Global money managers believe U.S. President Donald Trump’s threats to impose tariffs will not descend into a full-blown trade war, and even those particularly worried have done little to protect their portfolios.
Some of them might have felt vindicated on Wednesday when Trump agreed with the European Union not to impose car tariffs while the two sides launch negotiations. But if the threat of a transatlantic trade war has eased at least temporarily, the battle with China may only just be starting.
Trump has vowed to impose tariffs on all $500 billion of Chinese imports until Beijing ends its “unfair trade war”; he reiterated his threats on Wednesday, calling China “vicious”.
The stakes are high: a sustained trade conflict could cost the global economy nearly $500 billion, knocking growth by half a percentage point by 2020, the International Monetary Fund has said.
Yet most money managers reckon the dispute will blow over.
“The more we talk about the trade wars, the bigger we perceive the risks to be without anything fundamental necessarily changing,” said John Roe, Head of Multi-Asset Funds at Legal and General Investment Management, which manages $983 billion in assets.
“A bigger concern for us in the second half would be a pick-up in U.S. inflation. That has global ramifications that can’t be defused by a quick phone call.”
The prospect of a trade war does worry investors, who see it as the biggest risk to markets since the 2012 euro zone debt crisis, Bank of America Merrill Lynch’s poll showed this month. But few are preparing for all of Trump’s rhetoric to translate into action, or cause much damage.
One reason for that is belief that Trump’s rhetoric is aimed at voters ahead of November mid-term elections.
Second, measures so far have been small – Washington and Beijing have imposed tariffs on less than $50 billion worth of each other’s goods, essentially a rounding error for economies jointly worth $32 trillion.
And Trump’s attempts to upend the international order come at a time of relatively robust world growth. Past instances of protectionism have tended to coincide with downturns that saw governments scrambling to save jobs.
LGIM’s Roe said if the biggest worry was a 0.5 percent growth hit, “we are in a pretty benign environment.”
Also, recent trade-linked selloffs have been relatively contained – even before the U.S.-EU deal, world stocks stood less than four percent below record highs.
“No one really takes 100 percent of what Trump says . He changes his mind a lot and China has been relaxed and quiet in its response,” said Roberto Coronado, a credit portfolio manager at PineBridge Investments.
“Am I going to sell everything because of this? It doesn’t make sense. I would miss out and I would have made the wrong investment.”
Nor do options markets indicate investors are bracing for volatility to rise when tariffs on $200 billion of Chinese goods take effect from as early as September.
Three-month out-of-the-money equity volatility in European equities, which measures volatility expectations, has been lower than current levels less than one percent of the time over the past 13 years, two bank derivatives traders said.
Chinese equity volatility also remains low, suggesting few are preparing for a further share slump, said Anshul Gupta, head of European equity derivatives research at Bank of America Merrill Lynch. Chinese shares have fallen 15 percent in 2018.
U.S. markets do show some signs of nervousness.
Options pricing for the PowerShares QQQ Trust ETF, a passive fund which includes big-ticket tech names such as Apple , Microsoft and chip suppliers selling to China, show a higher preference for puts by mid-September, according to market analytics firm Trade Alert.
Puts are options that offer protection against price falls.
Investors have been more skittish about European automotive stocks, the derivatives traders said, but following Wednesday’s U.S.-EU announcement, volatility expectations look set to ease.
The bigger risk remains an escalation with China, all the more so because growth momentum may be faltering. A Reuters poll of 150 economists worldwide reflected an overwhelming conviction that global growth had peaked.
“$200 billion [of tariffs] would be an acceleration, something quite significant. That’s not fully discounted,” said Tim Graf, State Street Global Markets’ EMEA Head of Macro Strategy.
Investor reluctance to prepare for crisis mirrors a broader trend in recent years, in which big political or geopolitical shocks like Britain’s Brexit referendum or Italy’s political crisis are too hard or costly to hedge against, and therefore remain underpriced until they explode.
BAML’s Gupta said investors were not being complacent and understood potential trade-related risks but added: “it is very hard to pinpoint which way it goes from here and who blinks first, and when.”
There are also competing concerns, such as the end of central banks’ stimulus, rising interest rates, and desperation not to miss out on what could be the bull market’s last hurrah.
Protectionism plays well among Trump’s core blue-collar voter base, and trade noise could well boost his polling ahead of mid-term elections in November.
Others say Trump’s tough talk masks a desire to secure new bilateral trading deals that he can can present as a win for American workers.
Investors wanting a sound strategy should not preclude “the idea of a rational outcome to the whole affair,” said investment firm Carmignac’s Didier Saint-Georges.
Rhetoric may not descend into a growth-sapping war because many expect Trump to tone down the bellicosity on any sign the U.S. economy is suffering.
“He thinks the strong economy is the key to winning elections,” said Kim Forrest, a fund manager at Pittsburgh-based Fort Pitt Capital Group. “And he’s not going to jeopardize that.”
(Additional reporting by Helen Reid and Saikat Chatterjee in LONDON, Danilo Masoni in MILAN and April Joynes and Saqib Ahmed in NEW YORK Editing by Sujata Rao)
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