After a stormy start into the week, financial markets stabilized somewhat on Tuesday morning. Asian equities closed the gap with their European and US counterparts with the Nikkei sliding 0.65% to 20,585 points and the CSI 300 tumbling 1.07% to 3,636. In Europe, most equity indices were able to take a breather, while the Footsie, IBEX and SMI continue to lose ground. The decision by the US Treasury to label China a currency manipulator had little effect on the market, as it didn’t trigger another sell-off. The lack of punitive accompanying measures could explain the lack of reaction. After such an intense weekend, investors are expecting things calm down, at least in the short-term. A stabilisation of the equity market sounds more than reasonable.
However, the longer term is more than uncertain, as there are many unresolved questions. First, does the escalation of the trade war would make the Fed more prone to cut interest rates further? Secondly, is Donald Trump ready to go “full-throttle” on the trade war? It is relatively safe to assume that President Trump could use the trade war to force the Fed to provide more liquidity. Indeed, even if it has not been the case so far the trade will have negative effects on the US economy as well as the global economy at some point. Given the fact that the Fed has already a clear dovish bias as they cut rates last week, it is just a matter of time before they trim again. The question is what would be the final outcome? Would rate cuts and a new QE be sufficient to lift equities against the backdrop of slowing economic growth and tense geopolitical situation?
By Arnaud Masset