Trade hawks try to walk back dovish Mnuchin interpretation of U.S.-Chinese trade war being “on hold”
Today’s 2-year T-note auction kicks off this week’s big T-note package
Italian bonds continue to plunge on populist fiscal concerns
Trade hawks try to walk back dovish Mnuchin interpretation of U.S.-Chinese trade war being “on hold” — U.S. Trade Representative Lighthizer did not seem to be 100% on board with Treasury Secretary Mnuchin’s comments over the weekend that the U.S.-Chinese trade war is “on hold.” Mr. Lighthizer released his own statement seeming to suggest that the U.S. may yet use tariffs, investment restrictions and export regulations while the talks continue.
The bottom line is that there is an ongoing battle within the White House between the trade doves and hawks about how to handle China. The Trump administration has put its 25% tariff on $50 billion of Chinese goods on hold for the time being as larger U.S.-Chinese trade discussions continue. However, that tariff can now be slapped on China at any time because the procedural requirement of the 60-day comment period ends today. That means that if President Trump is dissatisfied at any time with how the U.S-Chinese talks are going, he could surprise the markets by implementing the tariff with no further prior notice.
There are many Chinese importers that will be reluctant to import U.S. goods due to the possibility that they might suddenly have to pay a tariff, which will put upward pressure on the U.S.-Chinese trade deficit. This has already happened with soybeans where Chinese purchases of U.S. soybeans have ground to a halt because Chinese importers are fearful that China might slap a retaliatory tariff on U.S. soybeans.
The Trump administration is currently consumed with preparing for the summit with North Korea on June 12. It was not surprising that the administration wants a time-out on the U.S-Chinese trade war while they deal with North Korea. Once the summit is over, however, then the Trump administration is likely to step up the trade pressure on China once again.
It remains to be seen whether the trade truce could last beyond the November U.S. mid-term elections. There is no doubt that if President Trump slaps a tariff on up to $150 billion of Chinese goods, China will respond with a reciprocal tariff that hits U.S. agriculture products particularly hard. Republicans cannot afford to go into the mid-term elections with the significant political damage in farm states that would result from Chinese agriculture tariffs.
Today’s 2-year T-note auction kicks off this week’s big T-note package — The Treasury today will sell $33 billion of 2-year T-notes. The $33 billion size of today’s 2-year T-note is up by a hefty $7 billion from the $26 billion size that prevailed during most of 2015-17. The Treasury has sharply increased the size of its shorter-term Treasury auctions to finance the larger U.S. budget deficit that has resulted from higher government spending and the Jan 1 tax cuts. The Treasury will continue this week’s $115 billion T-note package by selling $16 billion of 2-year floating rate notes and $36 billion of 5-year T-notes on Wednesday and $30 billion of 7-year T-notes on Thursday.
Today’s 2-year T-note issue was trading at 2.59% in when-issued trading late yesterday afternoon. Meanwhile, the benchmark 2-year T-note yesterday closed up +1.9 bp at 2.566%, which was just 3 bp below last week’s 9-3/4 year high of 2.596%. The 2-year T-note yield has soared by about 120 bp since last September due to the passage of the massive Jan 1 tax cut combined with increased inflation expectations and expectations for more-aggressive Fed rate hikes over the next several years.
The 12-auction averages for the 2-year are as follows: 2.85 bid cover ratio, $208 million in non-competitive bids, 3.8 bp tail to the median yield, 20.3 bp tail to the low yield, and 61% taken at the high yield. The 2-year is the least popular security among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of only 48.6% of the last twelve 2-year T-note auctions, which is far below the median of 64.6% for all recent Treasury coupon auctions.
Italian bonds continue to plunge on populist fiscal concerns — Italy’s Five Star and League parties are expected to receive approval from President Mattarella for their coalition government as soon as today and take power by this Friday or the weekend. A confidence vote in parliament is then expected early next week.
The Italian bond market on Monday continued to plunge as the markets worry about the populist coalition’s fiscal plans and their apparent intention to ignore the Eurozone’s fiscal rules. The markets are also worried about the populists’ idea of issuing temporary government IOU’s (referred to as mini-BOTs) in small denominations to pay off arrears on current Italian government financial obligations. Those IOU’s would further boost Italy’s already-massive debt load of 130% of GDP and could also potentially function as a parallel currency.
League leader Salvini is longing for the pre-Maastricht days when Italy had its own currency and there are fears that he might be trying to steer Italy down that path. The markets are also worried because the Five Star and League leaders are highly antagonistic towards the markets and are not likely to be easily restrained regardless of how far Italian stocks and bonds sell off.
The Italian 10-year bond yield yesterday soared by another +16 bp to a 3-year high of 2.38% and has now risen by more than 55 bp in the past three weeks. The spread of the Italian 10-year yield over bunds yesterday climbed by another +22 bp to a 1-year high 187 bp. The 5-year Italian credit default swap, which is the cost of insuring against an Italian sovereign bond default, has soared by 50 bp in the past month and reached a 7-month high of 135 bp yesterday.