Morgan Stanley: A "Vicious Cycle" Has Emerged And Will Only End When Stocks Dive

While many had considered that Trump's ever more bitter trade war tirades and rhetoric were just that, at best a negotiating tool as nobody could conceive the US president actively pursuing measures that could potentially threaten the US economy and stock market, over the past month it has dawned on most that in this case, Trump is not bluffing.

In fact, as Morgan Stanley's chief US public policy strategist writes in the firm's Sunday Start note, "we no longer doubt that the US administration's proposals signal the direction of trade policy. An escalatory cycle of protectionist actions, not just rhetoric, has begun and will continue."

In addressing Trump's unexpectedly stark retaliations, observed in the presidents engagement with China, the EU and Nafta nations, Zezas also notes that "this pattern of behavior shouldn't be ignored: the US and its key economic partners now view trade differently. One party's in-kind response is the other's escalation. This is what a vicious cycle looks like."

This, an increasingly bearish Morgan Stanley writes, is yet "another reason why pressure should continue in risk markets" and lists four specifics reasons for its negative outlooks:

1. The duration of these conflicts should now be measured in quarters, not weeks
2. Markets will discount multiple steps.
3. It doesn't have to be a material economic problem to be a market negative.
4. When it comes to policy, markets had their dessert before their vegetables

Expecting further fallout from trade wars, Morgan Stanley now sees many ways to position for escalation, predicting that tech will be the sector most affected by the emerging "vicious cycle" writing that in stocks, "tech is vulnerable as a sector where pricing has been insensitive to trade risks so far." Separately, Morgan Stanley also sees Asia EM entering a bear market, with the Hang Seng particularly vulnerable.

As for US rates and fixed income, the bank picks "duration over credit", writing that trade risk is one reason why "the 10-year Treasury has seen its high in yields – a positive for duration-sensitive asset classes like munis – while US credit should underperform further on late-cycle concerns."

The bank's last reco is to go long VIX as another spike in volatility is not too far off:

our cross-asset team sees value in being long volatility across a variety of asset classes into the summer.

As one potential offset to his bearish outlook, Zezas offers that the he may be underestimating the resolve of Congressional Republican leaders, who generally support free trade, to take back some tariff power from the White House through legislation, although as he concedes, polls suggest division within the party on this issue.

Which is why the Morgan Stanley strategist concludes that the only true "circuit breaker" to Trump's escalating trade war resolve would have to come from the "scoreboard" – namely a drop in the markets coupled with a jump in volatility.

* * *

His full note below:

Trade Risk: Believe the Hype

by Michael Zezas, Chief US Public Policy & Municipal Strategist at Morgan Stanley

We no longer doubt that the US administration's proposals signal the direction of trade policy. An escalatory cycle of protectionist actions, not just rhetoric, has begun and will continue. It's another reason why pressure should continue in risk markets, which now must eat their US policy vegetables after feasting on dessert in 2017.

Our 'dessert before vegetables' thesis suggests markets were conditioned for unambiguously accommodative policy outcomes entering 2018. A major, tax-driven fiscal stimulus had been just inked by an administration fond of pointing to the stock market as a scoreboard. Trade policy followed another scoreboard, bilateral deficits, making it possible for markets to envision a path away from the fundamental uncertainties of escalation and toward negotiation. A reduction in the US-China trade deficit could keep tariffs and other measures at bay, de-escalating the conflict without putting the global growth dynamic at risk. Treasury Secretary Steven Mnuchin appeared to signal this outcome on May 20, stating that "We're putting the trade war on hold" following China's announcement that it intended to increase purchases of US commodities.

What happened next, though, showed that US rhetoric did not seek to extract quick concessions, but rather to articulate a deeper disagreement. US officials announced their intention to go forward with tariffs on US$50 billion of goods. China outlined steps in response, and the US countered by proposing tariffs on another US$200 billion of goods. Meanwhile, the US broadened its scope, allowing tariffs on steel and aluminum imports from the EU, Mexico, and Canada to take effect. When these countries responded, the US began to prepare auto tariffs. This pattern of behavior shouldn't be ignored: the US and its key economic partners now view trade differently. One party's in-kind response is the other's escalation. This is what a vicious cycle looks like.

