(02 AUGUST 2019) DAILY MARKET BRIEF 2：Markets react to another round of tariffs

In a series of tweets on 1 August, President Trump announced his intention to impose another round of tariffs on Chinese goods; a new 10% tariff will be applied to the remaining USD 300 bn of US imports from China that were not already impacted by the 25% tariffs, taking effect on 1 September.

President Trump accused Beijing of reneging on a series of promises in this year's ongoing trade talks. This represents a re-escalation of US-China trade tensions after the "ceasefire" that was announced at the G20 summit on 29 June, and comes just as US trade negotiators returned from a trip to China.

Stocks, which had been in the green in early US trading, sold off sharply following the announcement. In fixed income, 2-year and 10-year US Treasury yields fell by 12bps and 11bps, respectively, and the German 10-year yield dropped to a new record low. Meanwhile, gold rose 1.2% and WTI crude oil closed at USD 54/bbl, down 7.9% on the day.

What comes next?

President Trump's announcement does stress the importance of ongoing negotiations, and there is ample time for negotiations to result in another ceasefire, thereby forgoing or delaying these threatened tariffs. However, this re-escalation of tensions also indicates that President Trump is prepared to escalate trade disputes even while campaigning for reelection. The president even seems willing to up the ante even further, by suggesting that the rate could rise to 25%, or even higher, if negotiations remain stalled.

It will be important to monitor business sentiment surveys to see if there is a significant impact on the demand for workers—if businesses stop hiring, this would greatly increase the risk of a recession. The global manufacturing sector has already been under pressure from the trade disputes, and these additional tariffs could make things even worse. This morning, the US ISM Manufacturing PMI fell to 51.2—the lowest since August 2016—with many respondents mentioning tariffs as a negative for their business.

The aggressive change in tone by major central banks, and the hope of a deal to forestall implementation before 1 September, may help to soothe some of the sting of this announcement. However, if implemented, these proposed tariffs would levy 10% on USD 300 bn of Chinese imports, translating into an approximately USD 30 bn tax on US consumers, or 0.15% of US GDP. The cumulative economic impact—including second- and third-order effects, as well as any Chinese retaliation—could be much larger. We also estimate that, if implemented, these tariffs could place an additional 1% drag on S&P 500 earnings growth over the next 12 months.

What does this mean for investors?

While we ultimately believe that US-China trade tensions will be resolved through negotiations, equities may struggle to move markedly higher until there is greater certainty. With global growth supported by accommodative central banks, we find value in "carry trades" that can help boost portfolio income and give investors a return in a sideways market environment.

1. In our FX strategy, we overweight a basket of higher-yielding emerging market currencies(Indonesian rupiah, Indian rupee, South African rand) against a basket of lower-yielding currencies (Australian, New Zealand, and Taiwan dollars). We think these currencies should benefit from a favorable carry environment, as well as steady global and EM economic activity.

2. Euro investment grade (IG) credit spreads should remain supportedby an accommodative ECB. In an environment of easier monetary policy, this position is a relatively low-risk way to harvest carry. IG spreads could tighten further if a dovish ECB leads investors to reach for yield. Leverage is around the median for the past decade, and interest coverage is healthy. Euro IG creditors also have lower debt levels than US dollar issuers.

3. We see good long-term value in EM sovereign bonds. US dollar-denominated EM sovereign bonds have a favorable longer-term risk-return outlook, in our view, with spreads of around 330bps over US Treasuries. This is particularly attractive at a time of low rates.

4. We also recommend a variety of other investment themes with the potential to offer attractive yield. For example, a dividend-focused strategy could top the MSCI EMU's expected yield of about 3.7%. In addition, we think the current market environment represents a sweet spot for US equity buy-write strategies, which involve buying equities while systematically selling call optionsto earn additional income in exchange for sacrificing some upside exposure. This strategy has historically been most appealing when equity returns moderate and market momentum falls.

5. Chinaremains one of our preferred EMs, though a bumpier ride toward an ultimate US-China deal could complicate the short-term outlook. Within EM equities, we also favor Brazil and Malaysia.

6. By UBS