The series of tweets throughout the past months by Donald Trump will undoubtedly be imprinted in investors’ minds for years.
It is a fact that the trade war saga is the biggest weighting on financial markets at this point in time – an anomaly which seems to be dragging on too long, and which can ultimately have serious consequences on global growth. The very unpredictable tweets from the man who controls the world’s largest economy have instigated remarkable market volatility, with excessive intra-day moves.
Following a torrid 2018, primarily based on the uncertainties surrounding the trade war saga, many investors played different strategies. Many awaited further developments to unfold prior to putting their money at work, while others opted to dip their feet, taking advantage of attractive valuations, following the slump in prices in 2018.
The bond market is now signalling uncertainty and a challenging market environment
In 2018 investors seemed to be more anxious, and this is one of the reasons why we had seen a downward trend in markets. Today’s paradox is simply being conditioned by the improvised tweets. However, this time round, markets are looking to be more constructive in their rationale and this is one reason why we are seeing intra-day rebounds. Investors still believe that a deal is important for both parties, with China possibly in a stronger bargaining position at this point in time.
The detriment for global growth of further escalations was put forward by institutions such as the International Monetary fund, which has revised its global growth outlook, while it advised on the importance of a trade deal to mitigate further deterioration in the global economy.
Thus it comes as no surprise that major central banks have once again stepped in. In fact, the Federal Reserve (Fed) in the US cut interest rates by 0.25 per cent last month, while the European Central Bank promised that it would intervene if downside risks persist, though it has discussed the possible options to adopt if need be.
The recent escalation in trade, through which Trump is threatening China to impose additional tariffs in September came unexpectedly, notwithstanding that further discussions should take place next month. This latest unpredictable tweet has put further pressure on central banks to act, action which should be taken immediately.
The bond market is now signalling uncertainty and a challenging market environment. This is reflected in the $15 trillion of government issued bonds trading at negative yields. That said, one should also be aware that the amplification of more easing from central banks is another reason for the dive in government yields, i.e., a rise in prices. Thus, the recent tightening in yields should also be attributed to the distortion created over the years by quantitative easing and the possibility of further easing going forward – a move which markets are anticipating.
Usually, under normal market circumstances low-yielding government bonds are associated with strong credit profiles. However, the current situation is not entirely the case. We have seen a strong tightening in yields also in weaker peripheral names on the back of more stimulus.
Going forward, in Europe we believe that a deposit rate cut is firmly on the cards, while the size of potential bond purchases is still up for debate. However, despite investors’ concerns that stimulus is imperative in order to counteract the current weakness in economic data, we believe that further easing might be less effective.
We believe that for it to make a difference we need to see a joint effort of fiscal stimulus, possibly through an increase in government spending and a prolonged monetary easing scenario. In case of the former, it’s still early days. However, we have recently seen the Italian Prime Minister asking the EU Commission to review finances rules governing the European Union. Surely, nowhere close to action, but it’s a step to possibly pile pressure, even on the back of Mario Draghi’s comments that fiscal stimulus might be an aid.
Ultimately, the enigma being faced will continue to weigh on investors’ sentiment. That said, the deal to resolve the trade war is being negotiated, but discussions might take longer than expected. Despite the US delaying tariffs on certain products last Tuesday – which is surely a sign of willingness – further clarity needs to be in place to convince investors. Pockets of value still exist. However, investors need to accept the volatility that is being triggered through these unpredictable events.
Jordan Portelli is an investment manager at Calamatta Cuschieri.
The information, views and opinions provided in this article are provided solely for educational and informational purposes and should not be construed as investment advice, tax or legal advice. This article was issued by Calamatta Cuschieri Investment Services. For more information visit https://www.cc.com.mt.