Trade tensions between the US and China may be coming home to roost for the global economy, with the most closely watched manufacturing surveys flashing warning signs from China to the euro-zone.
Chinese factory activity slowed in September, official and private surveys showed, as the world’s second biggest economy remains locked in a trade dispute with the US. Manufacturing also faltered in Vietnam, Taiwan and Indonesia last month.
With many of Australia’s largest companies exposed to the ebb and flow of global growth, notably mining, energy and transport plays, the slowing of activity in the world’s factories needs to be added to the growing number of risks confronting investors that include higher US interest rates, elevated valuations and simmering geopolitical tensions.
“The PMIs [Purchasing Managers Index] are closely watched as they are highly correlated with economic growth,” JPMorgan Asset Management market strategist Kerry Craig said.
“There has been a softening since the start of the year although PMIs remain above 50,” he noted. The 50 mark in PMI terms separates economic expansion from contraction.
The Australian economy is vulnerable to any sign that economic growth is slowing as it’s an open economy with high exposure to trade. The Australian dollar is down 0.6 per cent at US71.83c since the start of the week and is trading back at levels not seen since mid-September.
“There are some signs that tariffs are starting to have an impact on the [global] export sector,” said Ray Attrill, head of foreign exchange strategy at National Australia Bank.
Asia isn’t the only area showing signs of flagging manufacturing growth, with September’s survey of euro-zone manufacturers hitting its weakest level since September 2016 at the end of the third quarter.
Mr Attrill noted that the euro-zone data may have reflected disruption in the automotive sector ahead of the introduction of new emission standards, with German data especially weak.
Italy is also a concern for European investors. Investors took a dim view of remarks from the economic leader of the ruling League party who suggested on Tuesday that a local currency would solve Italy’s problems.
Weakness in China, Asia and Europe stands out in stark contrast to the US, where the factory sector powered along in September, according to IHS Markit survey data.
AMP Capital portfolio manager Nader Naeimi highlighted the wide divergence between signals of manufacturing health between the US and the rest of the world.
That’s a symptom of the trade wars between the US and China and the US tax cut, he said. However, “historically, wide divergences don’t last,” he said as “laws of financial contagion get in the way”.
There have been some extreme moves in emerging markets currency and bonds over the last few months and the Indonesian rupiah hit a 20-year low against the US dollar on Tuesday.
Copper prices are struggling as well. Oil prices have gained, however, even as the US dollar remains relatively strong, with Brent crude hitting a four-year high this week.
While high oil prices are generally bad news for energy importers such as Indonesia, a higher oil price can be seen as a positive signal about the strength of global oil demand.
Mr Naeimi, for example, sees the high oil price as a crucial sign that poor sentiment from manufacturing PMIs hasn’t tipped over into the real economy and said he believes that the current state of the global economy “is not too bad”.
Mr Attrill at NAB noted that services surveys are proving more resilient than manufacturing surveys and he’s also in the more positive camp when it comes to the global growth picture in the expectation that China will step in to shore up its economy in a meaningful way if required.
“If China sees that growth is going to be suffering, it’s not going to allow growth rates to fall so far that it will create a rise in unemployment,” he said.
Higher commodity prices
That could be good news for Australia, Mr Attrill said, if it feeds through into higher commodity prices.
Still, China is also a source of risk for markets due to its ongoing trade battle with the US. “If anything [trade tensions are] going to accelerate inflationary pressures in the US,” Mr Naeimi said.
The prospect of US inflation is also a concern for Morgans Financial strategist Andrew Tang.
“If inflation does start to rise, you might see the Fed tighten further and that might be the trigger,” he said. “I wouldn’t say risks have increased but markets are at a turning point.”
Any stumble in global growth will likely weigh on the commodity-heavy Australian market which will have negative implications for the ASX’s resources companies, he said.
Big names in the Australian resources sector include diversified miners BHP and Rio Tinto.
Valuations are already quite elevated in Australia, he noted, with Australian investors not paying attention to fundamentals pushed to chase growth. “There has been a lot of enthusiasm about the frothier parts of the market such as tech,” he said.