The Treasury yield curve is trying to tell you something. The risk of a policy mistake is up and the risk to further economic expansion has increased. The market narrative these days is driven by the dispute with China. As we have discussed in prior write-ups, the real issue at hand is the long-term balance of power (economic and geopolitical) pivoting on the key points of intellectual property and market access. The equity markets had priced in a relatively swift resolution with little effect and is starting to recognize the bigger picture.
The dispute with China is becoming one of the few bi-partisan issues in the US. In a May 2019 survey by news channel CBS, 62% of Americans favor trying to get China to change its trade policies to the US and had broad support amongst those identifying as Republicans, Democrats, and Independents. This is in spite of the same poll showing recognition that the tariffs will cause economic pain in the near-term. Chinese state-owned media channels are increasing nationalistic content to foster support. We are seeing the makings of US/China relations becoming the next “cold war” where each side’s power moves are masked somewhat with the banality of day-to-day discourse but have long-term cumulative impact.
The net effect is a drag on economic growth. This is at least the bond market’s view when you look at implied future inflation by comparing yields on Treasury yields that are fixed versus floating based on the consumer price index. Somewhat counter-intuitive to what might be expected by tariffs, inflation expectations have dropped roughly 0.2% across the 5-yr and 10-yr horizons. The impact on growth expectations and yields is global. Yields on 10yr German government bonds (called Bunds) are back to lows last seen in 2016 – NEGATIVE 0.2%! Of course, the hope is that the issue remains a modest drag and does not take an acute turn.
What may be more disconcerting to global investors is the announcement on Friday of tariffs against Mexico…in response to the border issue. The Trump administration is said to favor tariffs due to its ability to enforce them quickly, and bluntly, on issues it feels are important but a question is raised. Where else might this economic tool be used to send political messages not directly related to trade?
It is understandable that the market has swooned so far in May with the twist and turns becoming more evident. It will take some time to straighten out.