The People’s Bank of China (PBoC) on Sunday took action to help mitigate rising US-China trade tensions, trimming the amount of reserve cash some banks must hold by 50bps to unlock USD 108bn in additional liquidity. The move is a reminder to investors that policymakers can deploy macro tools to cushion the impact of economic disruptions. Officials around the world could also be willing to moderate the pace of monetary tightening if trade risks slow growth. Federal Reserve Chair Jay Powell last week stated that the trade outlook could be impacted by trade risks.
Such policy responses could help reduce the downside for risk assets. But the existence of a macro toolbox should not lull investors into complacency when it comes to preparing for portfolio volatility:
- Markets are currently focusing on heightened trade risks, rather than the potential for helpful policy responses. China's CSI index closed down 1.3% and the Euro Stoxx 50 index was down 1.1%.
- The White House has continued to make protectionist threats with increasing frequency. Most recently the administration has said it is considering imposing fresh tariffs on EU auto imports, and the US Treasury has said it is planning significant curbs on Chinese investment in US technology firms.
- Macro tools could be insufficient to fully offset the economic effects of trade tensions. While the first round tariffs should have a very minimal impact on growth and inflation, the damage will be amplified if the US follows through on a second round of tariffs if a 10% tariff is imposed on USD 200bn of Chinese goods. For China, on top of economic implications, trade tensions could negatively impact supply chains, weigh on investment sentiment, and potentially revive geopolitical risk in the Korean peninsula.
So while we remain overweight global equities, the rising risk to global trade underlines the importance of holding some counter-cyclical positions. We are overweight 10-year US Treasuries, which tend to benefit during equity market corrections.
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