Written by Han Tan, Market Analyst at FXTM
A moment of reckoning may soon be upon global markets.
Having blissfully paid scant heed to the downside risks to the global economy over recent months while pushing risk assets higher, investors now have to contend with the possibility of escalating trade tensions derailing its incipient recovery.
On late Tuesday evening, the US Trade Representative announced its intention to impose new tariffs on $3.1 billion worth of exports out of France, Germany, Spain and the UK. The new US tariffs, which could be as much as 100 percent, may arrive in September. Such a move could then prompt retaliatory measures from the European Union, potentially affecting $11.2 billion worth of US exports. At the same time, the Trump administration is also mulling bringing back tariffs on Canada’s aluminum that crosses the border over to the US. The announcement may come before the weekend, with the aluminum tariffs potentially taking effect starting July 1.
US President Donald Trump appears to be on the cusp of again living up to his self-proclaimed moniker, ‘Tariff Man’.
This time, it’s different
The news sent a risk-off shudder across markets, compounding fears over the still-rising number of coronavirus cases around the world. The Nasdaq saw its first decline in nine sessions, Gold prices surged to a new 8-year high, while Oil futures were forced to give up their claim to the psychologically-important $40/bbl handle.
One could argue that this risk of escalating trade tensions between major economies has been a mainstay for investors in recent years, and global equities have been able to push higher despite the fact.
This time however, the economic context is vastly different.
Dire economic outlook
This threat of escalating trade tensions comes at a time when the global economy is set to register its deepest recession since the 1930s. The IMF this week downgraded its global GDP forecast to minus 4.9% for 2020, compared to its April prediction of a three percent contraction. The world economy is set to lose an estimated $12.5 trillion combined between this year through 2021.
Granted, there are signs that the recovery is underway. The May US non-farm payrolls data was a positive shocker, with 2.5 million jobs added, while economists forecast that another three million have been added to the US labour market this month. The initial and continuing jobless claims have also been moderating. France’s PMI figures unexpectedly returned to expansionary territory in June, while business confidence also came in better than expected. China, the world’s second largest economy, is showing tentative signs that its steps towards a recovery are becoming surer, having posted two consecutive months of year-on-year growth for its industrial production.
Still, investors are under no illusion that the recovery will be swift. Hence, any threat to that trajectory, which is still very much in its infancy, could translate into heightened risk aversion in the markets.
The long, arduous road
Beyond the economic costs, the tide of Covid-19 cases has yet to meaningfully subside. The states of Florida, California, Arizona, and Texas have registered daily records for the number of infections, while flare ups in cases have also been detected in several countries, from South Africa to Australia. The pandemic has now registered over 9.4 million cases, having claimed more than 482,000 lives.
As major economies struggle to contain the coronavirus’s spread, that could weigh on the world economy’s ability to move beyond the pandemic. Extra trade tariffs being imposed amidst such an economic landscape would be akin to a booby trap being sprung amidst an already treacherous journey, potentially triggering a massive wave of risk aversion at the expense of risk assets.
Given such persisting fears, safe havens such as Gold, the Dollar, and US Treasuries, are expected to remain well-bid until such threats have safely passed. And with the November US Presidential elections also looming on the horizon, investors would do well to pay heed and tread carefully over the coming months.
Risk assets may soon be called upon to justify their stunning surge since March, or risk having it upended by the return of ‘Tariff Man’.
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