Signs of a truce in the brewing trade war between China and the US is good news for equities just as the market awakens to the risk of a deepening sell-off in Italy, where the prospect of a new coalition government embracing a populist fiscal regime has rocked stocks.
China and the US appear to have reached an agreement whereby China will import more American agricultural products and natural gas, but without ceding to one of President Donald Trump’s key reported demands that the trade deficit be reduced by $US200 billion ($266 billion).
Trade tensions weighed on stocks on Friday, the second day of this round of negotiations in Washington, when the S&P 500 fell 0.3 per cent to 2712 points and the Dow Jones Industrial Average rose by just one point to 24,715. Futures imply Australian stocks will fall 30 points at the open on Monday, from Friday’s 6087 close for a fall of 0.5 per cent.
Strategists warmed to the joint statement issued on the weekend, even though several aspects of the dispute are unresolved. AMP Capital said “a trade war has likely been averted”, and National Australia Bank called it “risk positive” with a nod to the Australian dollar which settled at US75.11¢.
“I feel like we’re in that stage for markets now where they’re alert about it, they know what’s going on, but the general sentiment is known and we were converging on some sort of solution. Now we’re in the second or third layer of the debate where markets sit back and wait for it to happen,” said Geoff Wood, head of macro and risk at long-short manager Morphic Asset Management, expecting stocks may rally slightly as a consequence.
The fate of ZTE, the Chinese handset maker which President Trump defended last week despite it being the target of a Commerce Department ban that in effect put it out of business, is unclear. Commerce Secretary Wilbur Ross has alluded to ZTE facing alternative harsh penalties at the President’s request.
The issue dominating the bond market was not China-US relations but the formation of a popular-leaning coalition leadership in Italy unifying the Five-Star Movement and League party.
The FTSE MIB, the Italian benchmark, fell 1.5 per cent on Friday to 23,449 points dragged down by bank stocks. The 10-year Italian bond sold off further against the German 10-year bund, widening the spread to 160 basis points. The parties have yet to name a prime minister or form a proper government.
“This is one that crept up on the market in the background and has taken people by surprise,” Mr Wood said. ”When you lend to a government agency you don’t know who you’re lending to past the next election cycle. One of the biggest trades has been Japanese investors buying European debt, super-long Italian bonds, on the understanding they were lending to a much more conservative Western government.
“What you’ve got is a more Greek style set-up,” he said.
What the parties are proposing will mean increasing Italy’s budget deficit including lowering the pension age, introducing a form of basic income and reducing taxes without backing alternative revenue-raising measures.
Citigroup says that while many of the policy goals are difficult or impossible to achieve, the proposed coalition will have a “far more confrontational” attitude towards the monetary union relative to any past Italian governments.
Capital Economics, which sees Italian yields rising to 2.5 per cent if not higher, finds Italy has been one of the biggest beneficiaries of European Central Bank asset purchases, set to end this year in its view.
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