After months of simmering tension between the world's two largest economies, the U.S. will impose tariffs on $34 billion worth of Chinese goods at just after midnight on Friday. The key question for financial markets: will it trigger fresh volatility, or is the trade war escalation already priced in?
The rally of as much as 4.5 percent in European carmakers on Thursday, fueled by discussions on lowering tariffs with the U.S., suggests markets had already been primed for adverse news on global trade. Yet Chinese shares remained under pressure as officials wouldn't say whether talks that could deliver a last-minute reprieve were ongoing.
"We can no longer talk about whether a trade war will develop, only the scale of the conflict," Steve Barrow and Jeremy Stevens at Standard Bank wrote in a note this week. "A promising global economic and financial market picture has been thrown into turmoil."
This new era of protectionism could hardly have come at a more sensitive time for markets. While the backdrop for growth is indeed strong — particularly in the U.S. — financial assets were already girding for so-called quantitative tightening as the world's major central banks step back from stimulus.
That's siphoning liquidity from the system, and volatility is on the way back as a result. The Cboe's Volatility Index, known as the VIX, has averaged 16.3 this year, compared with 11.1 in 2017. After recovering from a spike in February's market blow-up, currency swings have risen for six of the past seven weeks, according to JPMorgan Chase & Co. indexes.
"Investors should expect volatility to continue," says Mark Haefele, chief investment officer at UBS Global Wealth Management. "We recommend investors stay invested, but consider five actions: looking to alternatives, hedging equity exposure, improving credit quality, diversifying sector and country risks, and taking a longer-term view."
The worst-case scenario is that the trade war, in concert with monetary tightening, upends the global business cycle. German Chancellor Angela Merkel raised the specter of the financial crisis as she warned of potential fallout on Wednesday. Shares of European carmakers had fallen more than 11 percent since mid-June through yesterday.
Still, the sector's rebound today suggests that a lot of negative news on tariffs is already priced in, Michael Bell, a global market strategist at JPMorgan Asset Management, said in an interview. If trade concerns die down, stock markets may see a "pretty big bounce," he said.
