Caution Reigns for Strategists After Trade-War Tension Jumps

(Bloomberg) -- August was already living up to its reputation as a higher-volatility month and now President Donald Trump’s latest tariff boost and China’s counter have created even more fall-out in global markets.

Here’s a snapshot of how strategists and investors see the impact of the latest escalation:

Recession Risks

Chetan Ahya, Michael Zezas et al., Morgan Stanley

We view risks of further escalation as meaningful. If the U.S. raises tariffs on all imports from China to 25% and China makes a matching response with these measures staying in place for 4-6 months, we believe that the global economy will be in recession in 6-9 months.

FX Caution

Zach Pandl et al., Goldman Sachs Group Inc.

The unexpected escalation in the U.S.-China trade conflict late last week looks set to reinforce a number of existing trends in global FX markets, including yen strength, weakness in several currencies in emerging-market Asia, and a tough environment for EM FX carry trades. Policy support appears unlikely in the near term, so for now investors should lean FX risk in a cautious direction.

Read more about the rally in haven currencies.

Stephen Innes, VM Markets Pte.

FX strength or weakness mostly depends on what side of the currency war debates you’re on. In the meantime, risk-off is the safest direction; dollar/yen lower. The euro/dollar rally fizzled at 1.1150 -- hardly the volatility one expects from a market pre-positioning for a full out currency war. However, the mere threat alone should keep the dollar on the defensive over the near term.

Treasury Rally

Praveen Korapaty et al., Goldman Sachs

Given the proximity to all-time lows set around the Brexit vote in 2016, we believe the probability of U.S. 10-year yields revisiting (and going through) those levels has risen substantially. At the same time, we think markets will press front-end cut pricing even more, which reinforces our bull-steepening bias in U.S. yield curves. We could also see medium and longer term breakevens compress further, pushing them in the direction of the 2015/16 lows.

Going With Gold

Jingyi Pan, IG Asia Pte.

We’re going with gold in the near term with its safe haven appeal increasing. Crossing the $1,534 resistance, room is opened up on the upside for gold prices toward the $1,600 level, which could be the case should further unprecedented trade barriers be seen from both the U.S. and China.

S&P 500 Support

Julian Emanuel, BTIG LLC

A headline-driven test of the S&P 500’s 200-day moving average (2,790) as we head into September -- traditionally the weakest month of the year for stocks -- is a strong possibility, with a break below opening the door to the 200-week moving average at 2,470. At the same time, we bear in mind that the secular uptrend, defined by the 200-week MA, has contained all of the sell-offs of the 10-year long bull market, that past “summer slides” fully recovered by year’s end more often than not.

Margins and Valuations

Dennis DeBusschere, Evercore ISI

For now, better than expected productivity and elevated margin sentiment point to solid U.S. economic growth and are a support for margins. S&P earnings growth expectations have remained stable, supporting cash return. High cash return rates are an important valuation support.

Demand Shocks

Vishnu Varathan, Mizuho Bank Ltd.

There is no justification for thinking that rate cuts and re-opening the quantitative easing spigots will meaningfully cushion adverse demand shocks from trade.

--With assistance from Adam Haigh, Heejin Kim, Abhishek Vishnoi and Ishika Mookerjee.

To contact the reporter on this story: Joanna Ossinger in Singapore at jossinger@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Andreea Papuc, Cormac Mullen

©2019 Bloomberg L.P.