The global macroeconomic and investment picture this month has undergone a complete change from the previous four months and the trade war is to blame. On May 10, the US raised import duties to 25% from 10% on $200 billion worth of Chinese goods. Three days later, Chinese authorities retaliated by raising tariffs on $60 billion in US goods. On the same day, the US set in motion a plan to raise tariffs on the remaining $300 billion in Chinese goods by the end of June if no deal emerges.
The following week, the US restricted the sale and transfer of American technology to the Chinese telecom giant Huawei, which was met by a visit by Chinese President Xi Jinping to a rare-earth factory the next day, a possible signal of the next move in the tit-for-tat game. The US then gave a 90-day reprieve to allow limited transactions with Huawei.
The escalation of the trade and tech war has led to volatility in global financial markets. Stock market indices fell sharply before rebounding a few days later when the market felt reassured that the situation would not get much worse, and the yen and dollar, safe-haven currencies, retained strength. Consequently, US treasury yields came down, though commodity prices continued to fluctuate.
The question is, what is the endgame? And what should we, as investors, do? To answer that, we will take a look at the possible scenarios for the trade war.
SCB Securities believes that this time around, China and the US will work to avoid a full-blown war that would make both worse off economically. In the immediate term, we believe that the advantages of a trade war with China outweigh the disadvantages for the US, particularly on the political front. But in the long run, the disadvantages weigh heavier and this will encourage Washington to bring a halt to hostilities.
With that in mind, we see a 50:50 chance that the two sides can reach some sort of agreement in private meetings at the G-20 summit in Japan at the end of June, with China agreeing to amend its laws to include enforcement on key issues such as intellectual property rights, and the US agreeing to reduce the recently imposed tariffs.
At the same time, the politics involved in the negotiations may cause an "accident", in either China or in the US. Hence, another 20% probability is assigned to a moderate case in which the two sides neither raise nor cut tariffs. The last scenario is the severe case (30% probability), in which the US bumps up tariffs to 25% on $300 billion in Chinese imports as threatened.
With that in mind, we project the likelihood of performance for different asset classes as follows.
First, stocks. We believe that stock markets will most likely move up, especially on news that the US and China have agreed on a trade deal. We believe that the most recent news that Washington has put off considering an increase in tariffs on motor vehicles for six months is a good sign that the US does not want the trade war to heat up any further. If that is the case, stock markets in developed countries will perform better, with 5% upside from recent levels, while investors might be more cautious about investing in emerging markets.
But if the situation deteriorates, global markets have room to fall -- and downside risk is limited by the current relatively cheap valuations. We believe that the Thai market will be resilient, with downside risk of about 5% from the current position.
Second, on rates, we believe that the yield on US government bonds will rebound 30-40 basis points from current levels (at both the short and long ends) since the economy will gradually come back up, inflation is subdued, the trade war will simmer down, and the Federal Reserve will hold its policy rate unchanged (as projected) through the remainder of the year.
Even if the trade war does escalate to our moderate case, we still believe that the rate will be kept roughly at the current level. But in the severe case, yields of both short- and long-end treasuries will plunge, as will the Fed funds rate. We predict a larger fall in the longer end than in the shorter end, which will lead to a flattening of the yield curve.
Lastly, for commodity prices, we believe that the price of Brent crude will be stable at the current level of $70 a barrel on small growth in global demand, the Iran sanctions and an extension of the Opec supply cut. The gold price has limited upside because of greater demand from central banks. In the tariff escalation case, however, we predict a decline in the prices of crude oil and gold, with a steeper fall in oil than in gold, especially in the severe case that a trade war reduces economic activity and subsequently leads to lower demand for oil.
Our analysis leads us to recommend investing in risky assets if investors expect the latest salvo fired in the trade war to end at that, especially in developed markets and in the Thai stock market, whose valuations are currently attractive.
Investors with little faith in a positive ending to the trade talks should underweight risky assets, especially in emerging markets, and put more into fixed-income assets such as treasuries, investment-grade debentures and real estate investment trusts, or in the worst case, cash and money markets.
When all is said and done, no matter what the endgame will be, the safest bet is to diversify investment in various asset classes to minimise risk while enhancing returns.
Piyasak Manason is senior vice-president and head of the wealth research department at SCB Securities.
