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July market update: Short-term risks have increased

Short-term risks have increased as Donald Trump ratchets up tensions with China.

Short-term risks to the market have increased as Donald Trump ratchets up tensions with China.

Jon Cunliffe

in Features


The first seven months of this year have been characterised by broad-based asset price reflation, with all the major asset classes delivering significantly-above-average returns. A key driver of this outcome has been a marked shift in the key central bank’s policy stance, led by the US Federal Reserve, which cut its key Fed Fund rate at its July monetary policy meeting.

A few short months ago, the markets were expecting higher US interest rates and, as the US-China trade dispute dragged on, there were genuine fears that the US central bank’s policy stance could lead the US economy sleepwalking into the next recession. Elsewhere, the European Central Bank stated that the region’s growth and inflation outlooks had deteriorated further and its commentary has paved the way for a number of policy easing measures at its September meeting. Elsewhere, whilst the Bank of England and Bank of Japan have not formally guided the markets to anticipate easier policy, they have not stepped in the way of markets anticipating such a move.

This shift in the interest-rate landscape resulted in sovereign bond yields falling sharply. This reduced, in the markets’ eyes, much of the adverse tail risks to the global economy resulting from the downshift in manufacturing activity and ongoing trade narrative. As a result, market participants felt the prospective risk-adjusted returns across most asset classes to be somewhat better than they had seemed a few months ago, prompting a much more “risk-on” financial market environment.

However, after the July rate cut, interest-rate guidance from the US Federal Reserve’s Chair, Jerome Powell, fell short of a pre-commitment to ease policy further, but rather to adopt a wait and see approach. This caused some disappointment in the market and saw equities end July off their highs.

With the month-end announcement by Donald Trump that the US intends to place a 10% tariff on all remaining Chinese imports (circa $300bn) to the US on 1 September, we have witnessed the next round of the trade war. The background to this seems to be Trump’s lack of confidence in being able to agree the type of comprehensive trade agreement that will go down well with the electorate ahead of the 2020 presidential election. Elsewhere, Trump might also have taken the view that the Federal Reserve will cushion both the economy and the markets by a much more aggressive path of rate cuts. However, the subsequent retaliation by the Chinese authorities via allowing the Yuan to weaken beyond 7 to the Dollar and the ban on US agricultural purchases does raise the stakes and the potential for a policy misstep.

Taken together, we continue to feel that the global economy and financial markets remain on “the bright side of the muddle through”, an environment where moderate growth and central bank policy stimulus supports reasonable medium-term returns. However, in the very short term we feel that risk-return is a little unfavourable and are a little more cautiously positioned than normal.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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