A surprise tariff announcement by the U.S. met with an unexpected depreciation in the Chinese currency, sending shock waves across global markets last week. This latest escalation in U.S.-China tensions reinforces our view that trade and geopolitical frictions have become the key driver of the global economy and markets. We stress the importance of portfolio resilience in this environment, yet view the decisively dovish shift by global central banks as helping extend the global expansion.
U.S. President Donald Trump announced a 10% tariff from next month on the $300 billion of Chinese imports not already subject to tariffs. This triggered a wave of tit-for-tat retaliations. China let its currency breach the psychologically important 7-per-U.S. dollar level – a departure from the People’s Bank of China (PBOC)’s usual practice of stabilizing the yuan when it’s under pressure. See the line for the yuan’s exchange rate. This sparked memories of the 2015 yuan devaluation that rocked global markets. Yet we do not expect a repeat. Capital outflows from China hit historic levels in 2015, but have ebbed since, with better curbs in place. And we see the deliberate nature of PBOC’s latest move stemming fears of uncontrolled devaluation. Spillover to other EM currencies has been subdued versus 2015. We see Beijing allowing the yuan to fall further, but in a controlled manner. Other recent tit-for-tat actions: The U.S. designated China a “currency manipulator,” China said it would stop buying U.S. agricultural goods, and the U.S. delayed a decision to loosen restrictions on Chinese telecoms giant Huawei.
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Focus on portfolio resilience
Trade disputes extend beyond the U.S. and China, and trade policy has increasingly become a tool that global governments use to pursue political objectives. The latest example: A row between Japan and South Korea over wartime compensations has morphed into an intensifying – and likely long-lasting – trade and technology dispute. Europe could be the next front of the global trade war, as European governments step up taxation of U.S. tech companies. See our geopolitical risk dashboard for more.
Rising macro uncertainty has contributed to a dovish tilt by global central banks. This stems downside risks to the economy and reinforces our view that despite a downgrade to our growth outlook, the global expansion can run on for longer. The latest shot of monetary easing came from central banks in New Zealand, Thailand and India. The trio surprised the markets, cutting rates by more than expected last week. The accommodative stance of central banks underscores our still-positive view on risk assets. This includes income opportunities such as local-currency EM debt of countries with low exposure to U.S.-China trade tensions.
The market turbulence underscores our call for portfolio resilience. Government bonds have lived up to their promise as portfolio stabilizers, even with U.S. 10-year Treasury yields now near three-year lows. German government bond yields have also declined – though not as drastically. This illustrates another of our key views: Core European bonds may offer a thin cushion against stock market selloffs as yields approach an effective lower bound. We like European sovereigns on a tactical basis, notably those from southern-tier countries, as we expect the European Central Bank to unleash further stimulus. By contrast, we see market expectations of aggressive Fed easing as excessive, given limited near-term recession risks. We see inflation-linked bonds offering buffers against equity drawdowns and underappreciated inflation risks. We prefer the U.S. equity market for its still longer-term reasonable valuations and a concentration of high-quality companies. We favor the min-vol factor, which has tended to do well during economic slowdowns.
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