Worried about trade wars? We think there is room for calm

Richard explains why trade war risks have been lowered in the short term, and what it could mean for markets.

We see the reduced risk of trade conflicts in the short term, as Donald Trump’s White House appears to have softened its attitude toward both the North American Free Trade Agreement (NAFTA) and China. This could bode well for emerging market (EM) assets.

The chart shows that both EM equities and the Mexican peso have staged a comeback from the sharp declines following Trump’s election. The Mexican peso – poster child for the leg of the “Trump trade” that involved dumping EM assets – has made a round trip, returning to levels seen before the U.S. election. EM equities’ performance relative to their developed market peers has been on the mend.

Second thoughts on free trade 

Trump‘s victory sent tremors across EMs as the risk of trade wars spooked investors. But the threat looks to have receded, especially after the Treasury Department did not name China a currency manipulator in its first foreign exchange policy review under the Trump administration.

There are other signs that the initial hostility is dissipating. The administration’s recent letter to Congress on renegotiating NAFTA pointed to a mild stance. Also, Trump’s April meetings with Chinese President Xi Jinping appear constructive, buying both sides time to address a large bilateral trade imbalance. In a show of cooperation, China has proactively offered some trade concessions.

We do see longer-term risks as the U.S. is likely to revisit some trade policies from the 1980s and pivot toward a transactional approach to trade. Geopolitical uncertainties are another concern. But in the short term, a lower chance of trade wars is good news for EMs that are benefiting from global reflation and solid domestic demand. Trump’s recent comments that the U.S. dollar is “too strong” and signs of a preference for a low-interest rate policy are also supportive. We see a declining EM risk premium as the market focuses on fundamentals, underpinning our overweight in EM equities. EM Asia equities stand out as a potential major beneficiary, in our view.

Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog

Investing involves risks, including possible loss of principal. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. 

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