Global Weekly: Trade tensions back on the table

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This week’s markets were again spooked by resurfacing trade tensions between US and China. What was expected to be the final round of negotiations for the US/China trade dispute, has ended up by tweets from US President Donald Trump that he intends to put the tariffs at work.

It is now uncertain how the next leg of the US/China trade negotiations will look. As a consequence, equity markets retreated on a global level. As could be expected, export-oriented countries that are potentially most hurt by trade tariffs, such as Germany but also China, were again hit hardest.

It seems unlikely that the negotiations between the US and China will collapse, as both parties would prefer to avoid any risks that would be detrimental for their economies. History, however, tells us that it takes time to make commercial deals. There was already a deadline in February that was missed. It could be that the latest Trump tweets are part of a negotiation strategy. The US leader, recently boosted by strong US growth data, could be adding last-minute pressure in order to eke out an additional advantage in the talks. Overall, it is not likely that the US/China trade negotiations will now completely collapse, although downside risks have risen.

As equity markets have recovered quite significantly since the low of December, valuations do not offer a significant buffer for tail risks, meaning that any bad news has the potential to have a significant market impact. As a consequence, it seems likely that markets will be volatile in the short term, as long as visibility remains low regarding the consequences of Trump’s tweets and their effect on negotiations.

We maintain our recommendation to take a neutral stance toward stocks. We do not recommend making any changes to your investment portfolio based on the latest hurdle in the US/China trade negotiations. Our neutral positioning should help us to overcome this period of volatility. We will continue to monitor the situation and its impact on markets and the portfolios of our clients.

Bonds: recovery at risk?

Uncertainty around a possible US-China trade deal ruled bond markets this week. Trump’s tweets raised the stakes, that are already high, jeopardizing the still fragile recovery of the global economy.

Central bank support, the prospect of a trade deal and green shoots in China have turned the tide on financial markets this year so far. Financial conditions have improved markedly, as equity markets and risk spreads in bond markets returned to the levels of September last year, just before the soft patch developed.

The soft patch that hit the global economy around year-end was probably to a large extent a result of the gradual escalation of global trade tensions during 2018, focussing more and more on the US and China. Business sentiment was depressed, corporates postponed capital investments and consumers were reluctant to spend.

The US Federal Reserve, the Fed, recognized the risks to growth and stopped hiking rates, already concerned with stubbornly low inflation, leading the way for central banks across the globe to explore more accommodative policies. US Treasury yields are now stuck around 2.5%, the level at which the Fed stopped hiking, while Bund yields are moving around zero, the level Japanese yields are hovering around for 3 years now. Central banks are expected to firmly hold on to this loose policy for at least the rest of this year. The global economy, however, probably needs a lid on global trade tensions in order to be able to extend the current cycle.

If the trade conflict unexpectedly escalates, this would be a major setback for the global economy and a challenge for policy makers. In contrast to last year, however, policy makers are now clearly aware that they would need to act quickly to control the damage. As the ECB and most European governments have only limited options available, Europe would have to depend much on fiscal and monetary stimulus in China and the US.

Risk premiums were already grinding somewhat higher, before the latest spike in trade tensions. Our constructive outlook is still built on the assumption that politicians will not escalate the trade tensions, albeit only to improve the chance of re-election or to silence domestic critics. This should allow the few green shoots, that we already see, to spread. Also to Europe, that is still struggling the most with the recent soft patch.

We expect a moderate improvement of the underlying trend in economic data over the next few months to confirm trend-like growth in the second half of this year - not a recession. This should allow risk premiums to move sideways and corporate bond investors to earn a carry on their positions. In emerging markets, local-currency bonds struggled in the last few weeks to keep up with hard-currency bonds, which were more resilient and moved in line with global high-yield bonds. We therefore continue to recommend an overweight in (hard-currency) emerging market bonds versus high yield bonds.