Given present market conditions, we think this dynamic exerts pressure on risk assets.

• The duration of these conflicts should now be measured in quarters, not weeks. Benign, negotiated outcomes may still be the endgame, but an extended cycle of escalation will give fundamental impacts time to play out in company financial statements and economic data.
• Markets will discount multiple steps. We now must focus on the cumulative and interacting impacts of the next few rounds. Hence we've argued that investors should expect both the auto tariffs and the second round of China tariffs to go forward.
• It doesn't have to be a material economic problem to be a market negative. Some have been quick to point out that announced actions fall far short of Smoot-Hawley trade barriers and anti-growth impacts. We agree. But that doesn't mean they're not negative for markets or couldn't get worse. Consider guidance from corporations like Daimler, MillerCoors, and Brown-Forman regarding the profit and demand impacts on their products from tariffs. Trade conflicts can create headwinds to earnings, and hence valuations, without sparking a recession. Hard-to-define downsides from further escalation only heighten uncertainty. Hence…
• When it comes to policy, markets had their dessert before their vegetables. Entering 2018, we think that markets were pricing in the positives of the US policy agenda, assuming that tax cuts and increased spending would add to GDP (Morgan Stanley estimate +0.5pp) while shrugging off trade risks as hypothetical. Today, the more complicated realities of the US agenda have come into sharper focus and risk offsetting the positives. Thus, even apparently minor trade actions could be market negatives.

We see many ways to position for escalation. In equities, our team thinks that US tech is vulnerable as a sector where pricing has been insensitive to trade risks so far. We also see Asia EM entering a bear market, with the Hang Seng particularly vulnerable. In US fixed income, we like duration over credit. Trade risk is one reason why we think the 10-year Treasury has seen its high in yields – a positive for duration-sensitive asset classes like munis – while US credit should underperform further on late-cycle concerns. Finally, our cross-asset team sees value in being long volatility across a variety of asset classes into the summer.

Of course, we must consider where we could be wrong. We may be underestimating the resolve of Congressional Republican leaders, who generally support free trade, to take back some tariff power from the White House through legislation, although polls suggest division within the party on this issue. Hence, a near-term 'circuit breaker' to trade escalation is more likely to come from the scoreboard – namely, more challenged and volatile markets.

The Global Economy Is Running Out Of Its Most Valuable Resource

The current state of the financial markets and the global economy depends on one single resource that nobody, even such renowned economists as Paul Krugman or Robert J. Shiller and dissenters like Max Keiser and Jim Rickards, dares to talk about. In private discussions central bank managers told us that they were aware that none of the existing economic theories and models fit this new situation. 

Yet, they do not broach it in their public speeches and lectures, preferring to deal with such topics as balance sheets and business cycles. All of which reminds one of a family visiting a terminally sick relative: everybody knows that he will never recover, and nobody whispers as much as a word about it.

All productive nations whether in East Asia or the West, have reached the peak of their 250-year-long development. Even the most devastating wars could not prevent their populations from growing in the long run. It is only now, during the many decades of peace and affluence, that the numbers of the inhabitants of the developed countries have been decreasing and the trend continues. The phenomenon has not been brought about by any famine or natural disaster but by the sheer fact that people do not want to have children.

Japan is an economic bellwether. The country refrained from mass migration and during the 2006-2016 period its population shrank by 0.5%, oil consumption dropped by 22%, car sales by 7% and GDP by 4%.

Japan is the first country to cope with the new reality and investors need to change their mindset to understand what this new reality stands for. In the past, every business cycle, recession or recovery, ended with a higher GDP and larger economy than before. In the future we will see the opposite: every business cycle will conclude with a lower GDP and a smaller economy than the previous one.

