Over the past few weeks, market turmoil stemming from escalating trade tensions between the US and China has sparked a number of questions from advisors, most of which are probably on investors’ minds as well. For that reason, I am dedicating August’s monthly commentary to frequently asked questions from the field.
What has caused the recent bout of volatility? In my view, the main cause has been President Trump’s announcement on August 1 that the US would impose 10% tariffs on the remaining $300 billion of Chinese goods as of September 1. While not as bad as the threat of 25% tariffs in May, this round would affect a wide range of consumer goods (though as of this writing, the president announced delaying some of the tariffs until December 15). Even if some of the tariffs are delayed, the overall picture of increased trade tensions is unchanged in my view, meaning that there will be an economic cost to both businesses and consumers. Almost all of these goods are imported from China, meaning US consumers are unlikely to find substitute products that offset the effect of tariffs.
What can central banks do to help? “Central banks to the rescue? Don’t count on it” was the title of my second-half outlook, and it bears repeating now. Equity markets are sensing a precarious mix of slowing global growth, increased trade tensions, and a Federal Reserve (Fed) that may find it difficult to meet rate-cut expectations. As Figure 1 shows, markets are pricing in a 100-basis-point (bps) (1%) fed funds rate cut by December 2020—approximately 100 bps (1%) more than the Fed’s most recent forecast in mid-June.
The market already reflects expectations of material Fed easing
Market expectations of fed funds rate on 12/31/2020
Are recession risks higher? Yes. Global manufacturing has been weak and there is evidence that trade tensions are depressing business investment. However, because the Fed and other central banks stand ready to support the economy (to the degree that they can) and because interest rates remain low, I still do not see an imminent recession.
Where might the US 10-year Treasury go? I continue to be bullish on US interest rates and believe we could see 10-year yields in the 1% to 1.5% range by year-end. If equities continue to decline, interest rates are likely to fall, pushing safe-haven assets higher.
What about the US dollar? I have been more bullish on the US dollar than consensus. The reason rate cuts are not necessarily bearish for the US dollar is because of its safe-haven status. In other words, when risk assets fall, the dollar tends to climb, and this has been happening recently. Moreover, US rates are still the highest among developed-market economies, which is also attracting capital.
How should we interpret China’s weakening of the yuan? The Chinese government recently allowed its currency to break the symbolic level of 7.0 yuan to the US dollar. This move could indicate a retaliation for US tariffs, or it could be a means of economic defense, designed to make Chinese exports cheaper. A weaker yuan is likely to spill over to other Asian emerging-market currencies, weakening them as well.
What are your asset allocation suggestions? I have been advocating a somewhat defensive portfolio stance—more defensive than the consensus. I suggest overweighting credit versus equities, overweighting the US versus other regions, and underweighting emerging-market equities. Consider owning precious metals to potentially hedge recession risk. Overall, this is a time to consider owning fixed income in my view.
What should we be watching? Financial conditions and US consumer sentiment are particularly important. If financial conditions tighten—think lower equities and less liquidity—the Fed may move to prevent recession. Flagging US consumption would take longer to detect, but consumer confidence surveys should indicate when and whether market turmoil begins to take a toll. Finally, we should watch interest rates. While low rates may not prevent further equity declines, I do believe they can help prevent a recession.
The views expressed here are those of Nanette Abuhoff Jacobson. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.
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