The increase in trade tensions over the last month has become the key
focus for markets. The US administration has implemented several new protectionist measures and is intent
on imposing even broader ones in the near-term, including greater control over foreign direct investment
in the US designed to reduce the transfer of intellectual property to countries viewed as adversaries.
While the direct macroeconomic impact of the existing measures will likely be small for now, further
escalation may hurt growth by impacting confidence or tightening financial conditions. We view
substantive escalation of trade disputes, leading to unilateral imposition of further tariff and
non-tariff barriers as a real possibility.
This comes at a time when growth momentum is at an
inflection point, while still remaining strong, particularly in the US. The US economy continues to trend
toward fiscal stimulus-driven overheating, while European growth is likely to have peaked. Most emerging
markets will continue to grow despite recent market volatility.
There is a renewed divergence
between the world’s two largest economies: the Federal Reserve is tightening policy to avert any
inflation risks while the European Central Bank has shifted in a dovish direction portends a significant
trend for global markets. The spread between 10-year US and German yields has already reached its widest
level in almost 30 years, and the euro has been under pressure. The deterioration of the fiscal outlook
and debt sustainability in Italy adds to the challenges in Europe.
This divergence in monetary
policy is likely to become a major theme again in determining market views. While still expect the dollar
to depreciate in the medium term based on the US’s weak external position, the growing rate differentials
will provide strong support for now. Sovereign bond yields are likely to rise further as central banks
withdraw accommodation but will reflect the divergence of performance. Equities will continue to gain as
global growth decelerates but remains strong, albeit with higher volatility.
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