The trade tiff between the US and China took a nasty turn last week, overshadowing the meeting of central bankers at Jackson Hole. The Chinese have hit back by imposing customs duties on USD 75bn of goods imported from the US and allowing the yuan exchange to ebb steadily lower against the dollar. Donald Trump has at last admitted that the trade tussle might lead to a recession, although he could not allow more than a two-month dip as any mention of ‘recession’ on his CV would hinder his re-election chances in 2020. He is reportedly looking into solutions such as a further cut in income taxes to offset the effects of the duties.

In another unrestrained blast of tweets last Friday, he once again caught investors off guard, triggering a sharp correction in equity markets. During this diatribe he first questioned whether Jerome Powel or Xi Jinping is America’s worst enemy. He then announced that import duties would rise from 25% to 30% on the close to USD 550bn of Chinese goods that are imported.

Jerome Powell stated during the Jackson Hole symposium that the signs for the US economy were still healthy. The job market is solid and rising wages are underpinning consumer spending. But he then listed a string of factors hanging over the global economy, one of which was the trade war. The end result is the Fed will continue taking appropriate measures to sustain the current growth trend. At the same time, several Fed governors expressed doubt about the timeliness of initiating a rate-cutting cycle. In this context, sheer gravity seems to be driving government bond yields ever lower, pulled down by slowing global growth, low inflation and the tendency towards looser monetary policies by the main central banks. The market has roughly priced in rate cuts by the Fed totalling 100 basis points between now and the end of 2020.

Currently it is possible to see some correlation between the current trajectory of interest rates and industrial production. Manufacturing indicators have been extremely disappointing recently. In the US, the PMI for manufacturing is situated in contraction territory for the first time since 2009, at 49.9. In Germany it’s even worse: their manufacturing PMI is at 43.6, with foreign orders dropping across all sectors and new business inflows on the decline.

More recently China has adopted a calmer attitude and seem intent on restarting talks, which has reassured investors somewhat. Market volatility is likely to endure in the meantime.

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