Global Weekly: Trade deal signed!

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Finally, after two years of threats and tariff hikes, the US and China signed a phase-one deal on 15 January! That is good news, as this formal agreement includes some progress on intellectual property, technology transfer and financial services.

This deal should decrease uncertainty related to international trade. However, several risks around its implementation remain: first, this is a bilateral agreement outside the framework of the World Trade Organization (WTO); second, most of the tariffs that have been put in place remain in place because Trump wants to use these as leverage for the phase-two negotiations.

The market reaction has been quite muted: US equity markets are trading marginally higher, with the S&P 500 flirting with the 3300 level; European markets remained flat. Implied volatility remains low on the US equity markets and keeps on decreasing in Europe.

Investors are already looking forward to the upcoming earnings season: in the US, financials are publishing strong results with JP Morgan, Blackrock, Bank of America and Citigroup all beating expectations. A reality check is starting. Any miss could generate volatility, especially in the most expensive parts of the equity market. But so far, momentum remains strong, generating some overbought conditions at the index level and some euphoria at the stock level.

Bonds: No worries on the market’s mind

Many strategists predict an economic recovery for 2020. Recession risk that was haunting markets only a few months ago has seemingly faded, although growth expectations remain modest for this year. Most data are supporting this view, as many leading indicators seem to be bottoming, and sentiment is helped by a perceived reduction of geopolitical risks.

Markets have been reflective of this scenario. Rates went down at the start of the year, but moved up again sharply once tensions between Iran and the US de-escalated. We see this as a confirmation of the upward trend in rates. We therefore reduced our portfolio duration (i.e. sensitivity to interest rate movements) from overweight to neutral. We do note that some data suggest growth may not be rebounding (especially the European manufacturing sector continues to show disappointing numbers), which may even trigger further supportive actions from the ECB. This should drive rates lower, but our conviction is not high enough to keep an overweight on duration.

Risky assets continue to perform

Furthermore, risky assets are performing well. Corporate high-yield spreads are now almost at historical lows, when bonds trading at distressed levels are excluded. Valuations have fully anticipated a growth rebound, leaving little room for disappointment. Performance of investment-grade credit is more muted with spreads unchanged since the start of the year. But the underlying market looks strong to us, considering the US-Iran tensions did not have any impact and bond issuance started at record pace since primary markets reopened in the new year. We would not be surprised if a little more credit performance can be squeezed out of this asset class. We acknowledge credit is expensive already, but the ECB’s bond-buying programme should protect the market if earnings or the economy disappoint.

Although geopolitical risks have been pushed to the background, we would not be surprised to see some of these return and cause volatility. This would push rates lower and hurt risk assets given their expensive valuations. Now that the phase-one deal between the US and China has been signed, investors may turn their attention to phase-two negotiations. Regarding Brexit, it is positive that the UK now has a leader that is in a stronger position than before, but it might still be difficult to reach compromises in the more detailed negotiations that will follow now. Finally, as the presidential elections in the US will come closer, this may cause some interesting headlines.