Asia stocks sunk as Trump fires new trade salvo

SYDNEY (Reuters) – Asian shares extended a month-long slide and sovereign bonds surged on Friday after U.S. President Donald Trump ramped up trade tensions globally by suddenly slapping tariffs on all goods from Mexico, sending the peso tumbling.

Washington will impose a 5% tariff from June 10, which would then rise steadily to 25% until illegal immigration across the southern border was stopped.

Trump announced the decision on Twitter late Thursday, catching markets completely by surprise and sparking a rush to safe harbors as investors worried the escalation would upend an already fragile world economy.

“The threat of U.S. tariffs on Mexico to take effect inside two weeks is a sharp blow to investor sentiment,” said Sean Callow, a senior FX analyst at Westpac.

“Mexico is the U.S.’s largest trading partner and a flare-up in trade tensions was definitely not on the market radar,” he added. “This is obviously a major setback for CAD, MXN and the thousands of US businesses that use Mexican-made products.”

Yields on the 10-year Treasury note quickly fell to a fresh 20-month low of 2.18%, while the dollar jumped 2.1% on the Mexican peso. E-Mini futures for the S&P 500 sank 0.9%, leading Asian bourses lower.

Japan’s Nikkei fell 1.2% in early trade, to be down 7% for the month so far. MSCI’s broadest index of Asia-Pacific shares outside Japan eased 0.1% and was likewise off a hefty 7.7 for the month.

Investors clearly feared that opening a new front in the trade wars would threaten global and U.S. growth, and pressure central banks everywhere to consider new stimulus.

On Thursday, Federal Reserve Board of Governors Vice Chair Richard Clarida had said the central bank would act if inflation stays too low or global and financial risks endanger the economic outlook.

“What the Clarida’s comments have done is clarify in many people’s minds the answer to the questions of whether low inflation proving more than transitory would itself be enough to get the Fed to ease – the answer appears to be ‘yes’,” said Ray Attrill, head of FX strategy at National Australia Bank.

“That served to reinforce prevailing market expectations that the Fed will be easing in the second half of this year.”

Indeed, the case that the inflation slowdown was temporary took a hard blow when the core personal consumption expenditures (PCE) index, the Fed’s favored measure of inflation, was revised down sharply to 1% for the first quarter, from 1.3%.

The increase was the smallest in four years and pushed inflation further below the Fed’s 2% target.

Trump’s tariff threat only added to the dangers and the market further narrowed the odds on Fed easing this year. Futures imply 42 basis point of cuts by year end in the current effective fund rate of 2.38%.

YIELD INVERSION = RECESSION RISK

Bonds extended their bull run with 10-year Treasury yields now down a steep 31 basis points for the month and decisively below the overnight funds rate.

Such an inversion of the yield curve has presaged enough recessions in the past that investors are wagering the Fed will be forced to ease policy just as “insurance”.

Yet Treasuries are hardly alone in rallying, with bond yields across Europe either at or near record lows. Yields in Australia and New Zealand are also hit an all-time trough on expectations of rate cuts there.

Those declines have kept the U.S. dollar relatively attractive from a yield point of view and it was trading near a two-year high against a basket of currencies at 98.147.

The euro was huddled at $1.1130, having shed 0.75% for the month. The safe haven yen has been faring better and was holding a small monthly gain on the dollar at 109.33.

Sterling was poised for the biggest monthly drop in a year as the imminent departure of Theresa May as prime minister deepened fears about a chaotic divorce from the European Union.

The pound was last at $1.2609 and nursing a 3.2% loss for the month so far.

In commodity markets, spot gold edged up a touch to $1,290.65 per ounce.

Oil prices were at their lowest in over two months after a smaller-than-expected decline in U.S. crude inventories and on fears of a global economic slowdown.

U.S. crude was last down 71 cents at $55.88 a barrel, while Brent crude futures lost 81 cents to $66.06.