Shifts in trade policy drive equity markets in August

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Financial markets continued to track news from the trade front. Equities fell in the very first trading sessions of August after China and the US resumed their trade spat with additional tariffs on Chinese goods, effective in September.

In particular, investors were spooked by statements from both sides and by the weakening in the yuan. The possibility of a currency war emerged when the USD/CNY moved above 7, prompting the US Treasury to designate China a “currency manipulator”.

  • By mid-August, the MSCI AC World had dropped by 5.1% on the month-to-date.
  • Global equities rallied later, saving the month from a disastrous showing (-2.6%).
  • Government bonds rose sharply on a flight to safety, global growth fears, and expectations of monetary easing.

Overreactions to trade policy uncertainties  

Equities continued to trade erratically during the second half of the month, driven by shifts in trade policy, which on both sides consisted more of talk than actual decisions. Investors’ knee-jerk reactions to anything that China or the US said reflected their nervousness amid heightened risks to global growth and burgeoning uncertainties. This nervousness spilled over into other asset classes, with gold up by 7.5%, oil and industrial metals down (by 5.9% in the case of WTI), and currencies regarded as safe havens up (the yen and Swiss franc in particular).

Fundamentals, including corporate results and economic indicators, have been mostly cast aside in recent weeks.

Strong earnings and better-than-expected data from the US may have been behind the mini-rally in equity indices late in the month, but comments on trade policy nonetheless played a decisive role. Equity investors were reassured by reports that Sino-US contacts had not been broken off and that negotiations might indeed resume. However, they were less receptive to central banks’ accommodative language.

Exhibit 1: Emerging equities underperformed  

Exhibit 1: Emerging equities underperformed

Equity markets in the eurozone and in the US outperformed

  • The MSCI AC World (in US dollar) ended the month down 2.6%. Emerging equities unperformed by far (-5.1% by the MSCI Emerging in USD), driven by special situations that are often more political in nature than economic (such as in Hong Kong and Argentina) and that undermined the shares and currencies concerned.
  • Growth concerns in China, which led officials there to announce stimulus measures, sent the yuan down (-3.8% to 7.1565 for USD 1), along with share prices.
  • Among developed markets, the eurozone held up better than the US, with the S&P 500 down by 1.8% and the EuroSTOXX 50 down by 1.2% in local currency terms.
  • The FTSE 100 (-5.0%) lost ground as investors began to price in a no-deal Brexit.
  • In reaction to a stronger yen, which penalised export-intensive stocks, Japanese shares fell by 3.8% (as measured by the Nikkei 225).
  • Globally, investors overweighted defensive sectors and underweighted cyclical ones. Low interest rates provided support to utilities, while undermining financials.

Exhibit 2: An abrupt decline in bond yields

Exhibit 2: An abrupt decline in bond yields

Did the environment worsen during the summer?

This seems to be the message being sent out by equity market declines and bond market gains. Sino-US trade tensions pose a risk to global growth and are undermining the confidence of economic agents.

The unpredictability of political factors is a destabilising element.

In this uncertain environment, the support measures flagged or announced outright by major central banks were not enough to fully reassure investors. The performance of some markets suggests that investors are sceptical about commitments to dovish monetary policies and their effectiveness, particularly in reviving inflation.

A difficult road lies ahead, particularly in the eurozone, where the ECB appears to have little room to manoeuvre at a time of lofty expectations (for key rate cuts, a resumption in securities purchases, and substantial loans to banks) that could well be disappointed.

The US economy, which is less exposed to global demand, appears to be better able to withstand the manufacturing slowdown. Moreover, the US Federal Reserve’s key rate levels give it more latitude (than the ECB) to react to a clear downturn in economic activity.

As a result, equity prices may continue to track shifts in trade policy.

Fiscal policy could provide investors with some short-term reassurance as long as the measures are ambitious and credible.

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Nathalie Benatia

Macroeconomic Content Manager

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