Investors have long feared that populism would have some negative global economic effects. The imposition of tariffs on Chinese goods by the US Administration confirms those fears. The optimistic view is that we are seeing another example of “the art of the deal” by which President Trump goes large with threats in order to extract concessions. The pessimistic view is that an escalation of trade tensions might be enough to bring the global expansion to an end. China’s retaliation to the first round of tariffs is a bearish development and markets are leaning towards a more pessimistic view, but only slightly. A positive for risky assets is that the hard economic data continues to be strong. The cycle remains robust. Trade is clearly a negative for sentiment but what might ultimately do for markets is a more aggressive Fed, higher rates and an inverted yield curve. On that front, there is some way to go.                       

  • A US-China trade war does not just hit the US and China. Just like a hard Brexit does not just hit the UK. While current economic data has remained solid in most economies, there are concerns about anything that could bring the expansion to a rapid end. An escalated trade war could be the blow to confidence that ultimately curtails investment and consumer spending.
  • The monetary environment is the other big threat. Most investors seem comfortable with monetary policy settings as they stand today. However, there is a risk that the Federal Reserve has to become more aggressive should US inflation rise more quickly than it has so far.
  • In my opinion, the US yield curve is not likely to invert until the 2-year yield gets to around 4% in nominal terms – that is short-term real interest rates are 2% at least. They are 0% at the moment. Secondly, there is a lot of misconception about yield curves. I saw an article recently that suggested that the “global yield curve” was already inverted. The reality is that there is no such thing as a “global yield curve”. Yield curves are constructed from interest rates on different maturities in the same currency. We might be heading towards an economic slowdown over the next two years but today there is no yield curve inversion predicting that.