The departure of free-trade champion Gary Cohn leaves the trade protectionist wing of the White House firmly in power, with uncertain market consequences.
Market volatility continued to decline in the past week, with US 10-year Treasuries now having traded within a 15bps range for the past 30 days. This occurred notwithstanding geopolitical developments threatening renewed turbulence, with a strong showing for populist parties in the Italian election and more hawkish developments with respect to the White House and trade policy. In Italy, we have always thought that the outcome of last Sunday's vote would be a fragile coalition and this continues to appear to be the case. With four major parties contesting the election in place of the old configuration of centre left versus centre right, there was never likely to be a clear winner, in our view. Weeks of negotiations now lie ahead and it is possible that new elections may be necessary with individual parties not having a clear incentive to give ground easily. However, a weak and unstable government is not really new news in Italy and with none of the major parties pushing for a referendum on EU membership; we see no credible path to ‘Italexit’ and EU break-up. Consequently, we retain a broadly constructive stance on Italian government bonds (BTPs) and are biased to add on weakness. Longer term, any reversal of reforms or fiscal slippage may hurt the sovereign's standing, but these credit metrics are unlikely to be stressed until the next time recession risks come to the fore.
In the US, the departure of Gary Cohn leaves the administration shorn of any discernible free-trade champion. We have tended to take a relatively sanguine view on the steel/aluminium tariffs that Trump announced the US would be seeking to impose, at the end of last week. Speaking with policy makers in Japan this week, there is an expectation that specific products (such as those that Japan exports to the US and which cannot be produced in America) will be excluded from import duties, and with China only the tenth-largest exporter of steel to the US, this particular measure is unlikely to be the trigger of a US-Sino trade conflict. However, we believe that the fact that the S&P 500 index is back to unchanged levels prior to the tariff announcement may well suggest to Trump that he can launch a trade war without worrying too much about US stock prices – especially if the US is able to improve its trading terms with those countries where it currently maintains a large trade deficit.
A more upbeat European Central Bank (ECB) pushed yields a little higher, though with policy on autopilot until September and little sense that the ECB is interested to raise rates before the middle of next year, Bunds remained in a range and in the periphery the tone was largely upbeat.
In many respects the yen continues to feel cheap on a real effective exchange rate basis and it is certainly true that compared to New York, in Tokyo you can enjoy food that is twice the quality for half the price.
Meetings in Japan this week suggested that a short on yen rates is likely, according to us, to be more of a 2019 trade than a 2018 opportunity. We were also interested to field questions from policy makers asking us for the reasons contributing to recent yen strength. In this regard, it was certainly interesting to draw price comparisons versus the US one week earlier. In many respects the yen continues to feel cheap on a real effective exchange rate basis and it is certainly true that compared to New York, in Tokyo you can enjoy food that is twice the quality for half the price.
Looking ahead, we think trade policy is the number-one risk concerning investors this month. In meetings with trade representatives around the G20, there is a clear expectation that the White House agenda will now catalyse into a package of measures directed at China in the days ahead, with respect to the misappropriation of intellectual property rights, and so we are at a point where we need to wait and see which card the US administration plays next. Optimists clearly hope that Trump's bark is worse than his bite, though pessimists point to the risk of a tit-for-tat round of measures and counter-measures that could materially impact global trade and global growth in the process. The outcome here remains pretty uncertain, but we observe that there may be a sense in which Trump is becoming emboldened in his boorish approach. For example, it has been interesting in recent days to observe how the White House is quietly keen on taking all the credit for forcing North Korea to the negotiating table, by adopting its hawkish stance. In short, Trump feels vindicated in his approach to tackling geopolitical issues and in this regard, it is only to be hoped that pride does not come before a fall.
Notwithstanding these concerns, it shouldn't be forgotten that the global economy seems to remain in very good shape. Monetary and fiscal policies are currently accommodative and fearing the worst has rarely been a winning investment strategy over the past several quarters. Hence we continue to view a long position in risk assets – particularly in the eurozone periphery and euro bank credit – as justified. Notwithstanding the Italian election, we maintain that at a macro level, politics in the EU are heading in the right direction. Meanwhile back in the UK, Theresa May's rebuttal by Brussels has been overshadowed for now by stories of Russian spies, nerve agents and various conspiracy theories. At least, if the row with the 'Beast From The East' gets out of control then the nation may end up being spared the pain and embarrassment of watching the national team underperform again at this year's football World Cup...though in truth, the 'Buffoon from Henley' is probably no more likely to get his way over that than anything else he is arguing for at the moment.