A shrinking population entails economic consequences. Oil consumption will decline, car sales will go down, and national GDP will be lower and lower. The paradox of it all is that the total economy may be shrinking, and yet people in the US, Europe and Japan will be doing better than before. Why? Because a less crowded country means less dependence on (foreign) oil, lower pollution and CO2 emissions, fewer traffic jams, more space and food abundance.

It is the financial sector that will be afflicted by the new reality, not the people. Without the support of central banks the Western financial industry will not survive a continued depopulation, a situation in which people save and spend less and less money. A buoyant economy invests in win-win deals, a stable economy is a zero-sum game, and in a depressed economy all investors lose. That is why central bankers are considering the imposition of negative interest rates. These are flashing warning signals.

Confronted with this reality, the American and European leaderships have opted for re-population. If the pace of this process remains the same, before this century is over, 50% of the Western states will be replaced with people from the Third World.

The Washington establishment began with the acceptance of unprecedented numbers of migrants from Latin America while the enlargement of the European Union made up for the lack of people, at least for the time being. As under the banner of the free movement of labour, Germany, the UK and the Netherlands got a fair share of migrants from Central Europe, this part of the continent has been deprived of its youth. For example the Polish generation in the age bracket 15-20 is 30% smaller. Now it is Ukraine's turn to hand over its youth to Western Europe. After the 2014 revolt in Kiev the European Union was in a desperate hurry to grant Ukrainian "patriots" the right of visa-free travel, so that they could leave their allegedly beloved home country.

Demographics is quite precise, and those in power saw the coming "disaster" in advance.Peter Sutherland, a former Goldman Sachs banker, became an advocate of mass migration. In 2008 he said: "Rich countries should not try to restrict migration from poor countries, even during the economic slowdown." Alas, migration is not about helping the poor – there are just too many of them – migration is about re-populating Europe. Migration is also about economics and finance.

All theories, all models that we know about the economy, finance and markets were developed when the European populations grew. The global economy is dependent on the industrialized world. Without Europe, the Sheikhs of Dubai would relapse into the life in tents, Africa's population would be about 90 million instead of 1.2 billion, and today's US would be a sparsely populated country with very few nomad tribes.

Prestigious consultancy firms have told their corporate clients that all societies are in essence the same and well on the way to becoming like Western economies. The Africans only need to change the law, and they will be as productive, diligent and efficient as people in Europe. Those pundits believe that if car sales stall in Europe, China will be the next market; if the Chinese market is flooded, we have still India, and then – probably around 2040 – the Africans will be the new customers.

We believe that the world's economy is concentrated in East Asia and in the West, with all other economies being but satellites, and it is not going to change, at least in the foreseeable future. If the West together with Eastern Asia collapse, the rest of the world will follow suit. If the West and Eastern Asia stop being interested in African resources, the Black Continent will crumble. We remind the reader that all African countries are dependent on food imports which they finance with the exports of commodities. Africa cannot sustain its current population let alone the doubling of it within 25 years. 50% of the African youth is younger than 25.

The consultancies of Ernst and Young call these youngsters "demographic dividend", a treasure trove for the global companies to reap. If they cannot capitalize on them in Africa, they have to bring them to Europe, as we see happening now. The current migration process which goes by the name of crisis is engineered and promoted by an influential lobby.

What's Really Wrong With The US Equity Business?

Prior to starting DataTrek with Jessica, I spent +30 years in the equity business, first in fund operations, then stock research, hedge funds, and finally writing market strategy for a brokerage firm. That time span represents an entire cycle for "Wall Street" as a business, from starting up a handful of mutual funds that charged 8% loads in 1984 to trading stocks at 0.2% commissions for ETFs that charge 0.04%. It has truly been the proverbial "Long strange trip".

There are many causes for this downward slide, and each carries a well-worn narrative. A few standouts:

• Declining asset management fees: Passive investing has seriously dented the popularity of active management, which has admittedly struggled to consistently outperform in the last 20 years of equity market volatility.

