Chart of the week – Trade war: have markets finally got it?

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After roughly half a year of on-again off-again, the skirmishes between the US and China over trade and intellectual property – and arguably, a dominant global role – have flared again. Consequently, financial markets reeled, although more so on the fixed income side. The reaction was particularly visible in US Treasuries, and admittedly, here the drop in yields had as much to do with market expectations that benchmark US interest rates will likely to be cut further.

  • Are things between the US and China that bad?
  • Is there an economic impact?
  • Should investors prepare for the worst?

In terms of the equity market reaction to the latest moves in the trade conflict – 10% tariffs on the last USD 300 billion of Chinese exports to the US countered by an exports-supportive drop in the renminbi and a Chinese suspension of imports of US agricultural products – it appears the rising tensions have again hurt Chinese equities more (see Exhibit 1). The effect on the US market has been cushioned by a dovish Federal Reserve and the expectation of further rate cuts.

Exhibit 1: Equity index levels (March 2019 = 100)

Exhibit 1: Equity index levels (March 2019 = 100)

Data as at 7 August 2019. Source: BNP Paribas Asset Management

When it comes to the economic impact on the US, imports from non-Chinese countries have supplanted the falling-away of Chinese imports as US demand remains brisk amid strong economic growth. For China, exports to Europe have been weak as well, undermined by the European economic slowdown.

Renminbi weakness: a nudge

Trade weakness can be seen as one of the reasons behind the Chinese renminbi’s fall against the US dollar, but we doubt the government will allow the currency to depreciate dramatically as that would create as many problems as it might solve. Any further losses by the currency could bring risks such as potential capital outflows and international investor squeamishness over investing in the country, which could drive Beijing to pursue a closely managed devaluation. Instead, Beijing will likely focus on stimulating the local economy through credit growth to avoid a hard landing.

It is worth noting that the renminbi weakness extended to other emerging market currencies. This should be good news for EM exporters, but less welcome for local central banks since it entails higher import prices, which lifts inflation. Overall, the US dollar rally has not been helping already weak EM growth and underperforming equities.

What of the global growth picture?

Sentiment in the manufacturing sector has darkened for four months in a row, with purchasing manager indices pointing to a contraction. Another round of US tariffs will do nothing to lift the gloom, though the result should be a further moderation of growth rather than a recession.

Coupled with low inflation, that leaves investors with a fragile Goldilocks scenario, though in fairness, the main stage where this is playing out is the US where consumer confidence and consumption have been holding up well. This is also evidenced by the latest company results. These show US companies easily beating (low) analyst expectations , while for European companies, the picture is worse given their greater dependency on trade. The prospect of stubbornly low eurozone inflation and sluggish growth should encourage the ECB to ease monetary policy, which should support equities.

Do not count on a bounce yet

As for markets overall, it seems too soon to expect a bounce. More positive news on the trade conflict could be a trigger, though another tweet from US President Trump could easily have the opposite effect. In the absence of better news on trade, investors can expect further central bank moves to tackle weak growth. In the meantime, they can look forward to more bouts of heightened volatility – on the geopolitical and economic fronts as well as in the various asset classes. As to the question in our headline, it seems the coin has dropped, as the saying goes. A trench war over trade looks set to dominate world headlines, markets and investor sentiment into 2020.


Also read: Renminbi weakens through 7 per USD after Sino-US strategic trade recalculation. What next?

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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

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Daniel Morris

Senior investment strategist, CFA charterholder

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