Danger here: Financial markets quake as trading screens flash dreaded R-word

Dublin’s Iseq share index has fallen 6.6% in seven weeks, leaving it the third worst-performing equity market since July

Stock markets globally were glad earlier this week to see that Donald Trump wasn't prepared to cancel Christmas.

Equities, which have had a bumpy rise this summer, ruining many investors’ holidays, rallied on Tuesday when the US trade agency delayed imposing a 10 per cent tariff on a raft of Chinese goods – including mobile phones, laptops, game consoles, toys and footwear – from September 1st to mid-December because of “health, safety, national security and other factors”.

The US president added another reason as he spoke to reporters that day before boarding Air Force One in New Jersey to head to Pennsylvania.

“We’re doing this for Christmas season, just in case some of the tariffs would have an impact on US customers,” said Mr Trump, who grabbed a slice of Christmas back in 1992 by securing a cameo role in Home Alone 2: Lost in New York. “What we’ve done is we’ve delayed it, so that they won’t be relevant to the Christmas shopping season.”


The stock market rebound proved short-lived, as investors found plenty of reasons to flee to the sides. This week has seen data showing some of Europe's largest countries are on the brink of recession, Italy roiled by another political crisis, bond markets flashing the most ominous warnings of an economic downturn in the US economy in more than a decade, and figures revealing that Chinese output is slowing more sharply than expected.

Meanwhile, the rising risk of a no-deal Brexit since Boris Johnson became the UK's prime minister last month has played out most markedly in a slump in sterling against other major currencies, including the euro.

Still, by far the biggest – and most pervasive – risk facing markets is the souring relationship between Washington and Beijing and its impact on global trade, according to Noel O'Halloran, chief investment officer with Dublin-based asset management firm KBI Global Investors.

“It’d be foolish to predict what’s going to happen there,” said O’Halloran. “You’re at the mercy of the next big tweet from Trump.”

European woes

While global equity markets rallied strongly in the first half of the year following a dismal 2018, they have come off since then. The Iseq index in Dublin has fallen 7 per cent over the past seven weeks, leaving it third only to Austria and Spain as the worst-performing western European equities indices since the end of June. The pan-European Stoxx 600 index has declined by 5 per cent over the same period, while the S&P 500, the most commonly used benchmark for large US companies, has dipped 3 per cent.

It’s not just equities. Volatility has spiked across a number of asset classes – including bonds, oil, and currencies, while the price of gold, viewed by many as the ultimately safe haven, breached $1,500 (€1,345) an ounce this month for the first time since 2013. Investment banking giant Goldman Sachs sees the precious metal hitting $1,600 within six months.

Concerns over the state of Europe's largest economy and exporting powerhouse, Germany, went into overdrive last week when it emerged that industrial production declined by 1.5 per cent in June – almost four times more sharply than economists had expected – fuelling fears that its key manufacturing sector was being hit by the escalating trade war between the US and China.

The German unemployment rate, which had fallen 4.9 per cent in April, its lowest level since the country’s reunification in 1990, has begun to creep up again, standing at 5 per cent in July. Confirmation of the gloomy expectations came on Wednesday when the German statistics office said the country’s economy shrank by 0.1 per cent in the second quarter, even as household, state spending and local investment expanded.

"In the rest of the year, political uncertainty is likely to weigh on the economy, in particular the export sector," said Deutsche Bank economists including Jochen Moebert, who are now predicting another GDP dip in the current quarter, which would amount to a technical recession. "A rapid recovery from this low-growth environment in 2020 seems unlikely."

Data out the week before showed that the UK economy shrank in the second quarter for the first time since 2012, as companies wound down stockpiles that had been built up ahead of the initial March 31st Brexit deadline.

Elsewhere, Italy, which contracted briefly in late 2018, risks being plunged into an outright recession as the country faces snap elections, former prime minister Matteo Renzi warned this week.

While Italy's deputy prime minister and leader of the far-right League party, Matteo Salvini, pulled the plug last week on his long-soured coalition with the anti-establishment 5-Star Movement, his efforts to hold a no-confidence motion in the administration, which would trigger elections, were postponed by the Italian senate on Tuesday until August 20th.

The political drama comes only months after Rome's budget showdown with the EU rattled markets across Europe. While Italy is the third-largest economy in the euro zone, it is the largest bond market – with its €2.4 trillion of public debt standing at more than 130 per cent of GDP.

Collision course

Salvini, riding high in opinion polls, may be setting Italy on a collision course with Brussels and the financial markets with his pledges of income tax cuts, a massive infrastructure spending programme, and plans to stop the introduction of an automatic VAT increase next year.

"There is little that Italy's government can do to prevent its debt ratio from rising," London-based research firm Capital Economics said last week. "For a number of reasons, not least of which is its membership of the euro zone, the three paths to debt reduction – faster GDP growth, fiscal austerity, and higher inflation – are either closed off or likely to be ineffective. Accordingly, we think that Italy will eventually be forced into a debt restructuring or outright default."

For the moment, though, the financial markets are far from pricing in such a scenario.