• Lower sell side research margins: Wall Street analysts were hurt by Reg FD and AC, which seriously limited their ability to get a non-public (but once legal) investment edge and deliver that to clients for a premium price.

• Lower hedge fund profitability: Low barriers to entry allowed too many hedge fund startups, compressing fees for even truly talented managers.

• Lower equity trading profits: Decimalization, market fragmentation, higher technology costs and long stretches of central bank-driven volatility suppression have killed desk profitability.

Now, equities are an optimist's game, and there's no shortage of hopeful narratives that argue we're at a bottom for many of these trends. The Fed is cutting back on its balance sheet, so volatility will return and lift trading profitability. The next bear market will see investors come back to active management. Asset allocators are more selective now, so the best hedge funds will regain pricing power.

We prefer to consider the decline of the US equity business writ large (both buyside and sellside) through a different lens: long term US equity returns.These, after all, are what pay for the money management, trading, and research services Wall Street has to offer. It is a lot easier to justify higher fees if returns are strong. And essentially impossible to pass along most costs when they are not.

Here are the trailing 20-year compounded average returns for the S&P 500 every 5 years since 1980, underlying data courtesy of NYU Professor Aswath Damodaran:

• 1980: 8.3% 20-year trailing nominal returns
• 1985: 8.6%
• 1990: 11.1%
• 1995: 14.5%
• 2000: 15.5%
• 2005: 11.9%
• 2010: 9.1%
• 2015: 8.1%
• 2017: 7.1%

This data puts trends in the health of the US equity business in a different light than the narratives we outlined earlier. Equity owners – the ones that actually pay for services like money management, research and trading – have scaled their expenses based on their realized returns. For example:

• The year 1999 at 17.7% 20-year trailing returns was the peak back to 1928, the start of this data series. Ask any old Wall Street professional and they will tell you that was exactly the peak of the US equity business.

• As of the end of 2017, 20-year trailing returns are just 7.1%, lower even than 1961 - 1980. And the same pros will tell you things are, well, very difficult.

This admittedly non-consensus framework also allows us to take a stab at forecasting the future health of the US equity business. Everyone from Vanguard's research group to Cliff Asness thinks the Shiller PE (current price divided by 10-year average earnings) is a good heuristic to estimate future returns, so let's go with that:

• Current Shiller PE: 32
• Average real future 10 year returns when the Shiller PE is between 25 and 46 (i.e. like now): 0.5% (see link to a paper with the data below)
• Assuming 2% inflation, that puts expected future returns at 2.5%

The bottom line here: if this lackluster future return forecast comes to pass, the US equity business will continue to see fee/commission compression for years to come. Asset owners have no choice but to continue to cut their expenses, which are (inconveniently) also the Street's revenues. That applies equally to the buyside (more passive investing, lower asset management fees) and the sell side (less ability to pay for research and trading).

We will finish on an upbeat note: the current and most likely future environment for the US equity business is ripe for further wide-scale disruption. Asset owners have ripped most of the obvious costs out of the existing system, but if returns are really going to be 2.5% then there will need to be further innovation to incorporate that reality. In that respect, Wall Street is no different from any other American industry. Growth and success will belong to the disruptors rather than incumbents.

Wall Street’s Rising Euphoria May Spell Trouble for Stock Market

The New York Stock Exchange (NYSE) is reflected in a mirrored-sign in New York, U.S., on Monday, Jan. 8, 2018. U.S. stocks were mixed, with the S&P 500 Index on track for its first decline of the year, as investors assessed the prospects for corporate earnings, while the dollar strengthened after three straight weekly declines. Photographer: Michael Nagle/Bloomberg.

Euphoria on Wall Street that  stocks can just keep on building on record highs is getting so stratospheric that it's reaching levels that previously signaled a slump.

