Key takeaways:
- A global trade war is a real threat
- The reaction from global policymakers, particularly central banks, will shape market sentiment
- Markets may stay volatile until policy clarity returns, but long-term fundamentals will ultimately reassert themselves
What's happened?
As investors are uncomfortably aware of, global equity markets have been in freefall since U.S. President Donald Trump’s announcement of “reciprocal tariffs” on April 2. As of this writing (April 4 at 10 a.m. Pacific), U.S., UK and European shares are down by close to 10% since the announcement. Government bond yields have fallen by 0.2 to 0.3 percentage points as investors rush to safe havens.
Market reaction since the announcement
- U.S., European and UK stock markets are down by around 9%
- U.S. 10-year Treasury yields have fallen by 20 basis points to about 4.0%
- UK 10-year gilt yields have fallen by 25 basis points to 4.4%
- German 10-year bund yields have fallen 20 basis points to 2.5%
- Euro has rallied by 2% against the USD
- Sterling is up about 1% against the USD
- 4 Fed rate cuts are priced by year-end, taking the federal funds rate to 3.25%
- 3 ECB rate cuts are priced by year-end, taking the deposit facility rate to 1.5-1.75%
- 3 BOE rate cuts are priced by year-end, taking the base rate to 3.75%
The global nature of the trade war is a real problem. For instance, the EU might only have a small direct exposure to U.S. exports, but overall exports of goods account for nearly 40% of GDP. For the UK, it’s around 15% of GDP. Markets fear that the trade war, potential retaliation and the policy uncertainty from the White House will cause a global recession and magnify the impact of the individual tariff decisions.
Retaliate or negotiate?
One issue to watch is whether governments choose to retaliate or negotiate. China today announced 34% retaliatory tariffs on U.S. imports. European Commission (EC) President Ursula von der Leyen has taken a more measured approach, saying that she will wait four weeks before announcing a response. And that the EC preferred to negotiate to “remove any remaining barriers to transatlantic trade.” The UK has made no official announcement, presumably on relief at the “low” 10% tariff imposed.
Another key factor will be whether President Trump decides to reduce tariffs on countries that he feels are taking steps to reduce what he perceives as unfair trade barriers. There is precedent for this behavior, as President Trump has a track record from his first term of making aggressive policy announcements to exert the maximum possible pressure, before relenting and announcing that he has achieved a great deal.
Release the doves
Meanwhile, the response of policy makers is also worth watching. Markets are anticipating more rate cuts from the ECB and the Bank of England. Dovish statements from central bankers will help to settle market nerves. The reaction of Fed chair Jay Powell will matter most. Indications that the inflation impact of tariffs will slow the pace of easing could deepen investor fears about a U.S. and global recession. Conversely, a clear signal that policy will quickly become accommodative to support economic growth will help investor confidence. Powell’s comments today suggest that the Fed is still willing to “wait for greater clarity”.
The bottom line
We have been through these periods of market panic before. Markets are likely to remain volatile until there is more policy certainty. Over time, the long-term fundamentals of economic growth and corporate profit growth will come back into focus.
At Russell Investments, we remain focused on portfolio diversification through this volatile period and are watching closely our measures of investor sentiment for signs that market dislocations have moved to an extreme.