(June 6): President Trump’s abrupt decisions to impose tariffs on goods from Mexico (initially set at 5% on June 10 and gradually raised to 25% unless Mexico takes more forceful action to contain illegal immigration) and also to end India’s preferential trade status represent further broadening of the US administration’s tensions with its trading partners.

It is becoming apparent that President Trump intends to systematically wield trade barriers as a tool for foreign policy, which bodes ill for global trade and also weakens the chances for a US-China trade agreement over the near term.

It will be a close call but we see slightly better-than-even odds that the first 5% tariffs on Mexico goods on June 10 will take place. For US-China trade, a trade agreement by the G20 in late June is not likely, in our view, and we now see a baseline scenario that negotiations will be long-drawn-out with some US tariffs on the final $325b of Chinese imports likely to be implemented in mid-July or after.

To be sure, heightened trade risks will form headwinds for growth. In terms of combined imports and exports, Mexico is the US’s 2nd largest trading partner, and both economies have benefitted from an unimpeded flow of goods that has enabled significant supply chain integration in North America.

While we did see some green shoots of growth in the US and China in Q1 2019, the underlying momentum was tentative. The strong Q1 GDP print in the US was in part boosted by unsustainable factors such as inventory and net trade. In China, the manufacturing PMI fell from 50.1 in April to 49.4 in May – marking the briefest period of PMI expansion since 2008 – and the weakness in the new orders component in May was particularly notable.

In terms of our asset allocation strategy, we had taken profits and reduced our overall equity position to neutral on May 8, and had cautioned against adding overall portfolio risk since. This has turned out to be a sound move as the market continued to move risk-off against a deteriorating backdrop.

Heightened trade risk and growth headwinds will further weigh on emerging markets and the high-yield fixed income space. At this juncture, we continue to reduce risk by neutralising our overweight positions in Developed Markets (DM) High-Yield and Emerging Markets (EM) High-Yield bonds.

This brings our overall portfolio risk position to neutral. We don’t see sufficient grounds to be overall underweight risk for two reasons. First, we do not see the base case for a recession in the next 12 months; and second, central banks and policy makers are watchful of downside risks to growth, and they can and will ease if needed.

One potential scenario is the Fed putting forth a set of rate cuts (75bps - 125bps) as insurance against a downturn if the economic outlook weakens in the months ahead. Prior to previous episodes of insurance cuts in 1995 and 1998, the US ISM PMI has fallen below 50 for at least 2 consecutive months.

Fed fund futures are now pricing a near certainty of Fed cuts by the end of 2019. Our Chief Economist Richard Jerram believes that rate cuts are possible but the Fed would need to see clear signs of economic weakness before acting.

Conrad Tan is Investment Strategist as Bank of Singapore