Prepare for market correction as US-China tensions threaten to turn into currency war

Many managers are worried about the prospect of a full-blown currency war

Anna Fedorova
13 August 2019

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Investors must buckle up and prepare for a "bumpy ride" in equity markets as the trade tensions between the US and China threaten to escalate to a full-blown currency war, experts have warned.

Market commentators have suggested it is time to seek out defensive positioning and take some risk off the table in case tensions between the world's two largest nations fail to subside.

Market volatility was sparked once again when US President Donald Trump announced plans to slap fresh tariffs of 10% on the remaining $300bn worth of Chinese imports that were not impacted by his first round of taxes.

The winners and losers from the escalating US-China trade war

The Chinese authorities responded by allowing the renminbi to fall below the psychologically important barrier of RMB7 to the US dollar, which fuelled Trump's wrath as he labelled China a "currency manipulator".

The renewed tensions led to deep falls in global markets, with UK and US stockmarkets suffering their worst day of the year so far last Monday (5 August) and the VIX surging over 30%.

However, the freefall was halted when the People's Bank of China (PBoC) fixed the renminbi's benchmark exchange rate close to the RMB7/USD mark.

Nevertheless, concerns remain the tensions could yet escalate into a full-blown currency war. George Efstathopoulos, multi-asset manager at Fidelity International, warned: "The prospect of a US-China currency war is worrying and has risen in probability".

UK and US markets suffer worst day of the year on currency war concerns

As a result, managers expect short-term outflows from domestic equities and risk assets in general, and have warned we could see a correction following a strong market run so far in 2019.

Seema Shah, chief strategist at Principal Global Investors, said: "We now need to prepare ourselves for a sharper US equity market correction as investors reprice the risk to the economy from the trade war - and the stronger US dollar.

"Certainly, the Federal Reserve will now be under severe pressure to cut policy rates again at the September meeting to offset the downside impact."

Defensive positioning

Against this backdrop, fund buyers are advocating a defensive stance in portfolios to lock in the profits from the strong first half of the year and mitigate the risk of a serious correction.

Paul O'Connor, head of the UK-based multi-asset team at Janus Henderson Investors, said: "With most financial assets having already delivered strong returns this year and visibility on the global macro outlook being unusually low, we see a strong incentive to lock in some profits in risk assets and to retreat until risk/return prospects improve or the global outlook becomes more predictable."

Dan Kemp, CIO at Morningstar Investment Management, added his portfolios are already defensively positioned and hold high levels of cash in response to "stretched valuations".

"While this should act as a buffer against volatility, it may also provide ammunition should any exemplary opportunities present themselves," he added.