The US and Chinese officials have been displaying bowls of confidence in their escalating trade dispute. They each want to impose tariffs on $50bn of trade. This is small relative to the size of global trade (defined as the sum of imports and exports) at $29.3trillion, US trade at $5.2trillion or Chinese trade at $3.3trillion.
There is a danger that these numbers increase and Trump is already threatening further tariffs. This could lead to unintended consequences at the World Trade Organisation. For the moment we think this is posturing and is a relatively contained issue, the main effect of which will be winners and losers in the corporate market. This is likely to create further dispersion and idiosyncratic risk in corporate credit and is in line with our theme of rising volatility.
By coincidence, the last time the US had a trade war (with Japan) was during Eric Bristow’s supremacy in the 1980s.
Liquidity and funding
We continue to think the main story of 2018 is tightening monetary policy and liquidity. This is having a pronounced effect on US Libor which is being compounded by corporate tax repatriations and heavy US bill issuance to finance the fiscal deficit.
Rising Libor rates explain the current preference for floating rate securities by the investment community. We think this is also causing the basis between cash bond and credit default swaps (CDS) to widen. Recall that a CDS is an unfunded credit asset traded on margin whereas cash bonds are funded instruments. As funding costs increase you would expect the basis between bonds and CDS to also increase.
Securitised supply has been low in Europe in recent years because of the Bank of England’s Term Funding Facility and the ECB’s QE programmes. This has meant that risk that would have been securitised by banks has been retained and pledged with the central banks. As monetary policy changes and these programmes expire, we expect supply to increase to normalised levels and for investment opportunities to increase. According to the FT, UK banks are selling asset-backed securities at the fastest rate in ten years. We see this as healthy normalisation and welcome this development.
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