The US and China reached a trade agreement at the G20 summit, with attention now turning to US labor market data on Friday
Investor optimism picked up on Monday, as the US will suspend the next round of tariffs on the remaining $300bn of Chinese imports “for the time being”. Recall that the review process for tariffs by the US Trade Representative (USTR) office, on the $300bn imports from China officially starts July 3 and a final tariff list could be ready by mid-July, albeit the USRT is now expected to delay any announcement. The suspension was communicated after a meeting between Trump and Xi at the G20 summit in Japan (28-29 June), and restrictions imposed on the Chinese firm Huawei will be softened as long as it causes “no great national security problem”.
On a negative note, the adverse impact on the global economy from the ongoing US-China tariffs (“no reduction in the tariffs currently being charged”) and the uncertainty stemming from concerns regarding a renewed escalation will remain in place until a final trade agreement is reached.
The US-China agreement is expected to support risk taking in the short term. Indeed, on Monday, Asian equities (ex-Korea) entered H2 on a strong note, posting gains (CSI300:+2.9%, Topix: +2.2%). For H1, the majority of global equity markets posted double digit gains (MSCI ACWI: +16%), with the exception of Nikkei225 (+6%). Indeed, Japanese equities have underperformed significantly YTD (-10% in LC, -7% in USD). The underperformance is evenly split between sentiment (Japanese 12-month forward P/E has increased by 11% YTD at 12.4x vs 16% at 15.6x for MSCI DM) and EPS growth. Indeed, consensus expectations for 12-month forward earnings have declined by 7% for Japanese companies vs 2% for MSCI DM companies. Key factors that weigh on Japanese equities’ underperformance are (i) uncertainty around trade and, to a lesser extent, the slowdown in the Chinese economy, (ii) relatively less-dovish monetary policy since early 2019, and (iii) the prospect of the VAT rate hike (to 10% from 8% in October 2019).
The rally in Government core bond prices continues, with yields slightly lower in the past week, while the H1:2019 performance was the strongest since 2016. The US 10-year bond yield is down by 68 bps to 2.01%. Its 2-year counterpart fell by 73 bps to 1.76% as the Fed is on an easing path. The German 10-year bund yield was down by 57 bps to -0.33%. Periphery spreads narrowed as yield-hunting due to heightened expectations that the ECB may re-activate QE supported demand for periphery bonds. Spanish and Portuguese bond spreads were down by 50-75 bps to 70 and 81 bps, respectively, while GGBs declined by 135 bps to 278 bps also due to idiosyncratic reasons. BTPs narrowed by only 7 bps to 240 bps as heightened political uncertainty took its toll. We take a brief look at Italy’s economic and fiscal situation on page 2 (see Economics Section), with BTPs rallying on Monday due to hopes that Rome may avoid an Excessive Deficit Procedure.
Corporate credit spreads narrowed across the board in the range of 40-126 bps in H1:2019. EUR corporate bonds were supported by increasing expectations that the ECB may reactivate the CSPP, while USD High Yields also benefited from higher oil prices (20%-28% in H1:2019). Overall, corporate spreads are declining towards their 2019 lows, as central banks are ready to embark on supportive policies. With USD real rates declining 80 bps and geopolitical tensions resurfacing (US-Iran), gold prices posted a 10% increase, reaching a circa 6-year high ($1409/ounce). See our Asset Scoreboard below for a detailed performance review for H1 and Q2:2019.