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Haven assets reigned as traders returned to their desks Monday after an action-packed weekend that saw tensions between the U.S. and China ratchet up again.
Treasury 10-year yields dropped below 1.5% to their lowest since Aug. 2016, while the yen rallied as investors ramped up their bid for safety amid concerns that a bruising trade war will hamper global growth. The Turkish lira led a decline among emerging-market currencies.
With the trade rift growing, investors have lifted bets on three more rate cuts in 2019 by the Federal Reserve. Chairman Jerome Powell’s warning at Jackson Hole Friday that the U.S. economy faces “significant risks” was quickly met with an exchange of more tariffs between the U.S. and China.
“Escalation of the trade war could extend the bond rally further, with increased probability that U.S. 10s revisit all-time yield lows set in 2016,” – at 1.318%, wrote a team of strategists at Goldman Sachs Group Inc. including Praveen Korapaty. “Cross-border flows into U.S. dollar fixed income, driven by a surge in negative yielding debt, may not moderate without broad improvement in data.”
U.S. equity futures fell as much as 1.6%, while stock markets in Tokyo, Australia and South Korea all opened lower on Monday. The yen advanced against all major currencies, climbing as much as 0.9% to 104.46, while bonds in Australia and New Zealand rallied. Treasury 10-year yields dropped as much as 7 basis points to 1.4695%.
“Speculators will continue to push up bids for the yen,” said Yukio Ishizuki, senior currency strategist at Daiwa Securities Co. in Tokyo. “Japan’s authorities are likely to take a wait-and-see stance for now, but a rally above 100 per dollar could see some response”
The Kiwi and the Aussie dollars dropped 1% as the Asian trading day got going on Monday. Meanwhile, the Turkish lira suddenly plunged as much as 12% against the yen in a flash crash, spurring speculation that Japanese retail investors were unwinding long positions.
“The market now expects the trade tensions to unleash an even bigger deflationary force and growth hit than it did before last week,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “Haven currencies, like the yen and Swiss franc, will be in demand and those tied to growth — including the Australian, New Zealand and Canadian dollar — will be under pressure.”
While U.S. President Donald Trump’s additional tariffs fell short of speculation for a stronger response, such as currency intervention, he has threatened to force American companies to leave China.
Treasury Secretary Steven Mnuchin, speaking on “Fox News Sunday” from the Group of Seven meeting in Biarritz, France, said Trump would have the ability under the International Emergency Economic Powers Act, if he declared an emergency. White House economic director Larry Kudlow agreed, in an interview on CNN’s “State of the Union,” but said “there’s nothing right now in the cards” to do so.
“The trade war between the U.S. and China is now escalating at a bewildering pace, which is likely to trigger further market volatility and expectations of ever more aggressive monetary easing from the Federal Reserve,” said Patrick Wacker, a fund manager for emerging-market fixed income at UOB Asset Management Ltd. in Singapore. “The yuan will keep falling towards the bottom of its new near-term range of 7.05-7.25 against the dollar.”
Trump’s piling on more criticism of Powell on Friday, coupled with his call to U.S. companies operating in China to consider leaving, pummeled markets going into the weekend. This backdrop also sent a key slice of the yield curve, which is closely watched as a gauge of an impending recession, further into inversion as traders’ viewed the growth outlook as more dire and ramp up bets the Fed cuts.
The gap between three-month rates and yields on 10-year Treasury notes fell Monday to a low of minus 51 basis points, the most inverted since March 2007.
“The market expects substantial rate cuts but the Fed isn’t moving along that line,” said Naokazu Koshimizu, senior rates strategist at Nomura Securities Co. in Tokyo. “Short-dated yields are struggling to fall even amid concern over a deterioration in the U.S. economy, leaving the yield curve prone to inversion.”
There is roughly a $16 trillion pool of global debt with sub-zero rates. Treasuries have gained 8.4%, leaving them on track for their best annual performance since 2011, according to the Bloomberg Barclays U.S. Treasury Index.
A dive in the greenback Friday also sparked renewed speculation the U.S. may intervene to weaken the currency.
The Bloomberg Dollar Spot index sank 0.35% on Friday.
Adding to the nervousness was a Group of Seven gathering in Biarritz, France, at which French President Emmanuel Macron appeared to anger the U.S. by seeking to put climate change at the top of the agenda.
On Sunday, possible signs that Trump may be regretting being aggressive on China at the G-7 gathering soon abated when the White House said media misinterpreted his initial remarks. That confusion will only add more uncertainty to the outlook, some analysts predicted.
White House Press Secretary Stephanie Grisham said that Trump doesn’t regret starting a trade war but he does have second thoughts on whether he should have hit the Chinese even harder.
Trump’s comment followed by the reversal only “adds more uncertainty to markets, which increases the odds of a U.S. recession,” said Andrew Brenner, the head of international fixed-income at Natalliance Securities in New York.
(Updates with Treasuries in second paragraph, analyst comment in 14th paragraph.)
–With assistance from Filipe Pacheco.
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