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  2. ECONOMY
January 07, 2019 12:00 AM

Global political sparks will keep flying

U.S.-China trade war, U.K.'s exit from European Union likely will make for a daunting time

Sophie Baker
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    Claire Dissaux believes tensions between the U.S. and China will only increase.

    Geopolitics will continue to occupy investors' minds this year with trade wars, the U.K.'s exit from the European Union and a number of political elections on the shortlist of concerns.

    Despite reports that the U.S. and China had agreed to a 90-day hiatus in their so-called trade wars late last year, money management executives still expect the issue to rumble on and impact global markets, with increased volatility and uncertainty.

    "The U.S.-China truce will probably offer only a temporary respite, while the outcome of negotiation is highly uncertain," said Silvia Dall'Angelo, senior economist at Hermes Investment Management in London. "Indeed, there are several reasons for caution: the only aspect the two leaders agreed on is a truce, 90 days is a very short time window to reach a trade deal (and) the respective starting points are quite far apart."

    Even if a deal is reached soon, "it will probably be a fragile and temporary fix rather than a comprehensive solution to structural issues. Fundamental tensions between the two countries are likely to continue to brew," she said.

    Added Joseph V. Amato, president and chief investment officer — equity at Neuberger Berman Group LLC in New York: "You might have short-term resolutions of small issues — if this were just about how many soybeans the Chinese were buying, this would have been resolved a long time ago. It is about fundamental, existential things for the Chinese economy. No matter how hard the U.S. wants to fight, some will be difficult to resolve. It's really an issue of transformational change in trade vs. transactional change — the Chinese want transactional change, U.S. wants transformational change and that's just very hard — systems are different, and (the) Chinese system seems to have worked very well for them."

    However, Mr. Amato warned that China cannot be the second-largest economy in the world "and be a significantly protectionist country — you can't be first or biggest and have a protectionist system. All of your trading partners will rise up against you."

    It's something Neuberger's executives will watch "very closely."

    Growth in nationalism

    Ryan Primmer, head of investment solutions at UBS Asset Management in New York, said the firm sees the "overall growth in economic nationalism as reflective of structural trends that are unlikely to abate anytime soon. In particular, the U.S.-China trade dispute appears to be as much about geopolitical strength and national security as the U.S. trade deficit. While the recent (Group of 20) summit has provided hope that a more conciliatory tone on tariffs may be struck in the short term, the very deep underlying issues are unlikely to be resolved quickly."

    Sources were split on how trade wars will hit markets.

    Seema Shah, global investment strategist at Principal Global Investors in London, said many forecasts have already priced in the negativity of a trade war on China. "We know it will hit far more than the U.S. But for the U.S., there will be some negative impact as several multinational companies start to struggle in China. It will start to feed through," she said.

    Claire Dissaux, head of global economics and strategy at Millennium Global Investments Ltd. in London, expects a slowdown toward trend (growth) for the global economy, which "is not a major event for financial markets, but uncertainty around that is quite high. The main risk is the trade wars and whether the tensions between China and U.S. escalate further. While (the) U.S. and China have agreed on a truce, we believe U.S. tensions with China go well beyond trade, making negotiations difficult to succeed, and there is still a significant chance that the (tariffs) hike from 10% to 25% on $200 billion (of Chinese goods) will go ahead in three months' time, and if it were to extend to all imports from China it would have a bigger macro impact on China and (the) U.S. as consumer goods will be affected."

    She said that, so far, the U.S. administration "has been careful not to have too much of impact on consumer. It's all about how financial markets react to that macro impact because that could be amplified quite a lot. There would be huge consequences for China, the rest of (emerging markets) and the U.S. In the worst-case scenario, investment in those markets would slow down dramatically and there would be a risk that market growth slows below trend."

    But whatever happens in the near term, China's relationship with the U.S. will be "pivotal … through the course" of 2019, said David Riley, chief investment strategist at BlueBay Asset Management LLP in London.

    And there's also a risk that trade wars expand elsewhere. "There remains the risk of a re-escalation in trade tensions between the U.S. and EU," said David Hoile, global head of asset research at Willis Towers Watson PLC in London. "Of course, the primary route for those trade tensions has been through the imposition of tariffs — primarily between the U.S. and China. The concern is that barriers start to escalate into other areas, for example a constraint on cross-border capital flows; constraints on U.S. businesses investing into China or using Chinese inputs in production and vice versa — that (could) become very disruptive to global supply chains."

    But it's not just trade wars keeping investors busy this year. Brexit will also remain top of mind.

    Some risks matter more now

    "These things (such as Brexit) do matter more than they did (early last year) when they were recognized as potential risks, but in (the first half of 2018 we) had an improving world outlook," said Larry Hatheway, group chief economist, head of investment solutions at GAM, Zurich. "Therefore, these sorts of risks now matter more to market participants."

    And, it seems, to markets. "Political risks are higher in Europe than almost anywhere else in the world, stemming from Brexit, the Italian budget and the ongoing rise of populism," said William J. Booth, managing director, co-CIO and portfolio manager at Epoch Investment Partners Inc. in New York. "Combined with a lack of structural reforms to promote growth and the (European Central Bank) unwinding its quantitative easing program suggests little reason to believe economic or earnings growth will reverse their underperformance vs. the U.S."

    While managers think Brexit negotiations will reach some kind of conclusion prior to the March 29 deadline — at which point the U.K. is effectively out of the union — its impact is uncertain.

    "It is possible a number of catalysts, like Brexit or the Italian situation, end up not being so dramatic, so there are a number of catalysts in the medium run that can help the market to find its footing again," said Pierre-Henri Flamand, CIO at Man GLG in London. "But even if we rally, I think the same problems will come back – the bond market and the Fed."

    And Michael Grady, head of investment strategy and chief economist at Aviva Investors in London, said the U.K.'s outlook, unsurprisingly, "remains entirely dependent on the outcome of Brexit. The compression strategy employed by Theresa May reaches its nadir in the third week of January, when (members of Parliament) must vote on the proposed deal. It looks extremely challenging for the government to win that vote, thereby triggering another bout of uncertainty as the March 29 deadline approaches. If the parliamentary vote on the deal fails to pass, we think it is more likely that we see an extension (or even revocation) of Article 50 as a path to a second referendum or general election, than for the U.K. to crash out without a deal."

    All about Brexit

    Neil Dwane, global strategist at Allianz Global Investors in London, thinks the first quarter will be all about Brexit and potentially the Italian budget, also a hangover from last year. He's also keeping an eye on European parliamentary elections in May; the future for the German economy following news that Angela Merkel will step down as chancellor in 2021; and the successor to Mario Draghi when his ECB presidency ends in October.

    Mr. Hoile thinks the impact of the next ECB president will be a 2020 issue, however.

    There's also the now-divided Congress in Washington, which "could see the House of Representatives create a lot of noise with attempted proceedings against President Trump and his administration," warned Mr. Booth.

    "With regard to the economy, much attention is being placed on the U.S. labor market and whether or not we finally see tightness translate into stronger inflationary pressures. The ongoing normalization of monetary policy by the Fed and the ECB bear watching as well. With quantitative tightening, we expect higher volatility in all asset classes, as a major purpose of QE was to suppress market volatility," he said. "Of course, it is usually the thing that no one is thinking about that has the biggest impact on markets."

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