U.S. markets followed the rest of global markets into the red today as the DJIA had its worst day of losses in 2019. Investors woke up to a broad global sell-off this morning and news that the People's Bank of China had lowered or set the yuan’s daily reference rate below seven per dollar for the first time in over a decade. The Chinese government has also asked its state-owned firms to suspend imports of U.S. agricultural products, according to multiple reports.
Industrial stocks like Caterpillar and Deere fell in heavy selling, as did shares of Apple, which sources a lot of its iPhone components and manufacturing from China.
Read more: Global Markets Hit as China Devalues Yuan
The lowering of the yuan was China's response to a new round of tariffs to be imposed on $300 million worth of Chinese imports to the U.S. set to begin Sept. 1. Just last week, the U.S. Commerce Dept. reported that the U.S. China trade deficit widened as the two largest economies in the world drift further apart on a trade deal. U.S. exports to China are down 18.1% this year, while imports have fallen 12.2%.
President Trump, who has been accusing China of manipulating its currency for years to make its exports cheaper, immediately denounced the move and called on the U.S. Federal Reserve to take notice.
Why the Fed?
Trump has targeted the Fed for not moving aggressively enough to lower interest rates. The Fed lowered interest rates by 0.25% last week, the first cut in over a decade. But Powell and the FOMC did not signal that this would be the beginning of a cycle of rate cuts as Trump and many investors were hoping. That, and the President's tweet that the U.S. would impose 10% tariffs on an additional $300 billion in Chinese imports on Sept. 1, sent U.S. markets to some of their worst losses of the year...until today.
China's response today threw more fuel on the fire as stock market losses increased throughout the afternoon. Industrial and tech stocks were sold off in a frenzy as investors piled into Treasury bonds and gold.
While Powell did not indicate further rate cuts ahead, options traders are pricing in a 100% chance of another rate cut when the Fed meets next in mid September. We keep our eyes on the CME's Fed Watch Tool to see what the options market is telling us about the Fed's future moves, and it is unanimous. 74% of traders think the Fed will cut by another 0.25%, while 26% predict a 0.50% cut.
What Happens Now?
That's the $10 trillion question, but these things we know:
- The U.S. will respond in some fashion. That could mean even more tariffs, or putting pressure on China's other trading partners that are friendly with the U.S. to not succumb to China's currency overtures. This is just getting started.
- Another interest rate cut by the Fed. We'll have to wait for September for that, unless things really go off the rails.
- More pressure on U.S. markets. Markets were already under pressure after reaching record highs, but earnings have been kind of lackluster and the Fed did not give stocks more tailwind last week.
- More pressure on U.S. Treasuries. The yield on the 10-Year fell again today to 1.73% as investors piled into bonds during the sell-off. It's a safe haven for now, but yields are getting more paltry by the day.
- Volatility is back and it's not going anywhere. We touched on this last Friday, but it's worth revisiting. Uncertainty is the name of the game and volatility is its vicious sidekick.