrote about in Research: Global reflation set to lose steam, 3 April 2017.
First, the equity bull market has historically paused during this phase and we see higher volatility. Focus on risk factors moves back to the fore and on that front the meeting between US president Donald Trump and Chinese president Xi Jinping will remind us of the risk of a trade war and/or escalation on the issue of North Korea (see more below). We are still bullish on stocks in the long term but for now we expect a shift to sideways trading for some time.
Second, a peak in the business cycle will give more support to government bonds. A peak in headline inflation and falling inflation expectations in the eurozone should give a stronger voice to the doves within the ECB and we believe the bond bear market is over for now.
Third, less steam in the reflation theme will tend to work in favour of the USD and support our view of a stronger USD in the short term. The Fed has a stronger focus on employment relative to inflation compared to the ECB and the US labour market is expected to stay robust even if the cycle starts to decelerate a bit. On the other hand the ECB will continue to be challenged by a core inflation rate below 1% and keep a dovish stance as the cycle peaks and inflation heads lower. We look for a move to 1.06 in EUR/USD +3M. In the longer term, we still expect valuation and current account balances to be supportive for EUR/USD and we retain a forecast of EUR/USD moving towards 1.14 on a 12M horizon. For an update of EUR/USD drivers 4 April 2017.
Difficult Trump-Xi meeting could be reminder of risk factors
The US missile strike on Syria is a reminder that geopolitical risks are present. Russia’s president Putin ‘regards the strikes as aggression against a sovereign nation…in violation of international law, and also under an invented pretext.’ It is too early to judge any implications of this but it clearly adds to the list of geopolitical tensions that includes North Korea and the South China Sea. Regarding the latter, the Philippines president yesterday ordered military occupation of islands that China claim. It could trigger a military response from China if the Philippines follow through on this.
The meeting this week with Trump and Xi has got off to a good start – but nevertheless will be a reminder that the disagreements between the US and China are real and that the potential implications are not negligible. Trade is a key area of disagreement, but we should not expect any action in this area from the US until H2.
A quick way to get an overview of the main tensions is to look at Trump’s Twitter profile for the past couple of weeks. On 30 March Trump tweeted ‘The meeting next week with China will be a very difficult one in that we can no longer have massive trade deficits…and job losses. American companies must be prepared to look for alternatives’. On 17 March Trump tweeted ‘North Korea is behaving very badly. They have been "playing" the United States for years. China has done little to help’.
On 31 March Trump ordered a comprehensive country-by-country study over the next 90 days to investigate ‘trade abuses’ by other countries that contribute to US trade deficits. ‘The theft of American prosperity will end. Thousands of factories have been stolen from our country, but these voiceless Americans now have a voice in the White House’. Secretary of Commerce Wilbur Ross will deliver a report, working closely with National Trade Council Director Peter Navarro and US Trade Representative Robert Lighthizer. All three of them are hardliners on China. In an interview with Bloomberg, Navarro said that Ross will deliver a report to the president and ‘in 90 days we start moving’.
Given what Ross and Navarro have written earlier, there can be no doubt that the report will single out China as the main contributor to the trade deficit by using abusive trade practices. Navarro’s documentary ‘Death by China’ is one long bashing of Chinese trade practices. And Ross and Navarro co-authored a white paper in September as part of the Trump presidential campaign that spent several pages explaining how China is an important reason why US growth has struggled for the past 20 years.
How strongly Trump will address the trade issue at the meeting with Xi is uncertain. But he will likely warn China that unless there is a change in trade practices, the US will take measures to ‘level the playing field’. However, it is hard to see China giving Trump enough for him to be satisfied. And this raises the risk of a trade war breaking out later this year.
When it comes to North Korea the US is increasingly concerned that the regime is getting closer to developing an Intercontinental Ballistic Missile (ICBM) that to be used with a nuclear warhead. Trump had previously said that it was not going to happen but as North Korea continues to carry out tests and get closer to development of an ICBM the situation becomes increasingly urgent to address. As the tweet above suggests, the US is very critical of China that they have not done enough to stop North Korean president Kim Jung-Un from continuing with the tests.
