The Philadelphia Semiconductor Index had gained nearly 40% between the start of the year and late April, only to give back two-thirds of its gains during May as the White House imposed a ban on US high-tech sales to Huawei Technologies.

US tech stocks led the Wall Street session down in a whipsaw session that saw the Dow-Jones Industrial Average rise by 211 points before closing down by about 200 points. President Trump’s declaration in Japan that the United States was “not ready to make a trade deal” with China appears to have torpedoed the US stock indices.

Remarkably, China’s Semiconductor Manufacturing International, the mainland’s largest chip foundry, rallied while the US semiconductors sagged. SMIC has chronically underperformed its peers, but caught a tailwind from the tech war. The company delisted itself from NASDAQ last week, claiming that the decision had nothing to do with the ongoing tech war.

Compared to Taiwan Semiconductor Manufacturing, SMIC has been something of an also-ran in chip design and manufacturing, and its outperformance during May is a gift from the US Administration. By this point every major newspaper in the world has noted what I reported in this space on May 19, The US ban on high tech exports to China won’t stop Huawei from dominating the 5G mobile broadband market, but it will touch off a commercial war in the chip business that will hurt US producers, some of them perhaps fatally.

China’s domestic chip design and manufacturing, meanwhile, will draw on the enormous reserves of the Chinese state. China expects to emerge from the war as the dominant player in semiconductors, the decisive industry of the 21st century.

Austria’s AMS AG, Huawei’s largest European supplier, announced last week that it would continue shipments to the Chinese company. Its stock is up 94% year-to-date, outperforming its US competitors.

Bloomberg noted that this is an opportunity for Europe:

“Huawei and other Chinese companies in Trump’s sights are likely to find partnerships within the region more attractive as a result of the US restrictions, according to Luigi Gambardella, President of Brussels-based business association China EU. ‘The current trade tensions can only lead to more investments and contracts between Chinese and EU companies,’ Gambardella said.”

Meanwhile, signs of weakness continue to bedevil the US economy. JP Morgan last week took its 2nd-quarter GDP forecast down to 1%, while the Atlanta Federal Reserve’s GDPNow model projects a gain of 1.3%. As I noted last week, Markit’s purchasing managers indices for both goods and services fell during May to the lowest levels in years, barely above the zero-growth mark of 50.

Markit’s economists project second-quarter growth of 1.2%

The collapse in US bond yields has drawn more attention than equities. This is a sign of risk aversion as well as economic weakness. During May, inflation-protected Treasury (TIPS) yields were little changed, while nominal yields fell. TIPS yields have tracked expectations about the future federal funds rate, and the market has already priced in a rate cut for 2019. That sets something of a lower bound on TIPS yields.

The difference between TIPS and nominal yields gauges the market’s expectation for future inflation, and the drop in inflation expectations has been notable.

Breakeven inflation normally tracks commodity prices, but this gauge has fallen much faster than the main commodity price indices would have indicated. The chart below shows the residual of the regression of 10-year breakeven inflation on the S&P/Goldman Sachs Commodity Price Index. Something nastier appears to be at work.

There are a number of signs of incipient disinflation or even deflation in the market.

One is the deceleration of home prices. The Case-Shiller Home Price Index for 20 major US cities showed a year-on-year gain of just 2.7% as of April.

Shelter accounts for 40% of the US Consumer Price Index, which tends to lag market measures. It seems likely that future gains in the shelter component of CPI will fall.

The weak economy, meanwhile, has led to sharp price cuts in the price of freight transportation. The spot cost of booking a large US tractor-trailer has fallen from about $2.30 per mile in May 2018 to $1.80 today.

More broadly, though, the decline in inflation expectations reflects the market’s fading expectations about future US growth.