GLOBAL MARKETS-Trump tariff salvo batters European stocks, sparks bond rally


European stocks posted their biggest drop of 2019 on Friday and German bond yields hit record lows after U.S. President Donald Trump fired his latest trade war salvo at China, jolting markets and sparking a frenzied bid for safe-haven assets.

By Karin Strohecker

LONDON, Aug 2 (Reuters) - European stocks posted their biggest drop of 2019 on Friday and German bond yields hit record lows after U.S. President Donald Trump fired his latest trade war salvo at China, jolting markets and sparking a frenzied bid for safe-haven assets.

Trump vowed to impose a 10% tariff on $300 billion of Chinese imports from Sept. 1, escalating a bruising and protracted trade war between the world's two biggest economies.

China said on Friday it would have to take countermeasures.

The abrupt end to a truce in the trade spat capped a critical week for global markets after the Federal Reserve delivered a widely anticipated interest rate cut but played down expectations of many more rate cuts ahead.

Markets around the globe dived into a sea of red, with the pan-European Stoxx .STOXX dropping 2% in its sharpest daily tumble of 2019. The trade-sensitive DAX .GDAXI and France's CAC 40 .FCHI dropped 2.7%, the former hitting a fresh two-month lows.

"The combination of the Fed delivering a cut but not really what the market expected or wanted has tightened financial conditions, and may be partly the reason why Trump has gone for this escalation," said Gerry Fowler, investment director at Aberdeen Standard Investments. "It is not good for what was already weak business sentiment."

MSCI's index of world stocks .MIWD00000PUS dropped 0.6% as Asian bourses nursed heavy losses. Japan's Nikkei .N225 fell 2.1%, Hong Kong .HSI slumped 2.5% and China mainland stocks .SSEC, .CSI300 declined around 1.5%.

U.S. stocks futures pointed to main indexes opening 0.3% lower YMc1, ESc1. On Thursday, the S&P 500 .SPX skidded 0.9% to hit one-month lows overnight.

Trump's announcement, which came a day after U.S. and Chinese negotiators concluded a meeting in Shanghai without much progress, marks an end to a trade truce struck in June and could further disrupt global supply chains.

The proposed levies triggered a stampede for safe-haven assets. Core euro zone bond yields tumbled, with German 10-year government bond yields DE10YT=RR dropping more than three basis points to an all-time low of -0.529%. That tracked the drop in 10-year U.S. Treasuries US10YT=RR yields to 1.832% - the lowest since Nov. 8, 2016, the day Trump was elected president.

Trump's move may force the Federal Reserve to cut interest rates again to protect the U.S. economy from trade-policy risks after its first rate cut in more than a decade on Wednesday.

Although Fed Chairman Jerome Powell said the rate cut was a "mid-cycle adjustment" and not a start to a full-blown rate-cutting cycle, markets aren't fully convinced.

The October Fed funds rate futures FFV9 have jumped to now fully price in a rate cut in September, compared with only around 60% before the tariff announcement. Another 25 basis point move is priced in by December.

"In the grand scheme of things, it will become clearer and clearer that the Federal Reserve has started an easing cycle and will have no choice but to cut rates further," said Akira Takei, fund manager at Asset Management One.

The new tariffs would hit a wide swathe of consumer goods from cell phones and laptop computers to toys and footwear, at a time when the manufacturing sector is already reeling from the accumulative impact of the trade war.

The U.S. Institute for Supply Management said on Thursday its index of national factory activity fell to 51.2 last month, the lowest reading since August 2016.

In currency markets, the safe-haven Japanese yen JPY= surged to a five-week high against the dollar and soared to a 2-1/2-year peak against the pound GBPJPY=. The U.S. dollar .DXY softened a touch against a basket of currencies. /FRX

"How things progress for the U.S. and the US dollar will depend now much more on whether there are signs that the trade conflict is increasingly leaving a mark on the U.S. economy," Commerzbank FX analyst Esther Reichelt said.

The euro recovered to $1.1099 EUR=EBS, from a two-year low of $1.1027 hit in U.S. trade. China's onshore yuan slumped to its lowest since November 2018, falling some 0.7% to 6.9428 per dollar CNY=CFXS. In the offshore market, the yuan fell to as low as 6.9778. CNH=.

The British pound held near a 30-month low versus the dollar as the ruling Conservatives' majority in parliament was reduced to one seat, adding to concern over politics three months before the country is due to leave the European Union. Sterling GBP= was last 0.1% lower on the day at $1.2116.

In commodity markets, gold XAU= softened a touch to stand at $1,435.46 per ounce after having risen 2.3% on Thursday, staying near a six-year high of $1,453 touched two weeks ago.

Oil prices bounced back after suffering a sharp selloff. O/R

Brent crude LCOc1 rose 2.2% to $61.84 per barrel, after having fallen 7.0% on Thursday, its biggest daily percentage drop since February 2016. U.S. West Texas Intermediate (WTI) CLc1 crude rebounded 1.9% to $54.96, having shed 7.9% the previous day.

Bond Bonanza

Daily closes for Brent, U.S. crude in 2019 png

(Reporting by Karin Strohecker; Additional reporting by Hideyuki Sano, Tomo Uetake and Stanley White in Tokyo; Editing by Hugh Lawson)

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