"There's an assumption that when push comes to shove, neither Italy nor the EU Commission will push us over the edge," said Bernard Swords, chief investment officer at Goodbody Stockbrokers. "But that doesn't mean there won't be volatility. In relative terms, international investors have been selling the euro area for about a year and a half."

The bigger concern about the euro zone for investors is the fact that, on the whole, the region is hugely dependent on exports outside of the currency region as domestic growth remains low, he said.

On the other side of the Atlantic, a survey by investment banking giant Bank of America Merrill Lynch of major international investors, published this week, has shown that 34 per cent of the 224 money managers fear that the US-China trade conflict will tip the US into recession over the next 12 months. That's the most pessimistic reading from the group, who between them manage $553 billion of assets, in eight years. It compares to just 6 per cent of those surveyed in April.

A clamour for safe-haven investments amid fears of recession and expectations that central banks globally will lower rates have spurred investors into bonds.

The market interest rate, or yield, on 30-year US government bonds plunged on Wednesday below 2 per cent for the first time. Meanwhile, the 10-year yield fell below the two-year rate for the first time since 2007.

This phenomenon – known as an inverted yield curve – goes against normal market conditions where buyers of long-term bonds expect higher interest rates than those who invest for a shorter period. It triggered a 3 per cent slump in the S&P 500 in one day.

A yield-curve inversion is seen as a reliable recession indicator, though it does not always precede a downturn. Still, the average length of time since the 1990s for a recession to take place after an inversion has been 22 months, according to Credit Suisse.

In Europe, the yield on 10-year German notes hit an all-time low of minus 0.7 per cent on Thursday, while investors in similar Irish bonds, which the Government sold in January at a rate of 1 per cent, are prepared to buy at a rate of minus 0.147 per cent. Bond yields and prices move inversely.

Europe is ground zero as a record €14.4 trillion of bonds globally are currently carrying sub-zero rates.

Some 43 per cent of the fund managers canvassed by Bank of America Merrill Lynch in its latest survey expect short-term yields to fall even further over the next 12 months, while only 9 per cent see higher long-term rates.

"Taken together, this is the most bullish fund manager survey view on bonds since November 2008," said Michael Hartnett, chief investment strategist at Bank of America, in a note accompanying the survey results.

Meanwhile, Trump’s move to delay his latest round of tariffs on Chinese goods comes at a time when the world’s second-largest economy is already slowing rapidly. That’s even in spite of stimulus efforts by President Xi Jinping’s government to boost domestic demand to keep the economy growing at 6-6.5 per cent.

On Wednesday, China reported that its industrial output slowed to 4.8 per cent in July – the weakest reading in 17 years – from 6.3 per cent a month earlier and against economists’ expectations for a 5.8 per cent increase. It came just days after the central bank in Beijing said that lending had dropped in July, driven by a slump in corporate credit on the previous month.

China's years of 10 per cent annual GDP growth, spanning 1979 to 2010, are long behind it. Rate cuts The US Federal Reserve (Fed) cut interest rates last month for the first time in 11 years, lowering its main rate for the first time in a decade. Meanwhile, the European Central Bank (ECB), which ended new bond purchases under its €2.6 trillion quantitative easing (QE) bond-buying programme last December, is now considering cranking up the money-printing machine again, or lowering interest rates, to reboot inflation as the euro zone economy weakens.

“When you look back over the last 30 years, when the Fed started cutting rates, you were generally right to sell equities,” said Swords of Goodbody. “The one exception was in the 1995-1996 period when it cut rates as it saw a mid-cycle softening of the economy. That started a boom for both bonds and equity markets.”

Fed chairman Jerome Powell has signalled he is betting that he can keep the US economy – currently growing at an annual rate of about 2 per cent – purring with just a modest reduction in interest rates. In spite of the latest round of market turmoil, many money managers are putting their faith in monetary authorities.

“The antidote for all the things that markets have had to worry about over the last number of years has been that central banks have been willing to come in and play the saviour. And we’re seeing that again now,” said KBI Global Investors’ O’Halloran.

“I’d be much more relaxed about economic growth than the wider markets are fearing. Indeed, you could well see an acceleration in growth figures in the second half, helped by lower rates. Consumers globally are in decent shape, with unemployment levels generally low.”

While O'Halloran said that the Irish equities market – particularly shares in banks and housebuilders – is pricing in "an awful lot of bad news", few big international investors are likely to view Ireland as a buying opportunity as long as uncertainty over Brexit persists.

“No one is going to try to be a hero here,” he said. “But if you were to see a resolution to Brexit no worse than currently feared, you could see a material rally.”

Meanwhile, stock market optimists are betting that the biggest reason for buying into every market sell-off is the fact that Trump is seeking re-election next year.

His move to postpone the latest round of tariffs suggests to some that he’s prepared to ease off on China to prop up his favourite gauge of success: the stock market.

David Rosenberg, chief economist at Canadian wealth manager Gluskin Sheff & Associates, picked up his phone immediately after the delay was announced.

"Did some acronym called the SPX (S&P 500) cause someone to blink?"he tweeted.