FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

• China responded to the threat of additional U.S. tariffs by halting agricultural purchases and allowing its currency to weaken beyond the psychologically important 7 yuan to the dollar level.
• Central banks around the world responded to the heightened risk posed by the spiraling trade war by proactively cutting policy interest rates.
• The U.S. services sector showed signs of cooling in July as the ISM non-manufacturing index declined to 53.7 from 55.1 the previous month.

 As U.S. and China Dig in, Central Banks Ease

Heightened U.S.-China trade tensions continue to occupy the limelight. The fallout from last week’s Chinese tariff announcement by President Trump reverberated through the global economy. Last week, the President announced that the U.S. would be imposing a 10% tariff on the remaining Chinese imports previously untouched by tariffs starting September 1st. In response to the tariff threat, China’s currency weakened this week to below the psychologically important level of 7 yuan to the dollar. China also suspended purchases of U.S. agricultural products and has not ruled out placing tariffs on some U.S. imports.

The escalating trade tensions also extended risk-off sentiment in global financial markets. Many Asian currencies plunged in response to the yuan’s weakness, as the region is a central player in global supply chains with complex trade ties to both the U.S. and China. Other emerging market currencies also came under pressure, while the yen, which is seen as a safe-haven asset, appreciated. U.S. equities posted dramatic declines with the Dow registering a drop of more than 2.9% on Monday, its biggest one-day percentage decline since the end of last year. Treasury yields across the curve also tumbled and the yield on the 3-month T-bill exceeded the yield on the 10-year note by the widest margin since April 2007, deepening the yield curve inversion (Chart 1). Markets stabilized later in the week after China’s central bank signaled it wouldn’t let the yuan fall much further.

Following the yuan’s depreciation, the U.S. Treasury Department officially designated China a currency manipulator. The action, though mostly symbolic, requires the U.S. to consult with the IMF to try to eliminate any unfair advantage for China from currency manipulation, and could result in further tariff increases in the future.

Amid the growing trade worries, three central banks in the Asia-Pacific region (India, Thailand, New Zealand and the Philippines) proactively lowered interest rates this week. These actions are consistent with the expectation that the global rate-cutting cycle will intensify in the months ahead as the U.S. and China dig in for an extended battle. Meanwhile, despite the Fed delivering on an insurance rate cut last week, the market continues to expect further cuts in September as odds of a recession lurch higher.

In one of the few data releases of the week, the July ISM non-manufacturing index suggested that the recent economic soft patch is not just limited to U.S. factories. Though the services sector expanded, it did so at the slowest pace in nearly three years. The index eased for the second month in a row to 53.7 in July from 55.1 in June, coming in below expectations (Chart 2). The sub-index tracking business activity dropped sharply to 53.1 from 58.2 in June. New orders also decreased in July. With trade tensions rising and U.S. business activity cooling, the renewed uncertainty will undoubtedly factor into the Fed’s discussions as they attempt to engineer a soft landing for the U.S. economy in these turbulent times.

Shernette McLeod, Economist | 416-415-0413

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