Global Weekly: Trade tensions on the rise

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Despite a string of company results and a news flow revolving the US–China trade deal, returns on equity markets this week have been flattish. In this volatile environment, we continue to favour a neutral position in equity.

Over the weekend, optimism on the progress in US-China negotiations about topics such as intellectual property protection, farm good purchases and currency policy, changed into fears. US President Donald Trump unveiled plans to impose addition duties on Chinese imports.

In reaction, China decided to raise tariffs on US goods and the head of China's trade negotiation team, Vice Premier Liu He, shared China's conditions for ending the trade war pact with the US. First, the US must remove all extra tariffs. Second, targets set for Chinese purchases of goods should be in line with real demand. And last but not least, the text of the trade agreement should "balanced" to ensure the "dignity" of both nations.

The indirect impact of this intensified trade war is harder to assess than direct effects, such as higher US inflation in 2019 and 2020 and a negative impact on the GDP growth of US and China. Indirect impact comes in terms of tightening of financial conditions and dented business confidence. The US and China plan to meet in late June at the G20 summit to negotiate peace in their trade war, a deal which will relieve the stock markets.

On Wednesday, one of the largest e-commerce companies Alibaba reported higher-than-expected results for the first three months of 2019. Despite macro indicators of a slowdown in economic activity in China and negative trade war headlines, Alibaba was able to report revenue growth of more than 50% in most of the European core markets. Profitability in this quarter was also above market estimates due to stellar growth of high-margin recommendation-based advertising business and cloud-computing sales.

Bonds - The search for quality continues

The returned risk-off sentiment ruling the bond markets has continued this week, after Trump’s tweets regarding the trade conflict with China. High-quality bonds have clearly outperformed their more risky peers.

US Treasury yields trading below 2.37% caught up with this year’s low, that markets experienced in March. Bund yields decreased to below -10 basis points during the week, reaching new lows for this year as well, and are not far away anymore from the all-time lows we have seen in the third quarter of 2016.

In Europe, it is not only trade fears triggering the demand for quality. Italian Minister of the Interior, Matteo Salvini, is increasingly self-confidently facing a possible conflict with the European Union, supported by strong polls for his Lega party in the upcoming European elections. He again explicitly rejected the proposal to raise the sales tax, which experts from the EU and the Italian central bank consider unavoidable to not further inflate the Italian budget deficit.

The risk premium for 10-year Italian government bonds compared to Bunds has increased by around 30 basis points since the start of the month. We do not believe that Italy is running into a situation where it will not be able anymore to meet its financial obligations. It is interesting that we do not hear any comments from the EU to this news coming from Italy. We think this might change as soon as the European elections are behind us and the new commission is in place. A confrontation between the EU and Italy could then lead to further volatility in spreads.

After the Chinese government announced counter-actions in its trade dispute with the US, the spread widening in the corporate bond sector continued – both in the investment-grade and the high-yield area. Trump’s speculation about a delay for a tariff increase on EU cars some days later did not lead to a significant relief. Bonds from emerging markets suffered as well, while inflation-linked bonds are still facing an environment in which both US and European investors are pricing out inflation risk since the start of the month. European covered bonds were supported by the search for quality and could continue their strong year-to-date performance.

Looking forward, it is not unlikely that central banks will again be the factor to monitor. After a setback following the US Fed’s rejection to rate cuts, markets are now starting to again price in such a step, rising the risk of disappointments.