While our confidence that the U.S. and China would find a way to agree on trade has been growing, we always maintained that a failure to do so was the only genuine threat to economic growth in 2019.
A week ago, much of the negotiating progress appeared to unwind after President Donald Trump threatened to escalate tariffs on $200 billion of goods in the absence of clearer concessions from China. After four days of renewed volatility in financial markets, I put pen to paper on Friday morning, hours after the midnight deadline for concessions had passed.
Is the deal dead? And if it is, how serious are the consequences for risk assets?
Off the Radar Screens
Markets may have sniffed something out two weeks ago when the S&P 500 hit a new high and sold off violently on the day of the Federal Reserve’s press conference. Maybe recent weakness in emerging markets and industrial metals pointed to unresolved problems for global trade. Maybe—but, on the whole, this seems to have blindsided investors.
Even last Wednesday, when we polled CIOs at our annual Investment Leaders Summit, not one anticipated a recession in the next 12 months and not one expected inflation to be the catalyst of an eventual downturn. We think they are probably right—but those polls were a potent reminder of how far a growth-disrupting, inflation-stoking trade war had moved off everyone’s radar screens.
By midweek it was pretty clear that Friday’s deadline was likely to pass and that tariffs would go up, because if reports are correct, the current breakdown in negotiations has been caused by a fundamental and difficult sticking point.
U.S. Trade Representative and longtime China hawk Robert Lighthizer has been leading the demand that China’s concessions on trade policy be reflected in changes to Chinese law. This would make any new agreement easier to enforce and make it more likely to survive beyond the current U.S. administration. There may have been some progress toward this goal, but it appears that President Xi Jinping himself led the pushback.
A climb-down by either side would have likely led to equity markets finding their bottom and mounting a relief rally by the time this goes live, but as I write, there is very little space for either side to climb down into.
Still, an escalation of tariffs does not necessarily mean an end to negotiations and any hope of a deal. Indeed, our view is that this is very unlikely. Both sides can make space to climb down into, but it will take more than a couple of days and it will likely be done against a background of higher tariffs.
That does mean more weeks and months of uncertainty for investors on a matter that they had started to price out of risk assets, however. There was an element of “sell the rumor, buy the news” in Friday’s trading session, but ultimately, we would not be surprised to see this translate into the loss of half or more of the gains that equities have enjoyed over the first four months of the year. That would put the S&P 500 into correction territory.
Credit markets will feel the pain, too, but we think they may be less vulnerable, due to valuations, moderately good first-quarter earnings lifting fundamentals, and an improvement in market technicals and liquidity since the big selloff in December.
The picture could certainly get worse. The U.S. is starting the paperwork for tariffs on all other imports from China, which would more than double the scope of goods covered. This process will take one or two months, during which time we have to assume the trade teams will continue to negotiate. China has indicated retaliation—when and how remain uncertain.
If the next set of tariffs are imposed, the impact will be felt by U.S. consumers in the form of higher prices, likely leading to a modest bump in CPI, whereas the first round largely focused on capital and intermediate goods. And let’s not forget that, away from China, the big “Section 232” decision on auto tariffs still has to be made in five days’ time. Bad news on either of those counts has the potential to raise the probability of a meaningful downshift in growth.
This is still not our core scenario, however. The ultimate goal of settling on a durable deal is clearly in the best interests of all. We are likely in for a rough ride over the summer, but it may be an opportunity for the nimble to find some much-needed value.
Brad Tank is a Managing Director, Chief Investment Officer, and Global Head of Fixed Income at Neuberger Berman. He is a member of Neuberger Berman's Operating, Investment Risk and Asset Allocation Committees. To learn more, see Mr. Tank’s bio or visit www.nb.com.
In Case You Missed It
- Japan Purchasing Managers’ Index: +0.7 to 50.2 in April
- U.S. Producer Price Index: +0.2% in April month-over-month and +2.2% year-over-year
- U.S. Consumer Price Index: +0.3% in April month-over-month and +2.0% year-over-year (core CPI increased 0.1% month-over-month and 2.1% year-over-year)
What to Watch For
- Wednesday, 5/15:
- U.S. Retail Sales
- NAHB Housing Market Index
- Euro Zone 1Q 2019 GDP (Second Estimate)
- Thursday, 5/16:
- U.S. Housing Starts and Building Permits
- Friday, 5/17:
- Euro Zone Consumer Price Index
Statistics on the Current State of the Market – as of May 10, 2019
|S&P 500 Index||-2.1%||-2.1%||15.8%|
|Russell 1000 Index||-2.1%||-2.0%||16.2%|
|Russell 1000 Growth Index||-2.4%||-2.1%||18.8%|
|Russell 1000 Value Index||-1.8%||-2.0%||13.6%|
|Russell 2000 Index||-2.5%||-1.1%||17.2%|
|MSCI World Index||-2.2%||-2.2%||14.1%|
|MSCI EAFE Index||-2.6%||-2.6%||10.3%|
|MSCI Emerging Markets Index||-4.5%||-4.2%||7.6%|
|STOXX Europe 600||-2.7%||-3.0%||11.5%|
|FTSE 100 Index||-2.3%||-2.7%||9.0%|
|CSI 300 Index||-4.7%||-4.7%||24.0%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.2%||0.1%||1.2%|
|Citigroup 10-Year Treasury Index||0.7%||0.5%||3.0%|
|Bloomberg Barclays Municipal Bond Index||0.5%||0.6%||3.9%|
|Bloomberg Barclays US Aggregate Bond Index||0.3%||0.2%||3.2%|
|Bloomberg Barclays Global Aggregate Index||0.5%||0.5%||2.4%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-0.4%||-0.3%||6.9%|
|ICE BofA Merrill Lynch U.S. High Yield Index||-0.5%||-0.5%||8.3%|
|ICE BofA Merrill Lynch Global High Yield Index||-0.4%||-0.4%||7.4%|
|JP Morgan EMBI Global Diversified Index||-0.2%||0.0%||7.2%|
|JP Morgan GBI-EM Global Diversified Index||-0.1%||-0.2%||2.5%|
|U.S. Dollar per British Pounds||-0.7%||0.0%||2.3%|
|U.S. Dollar per Euro||0.5%||0.3%||-1.6%|
|U.S. Dollar per Japanese Yen||1.5%||1.6%||0.1%|
|Real & Alternative Assets|
|Alerian MLP Index||2.4%||2.1%||17.7%|
|FTSE EPRA/NAREIT North America Index||-1.0%||0.3%||15.8%|
|FTSE EPRA/NAREIT Global Index||-0.9%||-0.1%||13.6%|
|Bloomberg Commodity Index||-1.4%||-2.3%||3.4%|
|Gold (NYM $/ozt) Continuous Future||0.5%||0.1%||0.5%|
|Crude Oil (NYM $/bbl) Continuous Future||-0.5%||-3.5%||35.8%|
Source: FactSet, Neuberger Berman.