Trade war: What lies ahead for the markets and economy?

May 17, 2019 10:25
Market gauges such as VIX and VXV have confirmed investors’ heightened concerns as the US and China stepped up their tariff war. Photo: Reuters

Volatility has picked up noticeably in the global stock markets in reaction to the newsflow on the US-China trade war and Donald Trump's tweets on the issue.

Market gauges such as VIX and VXV have confirmed investors’ heightened concerns.

VIX is a real-time market index that represents the market's expectation of 30-day forward-looking volatility of the S&P 500, while VXV measures volatility over a 3-month basis. The VIX/VXV ratio is usually below 1 in normal market conditions.

However, the ratio has climbed above 1 since early May, as the US-China trade war escalated.

Spikes in this ratio historically heralded a drop in equity prices and increased volatility. Like what we have seen in the first and fourth quarters of last year.

It’s widely estimated that China’s GDP will be reduced by up to one percent due to US tariffs, depending on eventually how high and extensive they are.

South Korea's exports, which are closely tied to China's economy, and the Keqiang Index, both are still trending lower, along with other economic numbers like retail sales and industrial production, China is still grappling with an economic downturn, reflecting the deepening impact from the trade war.

The trade row, meanwhile, is seen to have limited impact on the US economy. That said, higher tariffs, if passed on to consumers, could exert upward pressure on inflation. But such pressure should be manageable as the current inflation level is still rather low.

Elsewhere, the Hong Kong dollar is once again approaching the weak end of its trading band against the greenback, due to increasing capital outflow, suggesting investors could be pulling money out of Hong Kong on fears of a worsening of the trade war.

The full article appeared in the Hong Kong Economic Journal on May 16

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist