MAY 15,2019

Hold tight for volatility as trade turmoil rattles markets anew.

Investors are standing by for a fresh bout of market turmoil as President Donald Trump turns up the heat on Beijing over trade. The standoff between the U.S. and China appeared to deepen at the weekend after Trump took to Twitter again, this time to say the Chinese may have felt they were “being beaten so badly” in the recent talks that it was better to drag their feet in hopes he would lose the 2020 election and get a better deal from the Democrats.

Amid the prospect of retaliation from Beijing to the U.S. decision to slap higher tariffs on $200 billion of Chinese imports, traders are expecting a jump in volatility as investors dump stocks and other high-risk assets in favor of U.S. Treasuries, gold, the dollar, yen and Swiss franc.

Nader Naeimi, who oversees about $1 billion in a dynamic market fund at AMP Capital Investors Ltd. in Sydney, said by email:

• “The biggest problem is the huge disconnect with what markets have been hoping for and what is transpiring now.
Markets had priced the best-case scenario and odds are shifting towards the worst-case scenario”

• “China’s response was certainly not what risk markets were hoping for, so I expect huge
volatility” at the Asia open

• Note: China is planning how to retaliate and has told Washington that it must remove all extra tariffs, set targets for Chinese purchases of goods in line with real demand, and ensure that the text of the deal is “balanced” to ensure the “dignity” of both nations

• “China demanding the U.S. drop the tariffs is setting the stage for a serious face-off”

• “Economic tensions can now morph into military tensions between the two countries, and then with the U.S.-Iran flexing their muscles, oil prices are at risk of spiking up”

• “For complacent equities, a perfect storm is brewing: tariffs, higher prices, a possible spike in oil prices in the face of fragile global growth. My asset allocation is gold, oil, inflation-linked bonds and defensive positioning” Mansoor Mohi-uddin, Singapore-based senior macro strategist at NatWest Markets, said in an email:

• Forward-looking currency markets are reacting to the prospect of China’s trade surplus falling and Chinese corporates with $840 billion of onshore foreign-exchange loans preemptively buying dollars
o “Similar behavior last year caused the exchange rate to rise from 6.25 to 6.95”

• The dollar’s strength against the yuan signals the greenback should remain strong versus the euro and other major currencies
o A sharply higher greenback fueled by trade wars was a key threat U.S. investors raised when the NatWest team visited clients in New York, Seattle and California recently

• “For the Federal Reserve — still unwilling to consider easing monetary policy — a surge in the dollar may become a risk to its current neutral outlook” Mohammed Ali Yasin, chief strategy officer at Al Dhabi Capital in Abu Dhabi, said in a text message:
• There’s concern that the new tariffs will be borne by U.S. consumers as prices will increase accordingly, lifting inflation above the Federal Reserve’s normalized rate of 2%
o “That may change the current stance of interest rates in the U.S. from hold-to-cut to become hold-to-raise by year end or early 2020, which means more stock-market volatility and negative pressures” 15

• “I really find the way Trump used his Tweets to manage the failure of the trade talks with China a failure in itself!”

• “I believe it undermined his negotiation team and killed any chance of a possible compromise to be reached privately before making a public statement by those teams! It looked like he panicked and wanted to throw the blame on them rather take part of the responsibility!”

Hasnain Malik, the Dubai-based head of equity strategy at Tellimer, said in an email:

• “Progress in U.S.-China trade talks is always going to be partial and temporary because the clash of interests at stake are not easily reconciled and the two negotiating parties are not under urgent pressure to settle”

• The set-back in negotiations will hurt global growth expectations and pressure emergingmarket assets

• “For those economies with manufacturing integrated with China it is worse. But it also remains the case that rival manufacturing exporters to China, such as Bangladesh and Vietnam, should benefit, over time, from the redirection of purchasing orders and greater marginal capacity addition”.

Raffaele Bertoni, head of debt-capital markets at Gulf Investment Corp. in Kuwait City, said in an email:

• Investors who are exposed to emerging-market assets should protect their portfolio by switching from countries that are already suffering from significant inflation pressure and heavily dependent on foreign-currency debt — including the Philippines, Indonesia, Malaysia, India, Turkey, Brazil and Argentina — to countries where interest rates are already low and there’s more room for easing monetary policy to support growth, such as South Korea, Thailand and Mexico

• U.S. Treasuries would be one of the few safe havens “still cheap in terms of real rates”

• Sees upside for U.S. investment-grade corporate bonds while remaining more cautious on U.S. high-yield debt which is more correlated to the performance of equity markets

• Expects the dollar, Japanese yen and Swiss franc to benefit from demand for haven assets