Keeping the market volatility in perspective

Trade tensions flare up again

What happened?

On Monday 18 June, President Trump instructed his trade representative to draw up a list of USD 200bn in Chinese products that will be hit with 10% tariffs. He also threatened to increase that total by another USD 200bn if China counters. The end result could be tariffs on USD 450bn worth of goods—a total that would almost match US imports from China in 2017. This was in response to China's decision on Friday to retaliate to the administration’s imposition of USD 50bn in tariffs on imports from China. This intensification of trade tensions renews fear that this could escalate into a trade war with negative implications for global growth and equity markets.

US large-caps and bond yields fell, although both finished well off their intra-day lows. The S&P 500 fell just 0.4% while the more domestically-oriented Russell 2000 small-cap index actually eked out a small gain (0.1%) on the day. However, the global growth-sensitive industrials and materials sectors dropped roughly 2% while the more defensive, yield-sensitive sectors—telecom, utilities and consumer staples—finished higher for the day. Asian equity markets, China in particular, experienced larger losses. The 10-year Treasury yield fell 3bps to 2.89% and the US dollar strengthened against all major currencies, except the safe- havens Japanese yen and Swiss franc.

What's next?

The US tariffs on USD 34bn of China imports go into effect on 6 July, and the remaining USD 16bn will be subject to further review. On 29 May, when announcing the finalization of the first list under the Section 301 investigation, the White House also announced the intent of imposing investment restrictions on Chinese entities by 30 June. On 24 May, the US started a Section 232 investigation on car imports. The first measures are not expected before 2019, but press releases suggest the potential for conclusion before the midterm elections in November. The Administration is likely to assess the initial impact of these tariffs on the economy, financial markets and President Trump’s public support before deciding to impose additional measures.

What does this mean for investors?

Although this escalation in trade tensions and a sequence of retaliatory threats is unlikely to disappear in the immediate future, our base case remains that the ultimate outcome will be a renegotiation of existing trade deals and a new deal between the US and China. Targeted bilateral tariffs may continue, but with limited effect on the global economy. The announced US and China tariffs should lower GDP growth in both countries by about 0.1% or less, while the tariffs should add a de minimis 2-3bps to US inflation. The impact will increase, however, if the US actually imposes tariffs on USD 450bn of China imports.

With US growth now accelerating after a tepid first quarter and global growth still above the long-term trend, the UBS Chief Investment Office (CIO) expects global equities to continue to grind higher. The limited market impact over the past few months in response to rising trade tensions reflects the minimal economic impact that the tariffs should have. But while the direct economic impact might be limited, investors should monitor the situation carefully as the timing of additional actions is uncertain, which can increase volatility.