Bonds, equities sound trade war wake-up call

Risk appetite has made an abrupt turnabout in the last 24 hours as investors slowly wake up to the trade war risks and potential knock-on effects to the global economy. The inversion of the three-month/10-year yield curve hit its deepest level in 12 year, sounding a warning bell for the global economy. We have warned previously that complacency in the face of escalating trade tensions would be misplaced, as the chances of a deal at the G20 are incredibly slim given the trajectory of the rhetoric.

As I write, European and US futures are following Asian equities into the red setting the stage for an ugly turn in risk appetite. It seems now that market participants are finally realising that the narrative of an H2’19 recovery is fast dissipating. At the centre of the market’s concerns is the obliteration of green shoots in global growth arising from escalating geopolitical tensions, as incoming data continue to raise concerns. Markets have been lulled into a false sense of security by benevolent central banks but could be in for a rude awakening as the H2 revival fizzles out and the outlook for economic growth is dampened.

As we wrote at the start of the month, our view remains that until we see a more robust macro environment and confirmation of a self-sustaining re-acceleration in economic growth, it’s time to move into capital preservation mode. Global markets remain vulnerable as they are yet to price in the protracted escalation and unfolding fight for technological supremacy.

Many are aware of the notion of a long and protracted battle between the US and China, but this is not reflected in positioning yet. The implications of a permanent shift in the US/Chinese relationship are hard to fathom as globalisation has profoundly entwined supply chains and economic networks. But as the probability that a tech “cold war” has increased, investors should not dismiss the notion of a splintering US/China relationship and the effect this could have on risk premiums. The impact on global growth will be pervasive, non-linear and lagging, something investors have been complacent about to date.