How will the US-China trade talks affect riskier assets?

Elevated tariffs on trade between the US and China sent shockwaves through global markets, withering risk appetite with a prevailing sense of uncertainty over the future of trade talks between the world’s two largest economies. All risk assets felt the impact as fears of a global slowdown returned, with some reacting in unexpected ways.

The Emerging Markets Index (MSCI) fell by nearly 6 per cent and is now within touching distance of wiping out its year-to-date advance. All but one EM currency, the Russian rouble, declined against the US dollar last week as the trade escalation alarmed investors, highlighting how exposed the developing world is to the persistent trade tensions.

Some currencies in the emerging market space are gathering more headline attention than others, with the Turkish lira once again in headlines. The currency has fallen just over 40 per cent since 2017 and is sensitive to market shocks, decreasing value as investors seek to reduce investment on higher-risk assets amid the trade war uncertainties.

Turkey’s own political woes aren’t helping to reassure investors but it’s the country’s economic weakness which is the real thorn in their side. If China slows down because of diminished prospects in the US, Ankara’s current challenges will face a further headwind because the Asian giant is Turkey’s third-largest trading partner globally and the first in East Asia. Chinese investors hold around $2.8 billion (Dh10.28bn) worth of investments in Turkey, which sells agricultural goods, metals, chemicals and other goods to China. Bilateral trade between the countries reached $23bn by the end of 2018 so the stakes are high for Turkey, should China see another slowdown in the coming quarters.

The yuan also fell at an accelerated pace against the dollar in the wake of the increased tariffs between the US and China.

The currency was even more pressured by a recent data release, declining to a new 2019 low on global trade uncertainty. The People’s Bank of China (PBOC) has taken a mild stance and may be considering additional stimulus to counterbalance any negative effects.

In April, the PBOC reassured markets that it will continue to support ample liquidity, but this was before the breakdown in US-China trade negotiations and speculation has edged up since that the central bank may now be prepared to encounter a weaker yuan to offset the upcoming economic pressures from increased tariffs.

In other assets, oil prices were taken down a notch or two for a couple of reasons: first, the increased risk that the world economy may slow down in the second quarter on the back of escalating trade tensions, meaning aggregate demand for oil could fall accordingly. Second, the US Energy Information Administration reported a higher-than-expected inventory build for the week ending May 10, leaving investors wondering what’s next.

The timing of the report was not positive for oil prices, coming as it did so soon in the wake of trade tensions rekindling. Oil prices rebounded on geopolitical tensions but I expect oil to stay vulnerable to pressure for as long as doubts remain over China’s growth while noting that there’s still hope the US and China could reach a trade deal.

Global stock markets flashed red, sending a clear signal that investors are concerned about the increased tariffs between China and the US which had already pressured company profits in 2018. The Chicago Board Options Exchange Volatility Index – which tracks volatility in US stocks – recorded sharp spikes, indicating a short-term return to volatility in US stock markets. In Asia, the Hang Seng dropped to a three-month low and in Europe, the Stoxx 600 Index shed gains seen in March and April.

While risk assets felt the pain of uncertainty, safe-haven assets benefited from investors attracted to the idea of hedging the riskier instruments. Gold spiked to a one-month high back up towards $1,300, appearing more robust than another safe-haven, the US dollar. The dollar did shed some of the gains seen in April but managed to stabilise shortly after the announcement that trade negotiations would continue. The yen benefited from the risk-off mood, appreciating against other major currencies including the euro and dollar.

The bright spots on the horizon include the prospect of continued talks between the US and China and the possibility of reaching a trade deal, but for the short term the investor mood is likely to stay cautious until the air clears. China’s goods are set to become cheaper because of the yuan’s weakness to other currencies, paradoxically this could have the effect of increasing its exports, but whether this happens or not remains to be seen in future data releases.

Looking ahead, the short-term prospects for risk assets remain uncertain and I expect investors to view safe-haven assets more favourably, at least until the immediate shockwaves have calmed.

Hussein Sayed is the chief market strategist at FXTM