SINGAPORE (BLOOMBERG) - In the end, all it took was two tweets from United States President Donald Trump to upend the peace.
After weeks of warnings from many on Wall Street that price swings across global markets were too subdued, the President's threat to boost tariffs on China sent volatility soaring on Monday (May 6). Stock-index futures slid more than 2 per cent, and the Shanghai Composite Index fell as much as 4.1 per cent. May futures on the Cboe Volatility Index jumped 15 per cent.
Whether they were a negotiating tactic or a sign of something more ominous, Mr Trump's tweets jolted markets that had been lulled in recent weeks by signs of progress in trade talks, a dovish turn by the Federal Reserve and better-than-expected corporate earnings. Investors who had grown accustomed to cross-asset volatility at or near historically low levels were once again forced to consider that all might not be smooth sailing.
"Trade had been put to the side by many market participants," Mr Andrew Tilton, chief Asia-Pacific economist at Goldman Sachs Group, said on Bloomberg Television. "Market pricing assumed there would be some kind of a deal, and no further escalation in tariffs. And meanwhile the growth outlook was actually improving. (Now,) this raises the spectre of a significant hit to growth should these tariffs escalate and should the uncertainty associated with that weigh on investment going forward," he said.
"It might not be as bad as it looks (but it's) very likely to undo all of the positive momentum we've seen," said Mr Michael McCarthy, chief market strategist at CMC Markets Asia Pacific in Sydney. The question is whether this is "a last-minute negotiation tactic" or will mark a breakdown in the talks, he said.
Nomura Holdings strategist Charlie McElligott said it's possible the S&P 500's recent run-up to record levels might have given Mr Trump enough confidence "to absorb a market drawdown and again lean into what some in the administration believe is Chinese 'slow-playing' - all in an attempt from to extract additional last-minute deal concessions".
Goldman economists Alec Phillips and Blake Taylor put the odds of tariff increases on Friday at 40 per cent, still seeing a deal as more likely than not. China is considering delaying the trip of its large delegation to Washington this week, according to people familiar with the matter, however, and the Goldman analysts warned that a cancellation would make a tariff hike the "base case".
"The key thing now is China's response. It's hard to see them folding and taking it on the chin," wrote Mr Kay Van-Petersen, global macro strategist at Saxo Capital Markets in Singapore, in a note to clients. "A scenario where we get a -3 per cent to -5 per cent pullback in the S&P 500 & limit down in China equities" is possible, he wrote. Currencies, interest rates and commodities could also be roiled, he said.
On the foreign-exchange side, Australian and New Zealand dollars could prove particularly vulnerable within the G-10.
"We will see some really significant downside corrections to the Aussie and Kiwi and a massive upturn in volatility", if talks break down and the Chinese team doesn't go to Washington, said Mr Nick Twidale, chief operating officer of Rakuten Securities Australia in Sydney.
Declines in equities could breed yet a further sell-off thanks to the role of quantitative players.
Moves by commodity trading advisers, or CTAs, could be triggered around 2,879 on the S&P 500, according to Nomura's McElligott. That level would be about a 2.3 per cent drop from the gauge's close last Friday. The futures were at 2,893.75 as of 10.20am in Hong Kong. Another "acceleration point where moves could get sloppy" is 2,890, a level important for some options strategies, he wrote.
The key is whether the tweets prove to be an epic incidence of poker playing or "a raging miscalculation with vigilante markets," Mr McElligott said.