Trade tensions reignite – staying diversified ahead of tariff talks

US President Trump has threatened a 100% tariff on all Chinese imports by 1 November in response to China’s trade restrictions on rare earths, which are critical for production in technology across industries. In turn, China’s move was a retaliation following earlier restrictions from the US on chips. This is happening ahead of a possible meeting between Trump and China’s leader Xi Jinping on the sidelines of the Asia-Pacific Economic Summit in South Korea, between 30 October and 1 November, which many business leaders and investors see as a key meeting to find a more durable trade arrangement or at least pause tariffs to allow negotiations. 

Predictably, equity markets fell after the tariff news last Friday, with bonds and gold prices rising – offsetting part of the equity decline. Our initial thoughts are that this is likely a negotiating threat, not an implementable plan, certainly not for a sustained period. This is because US corporates rely heavily on China for intermediate goods; imposing across-the-board tariffs would cause supply-chain chaos and push up inflation just as the US Federal Reserve (Fed) is easing. 

This preliminary baseline suggests that we might go through an initial period of equity market volatility, especially in cyclicals and tech hardware, followed by some relief if back-channels signal moderation or willingness to compromise – as Trump and Vice President Vance appear to have suggested over the weekend. China may retaliate symbolically at first, for example via tightening export licences for rare earths or targeting US agribusiness – but avoid a full-scale trade war until it gauges Trump’s resolve. 

Historical precedents, looking at Trump’s first presidency, suggest a pattern of escalation as a tactic of negotiation followed by de-escalation: in 2018-19, he escalated tariffs, then de-escalated into “phase one” deals ahead of the election season. With the US mid-terms approaching and the need to support the economy, we think this is a useful comparison and a rather likely scenario. 

Tariff threats create leverage for renegotiation. Once the headlines peak and inflation pressures resurface, the US might rebrand a partial rollback as a “win”. Congress and big business lobbies (retail, autos, technology) will likely resist full implementation, limiting endurance. So, at this stage, we expect a pattern of rhetorical peak followed by a negotiated retreat, perhaps with selective deals and provisions in critical sectors, components, and commodities (chips, AI, batteries, rare earths) rather than blanket tariffs. 

Longer term, the pattern is still one of geopolitical fragmentation and trade regionalisation, with an adversarial US-China relationship. Both the US and China will likely continue to boost production of strategic inputs (semiconductors, clean tech, defence materials) supported by subsidies and regulation. 

Our strategy remains anchored in broad diversification across geographies and asset classes, with a moderate tactical preference for equities over bonds, plus a range of risk mitigators and active management as the key to navigating this environment. 

Earnings, especially in tech, are strong enough to support valuations. Still, spreading investments across countries and investment styles is more important than ever. We maintain tactical overweights relative to our long-term allocation targets in the US, Europe, Japan, and emerging markets. Earlier this year, we diversified some of our US equities using an equal-weighted index that gives more room to sectors poised to benefit from fiscal stimulus and deregulation, such as industrials and financials.  

Where appropriate, we’ve added a form of portfolio ‘insurance’ – a warrant that rises if US equities fall (where client knowledge and experience, and regulations and investment guidelines, permit such strategies). It’s not a silver bullet, but it helps partially cushion unexpected shocks for investors comfortable with more complex instruments. 

In fixed income, we favour European bonds over their US counterparts, with a preference for short-dated bonds, to manage inflation and interest rate risk. Our government bond positioning is defensive and will likely benefit during periods of equity market volatility. We’re holding strategic positions in commodities and inflation-linked bonds to mitigate the risk of persistent inflation. Gold also plays its role as a store of value in geopolitically uncertain times. That’s why we’re tactically overweight. 

Last week reminded us that politics can move markets as much as economics. In the US, the government shutdown is underway after Congress failed to agree on a funding deal. The economic impact is minor – at most, about 0.1% of GDP per week, but the bigger issue is credibility. The shutdown raises investor doubts about Washington’s ability to manage its finances when deficits are already high. With major data releases like those on the labour market and inflation on hold, the US Federal Reserve (Fed) is flying blind on interest rate decisions. Gold drew strong safe-haven flows. Our overweight position in gold (where permitted) continues to work as intended, providing a hedge against uncertainty. 

Europe had its own stress points. France is back in the spotlight after Prime Minister Lecornu resigned, only to be reappointed again. Political uncertainty adds to existing concerns of rising deficit and slower growth forecasts. The market reaction? French bond yields spiked initially, with the spread between French and German government bonds widening to the highest levels since the euro crisis. Until the political situation stabilises more durably and fiscal clarity improves, pressure on French bonds is likely to remain high. These developments are one of the reasons why the euro weakened relative to the dollar last week, before starting to rise again after the tariff news. But, with the Fed cutting rates while the European Central Bank staying on hold, we think it’s just a matter of time before the US dollar resumes its weakening trend. 

Japan delivered a different kind of surprise. Sanae Takaichi’s win as LDP leader points to more fiscal spending and delays expectations for the next Bank of Japan rate hike to 2026. That policy mix supports Japanese equities, where we’re tactically overweight, but in the near term could trigger yen volatility and push government bond yields higher. 

Obviously, the next couple of weeks are likely to be dominated by headlines on whether the extra US tariffs will be applied or if negotiations defuse the threat. 

In Europe, Germany takes centre stage with the October ZEW survey, an important investor sentiment indicator (Tuesday). The UK will release its labour market (Tuesday), economic growth (Thursday), and industrial production data (Thursday) this week, providing a comprehensive view of labour and output trends. 

In the US, attention will be on Wednesday’s inflation data, which is a key input for the Fed’s upcoming interest rate decisions, followed by retail sales and jobless claims (Thursday), two key measures of household demand and labour resilience. However, the government shutdown, unless a range of fiscal bills are approved, could delay or disrupt the publication of official data releases.