Analysts are ratcheting up their forecasts for U.S. corporate profits at the fastest pace in more than 10 years, according to the research firm Bespoke Investment Group. And that's happening, unusually, right in the run-up to an earnings-season kick-off. While the upgrades could be taken as a positive reflection on the economy's outlook, in the past such bullish analyst sentiment has served as a precursor to a market decline.

The last time the gap between analysts lifting forecasts and those lowering estimates was this wide was in May 2010. The divergence at the time widened after the U.S. S&P 500 Index had climbed more than 10 percent over the previous three months. Just before analyst sentiment peaked, stock prices also topped out, and the index slid more than 15 percent.

More from Bloomberg.com: Cryptocurrencies Are Selling Off

Similarly, analysts are upgrading their estimates now in wake of a strong performance in equities. The S&P 500 jumped 6.1 percent last quarter, and has had its best start to a year since 2006. The earnings season gets into swing this week with reports from JPMorgan Chase & Co. and Wells Fargo & Co.

Looking at members of the broader S&P 1500 Composite Index, the pace of upward revisions of earnings-per-share estimates has reached the highest in more than 10 years, Bespoke Investment Group calculations show.

Stock Market’s Price Action Starting to Turn Bullish

As always, the economy's fundamentals determine the stock market's medium-long term outlook. Technicals determine the stock market's short-medium term outlook. Here's why:

1. The stock market's long term is bullish.
2. The stock market's medium term is bullish.
3. The stock market's short term is turning bullish (with Trump's trade war as a wild card)

Let's go from the long term, to the medium term, to the short term.

Long Term

The Medium-Long Term Model is bullish right now. It doesn't see a bear market or "significant correction" on the horizon. With that being said, here are some medium-long term bullish signs for the stock market from the past week.

Initial Claims and Continued Claims are still trending lower (improving). These 2 data series move inversely with the stock market. They also lead the stock market.

Truck Tonnage continues to trend higher. This is a medium-long term bullish sign for the stock market. Truck Tonnage tends to go down before an equities bear market and economic recession begins.

New Home Sales are still trending higher. New Home Sales tend to trend downwards before an economic recession and equities bear market begins.

The Citigroup Economic Surprise Index has turned negative. This is pretty much irrelevant for the stock market's medium-long term. The Economic Surprise Index doesn't measure whether the economy is improving or deteriorating. It merely measures whether the data is beating or missing analysts' expectations. The Economic Surprise Index goes negative every half year.

Medium Term

Several studies from the past week continue to suggest that the stock market will trend higher throughout the rest of 2018 (i.e. next 6 months).

June is over, and the Russell 2000 (small caps index) has gone up 4 consecutive months. When this happens, the S&P 500 has a very strong tendency to go higher in the next 6-12 months.

Meanwhile, the Dow broke below its 200 daily moving average, ending a 501 day streak above the moving average. When this happens, the Dow has a tendency to go down in the next 6-12 months.

So which one is it? The above 2 market studies seem to conflict with eachother.

The majority of market studies from last week were very bullish. There are a lot more bullish studies right now than bearish studies. Hence, it is more likely that the stock market will go up in the next 6-12 months.

Meanwhile, corporate buybacks continue to put a floor under the stock market. Corporate buybacks are surging whenever the stock market is falling.

Short term

I'd like to focus more on the short term this week. The short term is notoriously hard to predict, which is why I focus on the medium-long term. But there were some interesting developments from the past week.

The stock market is showing some signs of EXTREME fear (which, as contrarians know, is a short term bullish sign). And all the S&P 500 needed to do was fall a mere 3.5%.

For example, the Put/Call Ratio spiked to 1.32 on Thursday. The last 2 times this happened, the S&P had either already put in a short term bottom or was very close to putting in a short term bottom.

Meanwhile, AAII Bearish Sentiment just hit an extreme of 40.8%.

In addition, the S&P has touched its 2 standard deviation lower Bollinger Band (20 dma). The last 3 times this happened, the S&P fell a little more but wasn't far from making a short term bottom.

