Macro

Today I argue that the trade war could be over, or at least transform into a trade impasse, which might in turn unleash the mother-of-all search for yield rallies as global central banks slash the price of money once again. Back in May we argued that there was every chance the US and China would never resolve a trade deal and that America’s strategic priority was, in fact, to use tariffs as a tool to shift its critical supply chains away from its premier geo-political foe. If that was the aim, it is more or less mission accomplished (click on that link to read article or AFR subs can click here). Excerpt only:

It’s never been entirely clear whether a fickle and capricious President Trump subscribes unconditionally to the hawks’ project to push trade away from China towards more friendly actors, or if he is more taken by the alternative “Goldman Sachs consensus” that a deal should be done to sate markets, which want to (myopically) eliminate all forms of external risk irrespective of the long-term consequences.

Here judging Trump on his actions is illuminating. No deal has been done, and none looks likely to be forthcoming in the near-term. Instead, Trump has slapped 25 per cent tariffs on roughly one third of all Chinese exports to the US and is about to slug the remaining two-thirds with a 10 per cent tax.

These tariffs are doing precisely what Bannon’s hawks had in mind: China has slumped from being number one on the list of America’s top trading partners to number three, ranking behind more pliable and proximate counterparties, Mexico and Canada, which have no problems adhering to the rules of the Western Liberal-democratic model.

This could well be the end of the road as far as the current trade war is concerned—a semi-permanent stalemate between the two would-be global hegemons with the hawks prevailing in their efforts to permanently shift the global centre of economic gravity away from the Middle Kingdom...

With global central banks now all seemingly trying to out-do one another with their efforts to pre-emptively get ahead of nebulous economic risks and elongate the current business cycle, it is plausible that the market rally extends firmly into 2020 as global activity recovers on the back of yet another wave of unexpected stimulus...

In our own markets we have certainly observed a dramatic increase in the intensity of the (at times irrational) search for yield, and it is reasonable to assume that this will continue with gusto in the period ahead if volatility normalises and the reach for income reasserts itself.

One chart that is fascinating on this front is a comparison of the credit spread on Australian corporate bonds—as proxied by the iTraxx Australia credit default swap indexwith cash or risk-free rates as represented by five-year government bond yields.

You can see that the ratio of credit spreads to cash rates has never been as high as it is currently other than in the middle of the 2008 crisis. Every single time this ratio has spiked materially, credit has embarked on a huge rally (ie, spreads have compressed), which must now be at least one plausible contingency in the period ahead.




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