Trade-war scenarios force investors to rewrite playbook

Bloomberg

All it took was two lunchtime tweets, sandwiched between posts complaining about the results of the Kentucky Derby and another gripe about “Angry Democrats,” for investors around the world to rip up their playbooks for 2019.
What has replaced those playbooks now that US President Donald Trump has made good on his Twitter threats to boost tariffs on $200 billion of imports from China? Well, the new plans seem to still be works in progress, written in pencil rather than ink.
Exactly what has been priced into markets from the escalation of trade tensions — and what still needs to be priced in — is a riddle that investors the world over are urgently
trying to solve.
And, frustratingly, attempts at answers tend to come in three parts, depending on whether this latest escalation of tensions manages to trigger a trade agreement in the near term, a longer period of back-and-forth brinkmanship, or a full-blown trade war.
“The FX market is pricing trade tensions but not a trade war,” Bank of America economists led by Ethan Harris wrote in a note.
A US-China agreement in the near term naturally would provide the best chance for traders to pick up the scraps of their old playbooks and tape them back together. Trump offered some hope of that scenario by announcing that this week’s talks with China were “constructive” and his relationship with Chinese President Xi Jinping remains “a very strong one.” But the two countries nonetheless remain deadlocked.
That tone had changed when Trump took to Twitter to say that the Chinese may have felt they were “being beaten so badly” in the recent talks that it was better to drag their feet in hopes Trump would lose the 2020 election and they’d get a better deal from the Democrats. Trump warned they would get “far worse” terms if a deal was negotiated in his second term.
The chance of a prolonged period of tensions has strategists conjuring up a wide variety of investment ideas. Credit Suisse suggested a trade that benefits should the iShares MSCI Emerging Markets ETF fall between 4.5 percent and 8 percent over the next month, while UBS Global Wealth Management decided to end its recommendation to overweight emerging-market hard-currency sovereign bonds.
The consensus appears to have gravitated towards the idea that prolonged or escalated tensions would cause this past week’s trends to continue: weakness in emerging-market currencies and global equities, gains in haven assets such as the Japanese yen and US Treasuries, and heightened volatility just about everywhere.
China’s yuan, Thailand’s baht and the Philippine peso are the most at risk in a trade war, according to a Bloomberg Intelligence model.
Meanwhile, although US-China scenario analyses dominated the past week, focus could quickly shift.