London (Reuters) - Deflating hopes of a swift resolution to the Sino-U.S. trade war knocked world stocks off three-week highs on Tuesday, while growing fears the U.S economy could be headed for recession sooner than expected weighed on the dollar.
The rapprochement between U.S. President Donald Trump and China’s Xi Jinping at the weekend G20 meeting had fired up markets on Monday. But the upbeat mood quickly dissipated on skepticism that Washington and Beijing can resolve deep-seated differences on trade in the agreed-upon three-month negotiating window.
Adding to market woes, was an inversion of the short end of the U.S. yield curve which raised the specter of a possible U.S. recession.
Following declines on Asian bourses, where Japan’s Nikkei stock index closed 2.4 percent lower, the mood was somber in Europe with the wider blue chip index slipping 0.3 percent. Frankfurt’s DAX and Paris’ CAC 40 fell 0.6 percent while MSCI’s index of world stocks declined 0.1 percent.
“The initial relief rally was never going to last. Investors need more detail now in order for that risk on sentiment to survive,” said Jasper Lawler, head of research at London Capital Group. “So far that detail has not been coming through and investors have more questions than answers.”
There was confusion over when the 90-day period, during which the U.S. and China would hold off on imposing more tariffs, would start. A White House official said it started on Dec. 1, while earlier, White House economic adviser Larry Kudlow told reporters it would start on Jan. 1.
Moreover, none of the commitments that U.S. officials said had been given by China - including reducing its 40 percent tariffs on autos - were agreed to in writing and specifics had yet to be hammered out.
Meanwhile the U.S. yield curve focused investors’ minds. The curve between U.S. three-year and five-year and between two-year and five-year paper inverted on Monday - the first parts of the Treasury yield curve to invert since the financial crisis, excluding very short-dated debt.
Analysts expect the two-year, 10-year yield curve - seen as a predictor of a U.S. recession - to follow suit.
On Tuesday, the yield on benchmark 10-year Treasury notes was at 2.95 percent compared with its U.S. Monday close of 2.99 percent. And the spread between 10-year and two-year Treasury yields tightened to around 13 basis points - hitting its narrowest level since July 2007.
“The focus is now shifting to the inverted U.S. bond yield curve which has negative connotations, while implying the U.S. economy is heading towards what was only a few weeks ago an improbable economic slowdown,” said Stephen Innes, head of trading for APAC at Oanda.
“Now, even recessionary fear is starting to raise its ugly head.”
However, analysts said U.S. manufacturing data released on Monday pointed to a stronger economic outlook, with new orders a “key driver” in boosting activity.
Graphic: U.S. yield curve inversion - tmsnrt.rs/2RvJ6J5
Meanwhile oil prices extended gains, adding to Monday’s 4 percent surge as investors bet a key OPEC meeting on Thursday could deliver supply cuts.
U.S. crude and Brent crude added 1.6 percent to $53.82 and $62.7 per barrel respectively. [O/R]
The dollar weakened against major currencies, weighed down by falling U.S. bond yields.
The dollar index, which tracks the greenback against a basket of peers, softened 0.5 percent to 96.53, while the euro added 0.6 percent to $1.1416.
The dollar also weakened 0.8 percent against the Japanese yen and fell more than 0.5 percent to its weakest level since September against the offshore Chinese yuan to 6.83 yuan.
Federal Reserve Chairman Jerome Powell was scheduled to testify on Wednesday to a congressional Joint Economic Committee, but the hearing was postponed because of a national day of mourning for U.S. President George H.W. Bush, who died on Friday.
The dollar came under pressure last week on Powell’s comments that rates were nearing neutral levels, which markets widely interpreted as signaling a slowdown in the Fed’s rate-hike cycle.
Meanwhile sterling was back on the Brexit rollercoaster, rallying sharply after the EU’s top legal adviser said Britain had the right to withdraw its Brexit notice.
This was a bounce back from two-month lows it hit in early trade against the dollar on concern about British parliamentary approval for a proposed Brexit deal.
The pound last stood 0.7 percent firmer at $1.2814 while weakening 0.2 percent against the euro to 89.10 pence.
Spot gold jumped on the weaker dollar, trading up 0.5 percent at $1,237.24 per ounce. [GOL/]
Reporting by Karin Strohecker; Additional reporting by Andrew Galbraith ; Editing by Andrew Heavens