Meanwhile, U.S. corporate earnings estimates continue to trend higher. Q2 2018 earnings season is in the second half of July (2 weeks from now). If the stock market goes down before earnings season, it usually bounces on earnings season.

July is also the stock market's strongest month in the summer. This is mostly due to earnings season. As you can see, the 4 earnings season months (January, April, July, and October) are all bullish months.

Hence, these short term factors paint this picture:

1. The stock market might fall a little more in the next 2 weeks. Perhaps the S&P will revisit 2670, which is its 200 daily moving average. HOWEVER,
2. This short term weakness is limited in terms of TIME.
3. The stock market's price action (a short term indicator) is starting to turn bullish. It doesn't need to make a big decline for sentiment to become extremely "fearful". The stock market has managed extreme fear with a really small decline.

Conclusion

The stock market's medium term and long term are bullish. Despite all of the stock market's problems in the first half of 2018, the S&P 500 is still up 1.67%.

This is the stock market's long term bullish bias at work. Picking tops is much harder than picking bottoms. Selling too early is just as bad as selling too late. If you sell too early, the stock market might still be higher than the price you sold it at after the market falls.

With that being said, we are starting to see signs of bullish price action in the stock market. This is a short term bullish sign. The stock market might fall some more in the next 2 weeks on Trump's trade war news. But overall, this short term downside is limited by the upcoming Q2 2018 earnings season in the second half of July.

*Focus on the medium term and long term. Focusing too much on the short term is detrimental to your long term trading performance. Professionals focus so much on the short term, which is why the average hedge fund underperforms the S&P 500. Imagine this. In the financial industry, the average PROFESSIONAL underperforms buy and hold. Nonprofessionals can beat the average professional by doing nothing but sitting.

As Warren Buffett said, "the majority of my money has been made by being right and sitting tight".

Amazon Alone Is Responsible For More Than A Third Of The S&P's Return This Year

Whether it is capital inflows that cause stock outperformance, or rising stocks leads to investors chasing upside is one of those perpetual "chicken or egg" type financial questions (although in this day and age of index funds and passive investing lifting all "Marxist" boats on a sea of $18 trillion in  excess liquidity without regard for fundamentals, we have a strong feeling what the right answer may be) but whichever way the causal arrow points, one thing is certain: amid turbulent capital markets, panic-inducing spikes in volatility, and emerging markets on the verge of a bear market, tech stocks have seen a relentless investor interest in 2018, or as Eric Peters put it, "tech fund inflows are running at a $37bln annualized pace this year, 2x last year's stunning rate and 10x higher than any year in the past 15."

In light of such an outpouring of capital, it probably should not come as a surprise just how much of an outlier tech performance has been, and yet the following table from Goldman's David Kostin is shocking nonetheless. It shows that in 2018 whose the first half just concluded, just one stock alone is responsible for more than a third of the market's performance: Amazon, whose 45% YTD return has contributed to 36% of the S&P 3% total return this year, including dividends.

Amazon aside, the rest of the Top 10 S&P 500 stocks of 2018 are the who's who of the tech world, and collectively their total return amounts to 122% of the S&P total return in the first half of the year.

And another striking fact: just the Top 4 stocks, Amazon, Microsoft, Apple and Netflix have been responsible for 84% of the S&P upside in 2018 (and yes, these are more or less the stocks David Einhorn is short in his bubble basket, which explains his -19% YTD return).

Of course, after such a historic start to the year, the question is whether this unprecedented tech outperformance will continue? If Morgan Stanley is right, which expects a sharp market response to the escalating trade wars - which it has largely ignored for now - to hit soon, the answer is no:

In equities, our team thinks that US tech is vulnerable as a sector where pricing has been insensitive to trade risks so far.

For the sake of the market - and Trump's sense of S&P500-defined self-worth - MS better be wrong, because if resilient tech stocks are what has kept US equity market above water so far even as the rest of the world has slumped, then a tech crash may be all that it takes to launch the next recession.

