London — Deflating hopes of a swift resolution to the Sino-US trade war knocked world stocks off three-week highs on Tuesday, while growing fears the US economy could be headed for recession sooner than expected weighed on the dollar.
The rapprochement between US President Donald Trump and China’s Xi Jinping at the weekend Group of 20 (G20) meeting had fired up markets on Monday. But the upbeat mood quickly dissipated on scepticism that Washington and Beijing can resolve deep-seated differences on trade in the agreed three-month negotiating window.
Adding to market woes, was an inversion of the short end of the US yield curve which raised the spectre of a possible US recession.
Following declines on Asian bourses, where Japan’s Nikkei stock index closed 2.4% lower, the mood was sombre in Europe with the wider blue chip index slipping 0.3%. Frankfurt’s DAX and Paris’s CAC 40 fell 0.6% while MSCI’s index of world stocks declined 0.1%.
“The initial relief rally was never going to last. Investors need more detail now in order for that risk-on sentiment to survive,” said Jasper Lawler, head of research at London Capital Group. “So far that detail has not been coming through and investors have more questions than answers.”
There was confusion over when the 90-day period, during which the US and China would hold off on imposing more tariffs, would start. A White House official said it started on December 1, while earlier, White House economic adviser Larry Kudlow told reporters it would start on January 1.
Moreover, none of the commitments that US officials said had been given by China — including reducing its 40% tariffs on cars — were agreed to in writing and specifics had yet to be hammered out.
Meanwhile the US yield curve focused investors’ minds. The curve between US three-year and five-year and between two-year and five-year paper inverted on Monday — the first parts of the Treasury yield curve to invert since the financial crisis, excluding very short-dated debt.
Analysts expect the two-year, 10-year yield curve — seen as a predictor of a US recession — to follow suit.
On Tuesday, the yield on benchmark 10-year Treasury notes was at 2.95% compared with its US Monday close of 2.99%. And the spread between 10-year and two-year Treasury yields tightened to around 13 basis points — hitting its narrowest level since July 2007. “The focus is now shifting to the inverted US bond yield curve which has negative connotations, while implying the US economy is heading towards what was only a few weeks ago an improbable economic slowdown,” said Stephen Innes, head of trading for APAC at Oanda.
“Now, even recessionary fear is starting to raise its ugly head.”
However, analysts said US manufacturing data released on Monday pointed to a stronger economic outlook, with new orders a “key driver” in boosting activity.
Meanwhile oil prices extended gains, adding to Monday’s 4% surge as investors bet a key Opec meeting on Thursday could deliver supply cuts.
US crude and Brent crude added 1.6% to $53.82 and $62.7 a barrel respectively.
The dollar weakened against major currencies, weighed down by falling US bond yields.
The dollar index, which tracks the greenback against a basket of peers, softened 0.5% to 96.53, while the euro added 0.6% to $1.1416.
The dollar also weakened 0.8% against the Japanese yen and fell more than 0.5% to its weakest level since September against the offshore Chinese yuan to 6.83 yuan.
Federal Reserve chair Jerome Powell was scheduled to testify on Wednesday to a congressional Joint Economic Committee, but the hearing was postponed because of a national day of mourning for US. President George H.W. Bush, who died on Friday.
The dollar came under pressure last week on Powell’s comments that rates were nearing neutral levels, which markets widely interpreted as signalling a slowdown in the Fed’s rate-hike cycle.
Meanwhile sterling was back on the Brexit rollercoaster, rallying sharply after the EU’s top legal adviser said Britain had the right to withdraw its Brexit notice.
This was a bounce back from two-month lows it hit in early trade against the dollar on concern about British parliamentary approval for a proposed Brexit deal.
The pound last stood 0.7% firmer at $1.2814 while weakening 0.2% against the euro to 89.10 pence.
Spot gold jumped on the weaker dollar, trading up 0.5% at $1,237.24 an ounce.