My way or the Huawei

Summary

• Macro outlook worsens alongside the fallout in trade talks.

• Populist rhetoric in Europe is ramping up.

• There’s a potential overshoot in the US treasury market.

Markets were hit with a double whammy this week as the macro outlook deteriorated alongside trade talks with the US and China. Chinese data turned sour once again this week as retail sales came in below expectations. The Chinese data coupled with a pair of disappointing releases in the US (retail sales and Industrial output) provided further evidence that the recovery remains shaky at best. The market continued to become increasingly concerned about the outlook given the recent escalation and prospect of an all-out trade war between the two largest economies. A recent survey from Bank of America (BofA) found that 85 percent of credit investors think the deal is as good as dead. The recent escalation from the US to essentially ban Huawei (and implicitly ZTE) was viewed as a “grave escalation” with the potential to cripple the company. In many ways, it was viewed as the straw that broke the camels back. The ban has the potential to impede the buildout of 5G networks across the globe on the grounds of national security, which could have been believable if the US hadn’t also classified German automobiles as a threat to national security. Although this is likely to be part of the negotiation tactics, over the short run the greater concern is that China is likely to retaliate with similar force against US companies stationed in China (Apple, etc.). Tech stocks and the semiconductor index took the brunt of the blow in trading. Chinese platforms were referring to the US as using “bandit logic”, rivaling North Korea’s “gangster logic” last year (Article here). If you’re looking for “less-negative”  developments, the US did decide to “kick the can down the road” by delaying the decision to slap tariffs on imported car parts from Europe and Japan. The European auto parts index popped on the news but quickly reverted back to the levels before the announcement.  Adding to the populist rhetoric, Matteo Salvini (Italy’s deputy prime minister), decided to accuse the EU of starving Italians. What’s worrisome, besides his awful use of hyperbole, is that Salvini’s Charisma threatens to bring other far-right players like Marine Le Pen (France) back into the mix (not that she was ever gone, the Yellow Vest protests are essentially a rebrand of her platform). Angela Merkel (German Chancellor) is well aware of this and was out this weekend trying to sway voters ahead of the EU election which will take place over the next few days (article here). Some market participants were tying the developments in Italy to the fall in German Bund yields, which are now negative, flirting with Japanese bonds. This raises fears once again surrounding the level of negative yielding debt which runs the risk of amplifying the “search for yield” dynamic as investors are forced out of safe assets into riskier assets in order to meet their required return.  As a result of all the above, yields were broadly lower globally and although equities did manage to close out the week in the green, a broad flight to quality persisted throughout. The US and Canadian 10-year 3-month government bond spread inverted (led by long-end rates) and, although curve inversions are never a good sign, it is not clear that this inversion will persist. Similar to what happened at the March FOMC meeting, hedging dynamics due to prepayment risk in MBS (mortgage back securities) helped exacerbate the move lower in long-term rates as investors hedged their portfolios by buying treasuries. This is what created the false optic of a growth scare back in March, however, given the volume of developments over the past week, it’s not unreasonable to think that the recent inversion was also driven by growth fears. Tiago Figueiredo