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Fundamentals

The US decision to impose 10% tariffs on the remaining USD 300 billion of Chinese imports (effective 1 September) is momentous for two reasons. First, whereas the goods affected by the previously introduced tariffs could be substituted with equivalents purchased from other countries, production of the goods in question this time around (such as smartphone parts) is dominated by China, and therefore the impact of the tariffs is likely to be greater. Second, this final tranche of tariffs is focused on consumer goods, whereas previous rounds were more targeted on intermediate goods. Up until now, the consumer has been the bright spot of the US economy, but these tariffs could threaten that as companies are expected to pass through the higher costs to consumers. Beijing’s retaliation—in the form of allowing the renminbi to weaken—led the US Treasury to label China a currency manipulator. While the validity of that label is questionable, it is important nevertheless, as the US may use it as justification for further escalation. What form might this escalation take, given that the US administration has now tariffed all Chinese imports? In theory, there is nothing stopping the US from increasing tariff rates beyond the current maximum of 25%.

The final tranche of tariffs on Chinese imports will hit consumer goods the most

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Source: Goldman Sachs Global Investment Research; data as of 5 August 2019. *Proposed, not yet enacted.

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Quantitative valuations

Market reaction to the trade news was considerable, with risk assets selling off and safe havens rallying. Ten-year US Treasury yields fell 36 basis points (bps) to 1.70% in the week to 6 August—the lowest level since before President Trump was elected in November 2016. Meanwhile, US high yield spreads experienced the largest single-day widening move since the Brexit referendum in June 2016, rising 34 bps on 5 August. With the rally in core bonds, 90% of European covered bonds now have a negative yield, and a total of 15 countries have joined the negative 10-year bond yield club (as at 6 August). While 10-year US Treasury yields have already broken through the bottom end of our expected 1.75% to 2.25% range, we think rates could rally further as markets are being driven more by the trade newsflow than by valuations.

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Technicals

Technicals continue to be a powerful positive tailwind for fixed income markets. In particular, the prospect of quantitative easing from the European Central Bank is intensifying the search for yield and driving demand for any sort of positive-yielding fixed income security. Further support is coming from the seasonally low supply calendar and, particularly in the European high yield space, from cash returned to investors via corporate actions. Given a lack of incremental news on trade, these overpowering technical factors can continue to push fixed income returns higher—though we are mindful that technicals can reverse quickly.

What does this mean for fixed income investors?

As we look ahead to our Investment Quarterly meeting next month, the balance of risks is pointing firmly to an increasingly sub-trend growth environment. While central banks may be able to cushion the blow of tariffs by easing policy further, the likelihood of recession will ultimately be driven by trade and the extent to which it percolates through the economy. Strategically, we continue to favour a long duration stance, though there may be tactical opportunities to trade on trade newsflow, and we recognise that core bond yields could consolidate in the absence of new news.

Each week J.P. Morgan Asset Management’s Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.

Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.

IncludedImage Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
IncludedImage Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
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Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum