August was a memorable month for fixed income investors for a number of reasons. The sharp decline in bond yields was sparked by an escalation in the trade tensions between the US and China. The trade dispute and the risks around it have been known for some time. They have been top of the list of factors that investors and economists have been concerned about since the back end of 2018. Everyone agreed that tariffs were a negative for global growth but the extent of the impact was uncertain – a known-unknown, if you will.
For much of this year, the US – primarily via Tweets from President Trump – appears to have been the aggressor, setting the agenda and terms for any deal to be done. This changed in August when the Chinese began to take action and engage in a spot of trade tariff tennis. They successfully raised the stakes by applying tariffs of their own on US imports, but they then served up an ace. By allowing the renminbi to devalue versus the dollar (at least temporarily), they jolted the market, evoking memories of the summer of 2015. By their willingness to play hardball and retaliate, the Chinese have raised the stakes and in the eyes of the market at least, have increased the probability of the downside risks being realised.
Increasingly it looks like the only winner in this game could be government bonds. The escalation of the trade spat has been great news for government bonds as demand for them has sky-rocketed – August saw the highest total return for US Treasuries (3.6%) since November 2008, with UK gilts delivering an even higher return (3.8%). Record low yields have now been seen across Europe too, with 30-year German bonds moving into negative territory for the first time. With the US Federal Reserve citing trade as the key downside risk to their forecasts, the market reaction isn’t particularly surprising.
Can government bonds repeat this performance? They may be hard pushed to do so, but at the same time a meaningful reversal doesn’t appear to be forthcoming. In this head-to-head between Presidents Trump and Xi, neither side looks likely to forfeit the match, and the doubling-down of rhetoric could see it going to five sets before a “winner” is declared. Until then, government bonds will continue to wear the crown.