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How to navigate escalating trade disputes

12-Aug-2019
By Kate Moore, Scott Thiel

Key points

  1. An escalation in US-China tensions has roiled global financial markets, reinforcing our call to build portfolio resilience.
  2. Weak activity data exacerbated declines in global risk assets including stocks and most commodities. Perceived safe-haven assets rallied.
  3. China’s industrial output and retail sales data this week are expected to moderate after unexpected gains in the previous month.

How to navigate escalating
trade disputes

The recent escalation in US-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.

Chart of the week

China's foreign reserve flows and yuan exchange rate, 2007-2019

Chart of the week

Sources: BlackRock Investment Institute, with data from the People’s Bank of China (PBOC) and Refinitiv Datastream, August 2019. Notes: Flows in China’s foreign reserves are represented by monthly changes in PBOC’s foreign reserves. The yuan exchange rate is represented by the currency's spot closing rate versus the US dollar. The vertical axis on the yuan rate is flipped so that a downward move in the line represents a weaker yuan versus the dollar.

US 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-US dollar level – a departure from the People’s Bank of China (PBOC)’s usual practice of stabilising the yuan when it’s under pressure. 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 US designated China a “currency manipulator,” China said it would stop buying US agricultural goods, and the US delayed a decision to loosen restrictions on Chinese telecoms giant Huawei.

Focus on portfolio resilience

Trade disputes extend beyond the US 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 US 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 US-China trade tensions.

The market turbulence underscores our call for portfolio resilience. Government bonds have lived up to their promise as portfolio stabilisers, even with US 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 US equity market for its still longer-term reasonable valuations and a concentration of high-quality companies. We favour the min-vol factor, which has tended to do well during economic slowdowns.

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  • Global stocks tumbled before paring some losses. Most commodities sold off. Benchmark Brent crude oil prices dropped to the lowest since the start of the year. Perceived safe-haven assets such as gold, Japanese yen and government bonds rallied. German long-maturity bond yields touched record lows. Sovereign yield curves flattened significantly.
  • The League, part of Italy’s ruling coalition, pulled its support for the government, triggering a potential early election this year. The UK economy shrank for the first time since 2012 in the second quarter. Eurozone’s manufacturing downturn deepened. German and French industrial output declined sharply in June.
  • China’s services sector grew at the slowest pace in July in five months. Beijing reported better-than-expected trade data, but the export sector remains under pressure from increasing US-China trade tensions.

 


 

  Date: Event
Aug 13 German consumer price index, ZEW economic sentiment
Aug 14 China industrial output, urban investment, retail sales; eurozone second-quarter gross domestic product
Aug 15 US retail sales
Aug 16 University of Michigan survey of consumers; Organization of Petroleum Exporting Countries (OPEC) monthly oil market report

Chinese data will be in focus this week. Both industrial production and retail sales for July are expected to moderate slightly following the uplift in the previous month. Markets could be vulnerable if the data miss expectations, given the weaker investor sentiment and soft manufacturing business surveys globally in recent weeks. Policy stimulus has been supportive, and we see the potential for additional stimulus taken up by the Chinese government to offset the impact of increasing trade tensions – likely through further fiscal easing.

Mike Pyle
Chief Investment Strategist, BlackRock Investment Institute.
Elga Bartsch
Head of Macro Research, BlackRock Investment Institute
Beata Harasim
Senior Investment Strategist, BlackRock Investment Institute
Ben Powell
Chief Investment Strategist for APAC

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