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Will the Trade Dispute with China Affect the Bond Market?

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KATHY JONES: The big news lately has been the trade dispute between the US and China. It’s really roiled the market, causing a lot of volatility, especially in the equity market. Interestingly, it hasn’t had as much impact on the bond market as it has on the stock market. I’m Kathy Jones, and this is Bond Market Today. Today, I’m joined by my colleague, Collin Martin, and we’re going to discuss this China-US trade dispute and what impact it might have on the bond market.

So, Collin, you know, as I noted, we’re just not seeing that much movement in bond yield since all this welled up in the marketplace. I would say 10-year treasury yields have been at a very, very narrow range. Why do you think that is?

COLLIN MARTIN: Yeah, as you said, they’ve been in a tight range because there’s both positive and negative effect of the tariffs. It’s also important to point out that, you know, it’s still uncertain if this is just the start of negotiations or if we’ll see a, you know, pronounced long period of time of tariffs. That remains to be seen. But, as I said, there’s both positive and negative impacts of tariffs.

And on the positive side, which pushes prices up and yields down, is that tariffs can slow growth, you know, can serve as a tax on consumption. That can slow trade, can slow the growth rate of the US economy, and that pulls yields lower. But it can also raise inflation. We’re a big importer of goods. It can increase the cost of those goods, and, therefore, lead to higher rates of inflation. And inflation plays a major role in long-term treasury yields. So you kind of have that push-and-pull dynamic and you--therefore, they’ve been in a relatively tight range lately.

But another questions we’ve seen is--or seen, or heard is: Are there other actions China might take, such as what they might do with their large holdings of US treasuries?

KATHY: Yeah, that’s something that comes up from time to time, we hear it. Whenever there’s some sort of conflict between the US and China, there’s this fear that China will use its large holdings of US treasuries to retaliate maybe by selling a big chunk of those treasuries and pushing prices down and yields up, and, of course, that would be damaging to the US economy.

You know, personally, I think that this is an unrealistic expectation for two reasons. One is it probably does as much harm to China as it does to us. These are their assets that they hold, and they would be driving down the price of their own assets. Secondly, they need US dollars to transact. So China has a huge trade surplus, not just with the US but with the world. They’re a big exporter and they generate excess dollars, and those dollars need to be invested, and they need to be held for the next transaction because most transactions that happen in the global economy happen in US dollars. So they need a large market that’s very liquid to hold those dollars, and that’s the US treasury market. They tend to invest at the shorter end of the yield curve because they need that liquidity.

So I don’t think it makes a lot of sense for them to take that action, although it’s a fear that’s out there and it comes up from time to time, and I think it is something that might be holding back the bond market, keeping people a little bit nervous about what’s going on.

So if you’re an investor and things have been very volatile and you’ve been concerned and you’re not really sure what to do, you know, what are some steps you could take maybe to help dampen down some of that volatility?

COLLIN: Well, we think one step is to own fixed income. You know, the past few weeks has been a great reminder as to why high-quality fixed income investments can help an overall portfolio. US treasuries are one of the best diversifiers when coupled with US stocks. They tend to have a negative correlation with the equity market over time. And by that, I mean if stock prices are going in one direction, treasury prices are going to go, to some degree, in the other direction. So if we’re seeing this elevated volatility with stocks and we’re seeing price declines, treasury prices tend to rise, so it helps serve as a buffer. But, also, it’s great to point out that yields are higher today, so in addition to the diversification benefits you can get, you can also earn higher income payments today in high-quality investments like US treasuries.

KATHY: Yeah, and that’s a big advantage over where we were just a year or two ago, when we were still sort of dealing with the zero interest rate environment. That’s great. Thanks, Collin.

If you would like to learn more about the bond market and investing in fixed income, you can find us on the Insights and Ideas tab on Schwab.com, go to Fixed Income on the dropdown box, or you can follow me on Twitter @KathyJones. Thanks for watching.

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