Oil prices rose sharply on Tuesday after President Trump decided to delay tariffs, recognizing the negative impact tariffs would have on the U.S. economy. But by Wednesday, oil prices crashed again, as financial markets see the risk of economic recession rising in spite of the tariff delay.
The closely-watched spread between two-year and 10-year treasury yields finally flipped, the first time that has occurred since 2007. Yields on two-year notes are trading higher than 10-year treasuries, a phenomenon that has reliably preceded past economic recessions. Financial markets took note, and sold off stocks and commodities of all types.
This problem has been brewing for a while, with the early signs of an inverted yield curve showing up last year. Economists and analysts have been watching this for months, but the spread received a jolt after the recent announcement from President Trump regarding a new round of tariffs. He now seems to have regretted that decision, but market traders are not assuaged. The tariff delay “doesn’t really change the outlook on the trade tensions,” Louis Kuijs, chief Asia economist at Oxford Economics in Hong Kong, told Bloomberg. “We expect further policy easing in the coming months to help stabilize growth amid the above headwinds.”
The negative sentiment might be here to stay because reams of other data point to an economic slowdown.
For instance, China’s latest industrial data for July was the weakest since 2002. Germany’s economy contracted in the second quarter and is nearing recession. The same is true of the UK, which also saw GDP fall in the second quarter.
Car sales in China have declined for 13 of the last 14 months. Car sales in India and Germany also fell sharply in July. Global manufacturing activity and trade volumes are down. Related: A Booming Niche In Energy’s Hottest Market
The ECB is expected to cut interest rates again, and the U.S. Federal Reserve might be compelled to do so again, after only recently cutting rates for the first time in a decade.
Some economists think bond yields could go to zero or even into negative territory if recession hits. “This is the ultimate indicator that something is fundamentally wrong with the world economy,” Adam Posen, president of the Peterson Institute for International Economics, told the Washington Post. “The escalation of the trade war is making it worse.”
Notably, yields on 30-year treasuries plunged in recent days as well, a sign that capital is flowing into safe haven assets as fears of recession take hold.
After routinely boasting that the trade war was hurting China more than the U.S., and that China was forced to pay billions of dollars to the U.S. government because of tariffs, President Trump essentially admitted that U.S. consumers were bearing the brunt of the impact when he called off some of his proposed tariffs on Tuesday.
On the one hand, stepping back from the brink could put both sides on the path to a negotiated settlement – Chinese and American negotiators are scheduled for face-to-face talks in September – but it could also signal vulnerability.
Viewed from the perspective of Beijing, the flip-flopping from the U.S. is an admission from Trump that he can’t survive politically if the U.S. economy slows down too much. For Xi Jingping, there is little incentive to offer concessions of any significance. If that is the lesson then the trade war could drag on indefinitely. Related: Oil Prices Crash On Recession Fears
Notably, the delay of U.S. tariffs saw oil prices soar on Tuesday as it seemed to take away a major economic headwind. But the bump was temporary, with prices falling back just as sharply on Wednesday after the raft of poor economic data and the inverted yield curve pointed to an oncoming economic recession.
Some analysts don’t say any major pitfalls to oil prices. “Oil demand in China and the US is unlikely to weaken noticeably as a result of the trade conflict, though if this were to happen Saudi Arabia would further reduce its output,” Commerzbank said in a note. “Thanks to the OPEC+ production cuts, the oil market will be undersupplied in any case in the second half of the year.”
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Perhaps. But on the current trajectory, a supply glut is looming in 2020. On that much, most agree. But the problem is that recent price downturns were largely the result of U.S. shale growing faster than demand. This time around, the danger is much larger. A global economic recession would bring the expected supply glut forward, and make it much worse.
By Nick Cunningham of Oilprice.com
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The second fact is that while fundamentals of the global oil market are robust as evidenced by rising crude oil imports by China, oil prices are being undermined by glut which is being augmented by the raging trade war and which could stay with us in 2020.
The third most important fact is that China has won the trade war hands down. No amount of posturing or new tariffs could disguise this fact. The US economy particularly manufacturing and agriculture is suffering badly and US consumers are bearing the brunt of the impact of the tariffs on Chinese goods. This could cost President Trump the presidential elections in 2020.
The fourth fact is that contrary to claims made in this article, China’s economic data are robust as evidenced by rising exports in July, accelerating crude oil imports and an economy growing at 6.2% this year compared with 2%-2.5% for the US economy and 1%-1.5% for the EU.
The fifth fact is that the Chinese leadership has already reached the conclusion that they are dealing with a president who comes under the influence of the last adviser he speaks to and one who might agree something today and renege on it the following day. Therefore, there is little incentive for China to offer concessions of any significance.
President Trump knows that he has lost the trade war with China and is finding it hugely difficult to admit defeat. He has backed himself into a corner, with only one option open to him now, namely to call off his trade war and negotiate an end to the war on China’s terms. This is too bitter a pill to swallow. That is why he is prevaricating about ending the trade war.
Instead of cutting his loses, he is now trying to link the trade war with the political turmoil in Hong Kong as evidenced by his offer to have a personal meeting with President Xi Jinping to calm things in Hong Kong. The Chinese president will certainly pour cold water on such suggestion telling President Trump that Hong Kong is not a US concern and that he should mind his own business. China has already exposed US involvement in the turmoil in Hong Kong when it published a photo of an American diplomat meeting members of the Hong Kong opposition.
The hawks in Washington may still persuade President Trump to abrogate the time-honoured agreement the Nixon administration reached with China on the status of Taiwan. I wouldn’t be surprised if a pro-independence campaign follows soon in Taiwan with US instigation and blessing. Were President Trump to embark on such a course of action, he would have crossed a red line with an incalculable risk for the United States
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London