The implications of a US-China trade war for the markets2 min read . Updated: 26 Mar 2018, 03:24 AM IST
Both the MSCI World index and MSCI Emerging Markets index have fallen sharply since Donald Trump's China tariffs triggered a trade war. What are the concerns?
Bulls rushed for cover last week as the US and China exchanged the first shots in a trade war. Both the MSCI World index, which tracks developed markets and the MSCI Emerging Markets index have fallen sharply. What are the concerns?
Effect on growth
Markets are worried about the implications of a trade war. A full-fledged one that spreads to more goods and many nations will dent global growth. Bank of America-Merrill Lynch (BofA-ML)’s latest survey of fund managers found 74% of them believe the global economy is now in the late stages of the business cycle. Note also that the IMF’s world economic output update in January predicted growth would slow in 2019 in many advanced economies.
Rising protectionism will also stoke inflation—87% of investors polled by the said protectionism will be inflationary or stagflationary. Commenting on the latest flash Purchasing Managers’ Index for the US, Chris Williamson, chief business economist at IHSMarkit said, “The survey found average prices charged for goods and services are rising at one of the strongest rates seen since 2014."
Interest rates and liquidity
The US Fed raised interest rates yet again, but that was widely anticipated. The US’s big borrowing programme and the Fed’s quantitative tightening, taken together with inflationary pressures, should send rates northward. Real or inflation-adjusted interest rates in the US too have been rising. The Chicago Fed’s National Financial Conditions index shows liquidity has tightened since late last year. Libor rates have gone up, raising hedging costs, just as the rise in the Vix too has increased the cost of hedging.
The latest BoA-ML fund manager survey has “trade war" as investors’ biggest fear. The survey said, “Ominously investors (are) yet to act on fears: FMS (Fund manager survey) shows investors stubbornly long global stocks, banks, tech, still short bonds, defensives, and cash levels fell from 4.7% to 4.6%; in contrast, we forecast higher vol, lower corporate bond prices, peaking equity prices." Since the survey was done, investors have started to act on their fears.
The fall in Indian markets since the beginning of February has mirrored the worldwide plunge, but there’s also an additional downward pull. The premium India enjoys over its peers in the Asia ex-Japan region has narrowed a bit. There’s no dearth of reasons: the worsening situation in banking, looming political uncertainty, higher interest rates, strong oil prices, high valuations. True, Indian growth is mostly dependent on domestic factors, but its markets will obviously be affected by the risk-off sentiment.