Macroscope | Trade war escalation leaves markets shaken, but a meltdown is not on the cards

Trump’s latest tariffs and the yuan’s slide this week are forcing investors to take the threat of a prolonged stand-off more seriously

But a dovish Fed and growing confidence in China’s ability to manage its currency are among the reasons we are still some way from a fully fledged crisis

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A trader works on the floor of the New York Stock Exchange on Wednesday. The first few trading sessions of this month had suggested investors may be in for a brutal August, but, tellingly, sentiment has already recovered somewhat after Monday’s sharp sell-off. Photo: AP

Published: 1:00am, 9 Aug 2019Updated: 2:21am, 9 Aug 2019

August has historically been a rough month for financial markets. Sharp and disorderly sell-offs have often occurred at the height of the summer holiday season. Prominent examples include Iraq’s invasion of Kuwait in 1990, the start of the Asian financial crisis in 1997, the 1998 Russian debt default and, more recently, the unexpected devaluation of the yuan in 2015.

The first few trading sessions of this month suggest that investors may be in for another brutal August. On Monday, the benchmark S&P 500 equity index fell by 3 per cent – its sharpest daily decline this year.

That came in response to the decision by Beijing to allow the yuan to breach the crucial 7-per-US-dollar threshold in retaliation for American president Donald Trump’s imposition of 10 per cent tariffs on a further US$300 billion worth of Chinese goods from next month. Since July 26, the S&P 500 has lost 4.7 per cent.

What is more, in a clear sign that investors are belatedly starting to price in a full-blown trade war, the spread, or risk premium, on US junk bonds surged 34 basis points on Monday – the biggest daily increase since Britain voted to leave the European Union in June 2016, according to the Financial Times – amid mounting concerns that America’s economy is about to experience a sharp downturn.

Indeed, the gap between the yield on three-month Treasury bills and benchmark 10-year bonds – a measure widely viewed as a harbinger of recession – widened to 32 basis points on Monday, the deepest inversion of America’s yield curve since the global financial crisis.

In the space of just a few days, sentiment has deteriorated sharply because of a dangerous combination of a fierce escalation in the trade war and growing levels of complacency in markets, particularly in regard to valuations and investor positioning.

.css-1m2rp1p{color:#34b8b5;}Macroscope | Trade war escalation leaves markets shaken, but a meltdown is not on the cards

Macroscope | Trade war escalation leaves markets shaken, but a meltdown is not on the cards