Insights
Investment Insights
U.S.-China Tensions: Not a Widespread Risk…Yet
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U.S.-China Tensions: Not a Widespread Risk…Yet
On Thursday, May 2 a story form China’s Global Times leaked that U.S.-China talks hit an impasse. The market reacted negatively that day, but the following day, strong nonfarm payroll numbers turned the market in a more positive direction.
The timeline matters. Three days following the May 2 story leak, President Trump tweeted that tariffs may rise from 10%-25% on $200 billion of goods. This implies that Trump is trying to control the narrative and get ahead of the story.
What’s at stake for China? Morgan Stanley economists believe this could shave 0.3% from China’s gross domestic product (GDP), putting China on the threshold of falling below 6% growth, something President Xi Jingping expressly wants to avoid. As a result, China is likely to add more stimulus, as they have already announced cuts to reserve requirement ratio—could do a lot more.
Global market impact is still idiosyncratic and NOT YET a systemic event. Risk premia has risen marginally. U.S. equity prices have declined and U.S. Treasury bond yields have decreased by 2-4 basis points (bps).1 The U.S. dollar has marginally appreciated. Emerging market debt spreads have widened by 5 bps to 365 bps.2 U.S. investment grade spread have widened by 2-4 bps, with a 112 bps option adjusted spread (OAS) that is still near tights of the year.3 U.S. high yield spread widened by 5 bps, with a 360 bps OAS that is still near tights of the year.4
What are we watching? We are keeping an eye on the U.S. dollar, as a stronger dollar would signal heightened tensions, outflows from riskier assets and further escalation in U.S.-China tensions.
What are we doing as fixed income investors? We are staying the course. At this point the market reaction has been minor. However, it is important to note that China stimulus and stability is critical to world growth for remainder of 2019. If U.S.-China talks break down, risk premia will rise and global growth will be unlikely to recover further in 2019.
RISK CONSIDERATIONS
There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks.
Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In the current rising interest rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest rate environment, the Portfolio may generate less income. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities ("junk bonds") are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).
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