Announcement of a fresh round of US tariffs on China unsettles markets

Donald Trump proposes a new round of tariffs on Chinese goods

On 1 August 2019, President Trump proposed imposing a 10% tariff on all remaining Chinese imports that have so far been unaffected – i.e. some USD 300 bn of goods. Expected to take effect on 1 September, this measure would come in addition to USD 250 bn worth of Chinese goods already hit by a 25% tariff. The list of affected imports this time includes a significant amount of consumer goods, a step that the US administration had avoided taking in previous rounds.

This development came as a surprise after the Trump-Xi “truce” in their late-June Osaka meeting, and after the two sides had resumed negotiations. The first meeting between high-level officials took place in Shanghai early last week, and the next is scheduled for early September in Washington, DC.

However, President Trump has now decided to respond to the lack of progress in talks by escalating tensions further, possibly hoping that the threat of new tariffs could push the Chinese to try to strike a deal with more urgency. China has responded by allowing the yuan to depreciate (the USD/CNY exchange rate broke above 7.0 today) and by suspending imports of agricultural products from the US.

Meanwhile, the Federal Reserve (Fed) proceeded in its meeting last week with its well-telegraphed interest rate cut (the first in over a decade) and an early end to its balance sheet reduction process. While Chair Powell’s remarks that this decision reflected a “mid-cycle adjustment” rather than the start of an easing cycle initially disappointed markets, the re-escalation of trade tensions implies that the Fed might have to adopt an easier stance as a response.

Market impact and portfolio positioning

Investors viewed the outcome of the Fed meeting as a “hawkish” cut, and were disappointed by the central bank’s lack of commitment to a prolonged easing cycle. In addition, President Trump’s tweet announcing new tariffs on Chinese goods has irritated market participants further. This has led to a drop in equity prices (Euro Stoxx 50 down – 4.3%, S&P 500 futures -3%, CSI 300 -4.1%), an increase in the price of gold (+3%) and appreciation of the JPYUSD (2.4%), as of 31 July. Furthermore, US Treasury yields declined further (10-year yields down -25bps) and Fed funds futures are now pricing 60bps of rate cuts by year-end (although their initial move after the Fed meeting suggested only 32bps).

Performance of our tactical positions

The asset allocation decisions made over the past few months – favouring carry strategies over equities while seeking diversification and hedges – have worked well over this period. Our underweights in emerging market equities and global small caps have helped limit losses in the overall portfolio, as did our overweight positions in gold and the Japanese yen. Meanwhile, our preferred carry strategies overweights – emerging market hard currency bonds and infrastructure – have held reasonably well.

Our tactical positions contributed positively to portfolio performance, which further validates our defensive stance. We continue to face uncertainty around trade tensions against a backdrop of slowing global growth. While central banks have shown their willingness to support the economic cycle, the current market environment justifies keeping our current portfolio positioning unchanged.

Nevertheless, we will continue to monitor developments on both market and macroeconomic fronts, and stand ready to act if we see opportunities.

Currency market implications

Turning to currencies, we maintain our long Japanese yen (JPY) exposure across all portfolios. We have long argued that the yen enables us to express a directional view (JPY upside due to undervaluation, maturity of the business cycle and Fed easing) and simultaneously acts as a hedge to market shocks, especially in a period of elevated trade concerns. At the same time, we are turning gradually more neutral on emerging market currencies (due to the confidence hit from the additional tariffs and the potential further impact on global trade); and while we still expect carry trades to hold up well given the renewed decline in US yields, we think the price action will be more volatile. Finally, in light of the recent developments in the US-China trade saga, we have put some of our G10 and CNY forecasts under revision. We will communicate any potential changes over the next few days.