Again we see how the market is moving around on US-China news flow that is hard to lock down. China’s threats to stop rare earth exports is clearly a bargaining chip, if not exactly a trump card, but one the market is starting to really take seriously.
We’ve not heard this much about rare earth metals since the last time China imposed a ban in 2010. This could be a catalyst for further downside pressure – the ‘weaponization’ is indicative of China hunkering down for the fight. Whilst any short or long term economic implications will need to be assessed, from the chatter we’re seeing today this rare earth stuff is spooking investors. They may be much more sanguine than that, but there is a clear risk and indeed a sense that markets need to price more accordingly to reflect the downside risks from the trade conflict.
Commentary in China’s official People’s Daily is not helping either – everyone focusing on the ‘don’t say we didn’t warn you’ comment, which has war connotations. That maybe over-egging the pudding, but it's certainly not risk-on.
The effect on the market has been for a simple sell-off in equities, with investors cutting back on riskier assets in favour of relative safety of bonds.
On Wall Street, the Dow Jones industrial average slipped to 3-month lows on Wednesday after breaking down through its 200-day moving average, an important technical indicator.
The US 10yr yield has slipped to its weakest since September 2017, and the 3-month/10-year curve is inverted. Inversion of the yield curve - when shorter-dated bonds carry a higher rate than longer-dated paper - is often cited as a recession warning light. Worth noting that this was flashing before the recent breakdown in US-China trade relations. The 2yr-10yr is still not inverted though as markets price in a rate cut in the not-too-distant future. The worry now is that traders are eyeing the 2% level on the 10yr again and that would mean very heavy losses for stocks to get there.
What's been really surprising to many is the total calm in forex markets. Whilst the dollar has inched up, we're not seeing much movement from the major pairs. Even the yen is not really moving in spite of the apparent flight to safety - although as we have noted to clients the US dollar is finding strong bid as a relative haven.