The CNY Conundrum - Has The PBOC Deliberately Weakened Yuan As Part Of The Trade War?

HAS THE PBOC DELIBERATELY WEAKENED CNY AS PART OF THE TRADE WAR?

It has been another trade war week, as the market has been looking for clues on the Chinese retaliation measures against the Trump tariffs that are planned to go live on 6 July.

Global trade momentum started to weaken even before the trade conflict escalated. The three months from February until April marked the weakest running 3-month period for world trade since early 2015. A bad sign given that the period included a temporary cease-fire between Trump and Xi Jinping. Usually it adds downwards pressure on 10yr bond yields, when world trade is slowing (at least initially). A further slowdown of global trade in June/July/August could keep long bond yields under pressure over the summer. In other words, the trade war fog needs to dissipate for the 10yr US Treasury yield to unfold its upside potential to the range between 3.25%-3.50% (Major Forecast Update: USD to remain in the driving seat)

CHART 1: LESS GLOBAL TRADE, LOWER LONG BOND YIELDS

Last week we wrote that we found trade-based Chinese retaliation measures more likely than attempts to retaliate via the financial markets. The fact that Trump is threatening with new tariffs on goods worth a total of USD 450bn makes the retaliation process trickier for China. It is simply not possible to retaliate symmetrically, as there are not enough US exports into China to tax. This leaves an elevated risk of unorthodox retaliation measures being used. Prohibiting symbolic US products from entering Chinese territory could be one way of doing it. Expect more clarity on whether Xi Jinping will deliver an ALL-IN answer as early as this weekend.

Earlier in the week, stories emerged that the PBoC had been told by Xi's administration to stop buying or even off-load Treasuries. While it is hard to prove whether that was actually the case this week, there are signs that especially the Chinese market is discounting a marked escalation of the conflict. The Shanghai Composite is down almost 23% since its peak in January. The general risk off and lack of faith could be the reason for the weakening CNY.

We wrote earlier this year that 10yr bond yields in China and US rarely move out of tandem for prolonged periods (not observed since 2008), but this time around it could be that markets are sending a signal that US growth momentum holds up much better than Chinese growth trends. Just this week the PBoC cut its reserve requirements in the attempt to add some needed stimuli to the Chinese momentum.

CHART 2: 10YR BOND YIELDS IN CHINA AND US RARELY MOVE OUT OF TANDEM FOR LONG

This is another sign that US economic performance and market variables look substantially more resilient to the trade war than in the Euro area and China, which Trump is currently targeting. This is sadly something that will likely increase Trump's appetite of continuing down the current path and also a sign that Trump has the upper hand on both China and Europe currently.

No matter whether or not the PBoC has been a part of weakening the CNY (some Chinese sources indicate that the PBoC has helped the weakening trend), the current market situation may not be too bad for China, as a market-based upside pressure on USD/CNY allows China to 1) sell USD, 2) sell Treasuries and 3) ride the impulse from a slightly weaker currency.

We ultimately think that the PBoC will safeguard the 6.70 level in USD/CNY, as it would otherwise risk spurring another round of massive capital outflows as was seen after the devaluation in the autumn of 2016 (Read: CNY: Too weak too fast)

CHART 3: WEAKER CNY AND TREASURY SELLING? A COMBO THAT WAS POSSIBLE IN THE AUTUMN OF 2016

Should USD/CNY at 6.70 be seen as an issue for global growth in general? It could be if it is a sign of broader tightening of financial conditions in EM due to outflows or EM central banks combatting these outflows.

CHART 4: WEAKER CNY, STRONGER USD. A GENERAL PROBLEM FOR PMI MOMENTUM?

And as a side-effect, the weakness of the CNY has added to the downside pressure on other Asian EM currencies, as the capital flows continue to leave Emerging Markets broadly. The Indian central bank, which pleaded with the Fed for help a few weeks back, has been forced to support inventions in the rupee.