Global markets brace for more volatility amid trade wars

The Dow Jones Industrial Average and the S&P 500 fell by around 3 percent on Monday—the largest drop this year. The markets were responding to another escalation in the U.S.-China trade war:

For the first time in a decade, China allowed its currency to weaken below seven yuan to the dollar, prompting the U.S. government to label China a currency manipulator. Markets in Asia did not drop as precipitously as in the United States; both the Nikkei and Hang Seng were down by less than 1 percent at closing on Tuesday.

The downturn on Monday has raised fears that a bigger market correction could be on its way, as well as concerns that China might be willing to use its currency depreciation in the trade war. The yuan fell just days after the U.S. President Donald Trump announced plans to impose additional tariffs on Chinese goods on Sept. 1.

Why did China allow the yuan to depreciate?

A weaker currency makes exports cheaper in foreign markets, potentially offsetting the U.S. tariffs. Still, it comes at a cost for Chinese consumers and any companies that have borrowed in dollars, Patrick Chovanec, professor at Columbia University’s School of International and Public Affairs, wrote in an email. “That short-term game comes at a longer-term cost, but Beijing appears ready to pay it,” he said.

How will investors react?

The tumble came less than a week after the U.S Federal Reserve announced it would cut interest rates—and it could be under pressure to lower them again in the fall. The U.S. economy was already slowing: “The tariff announcement has just refocused everyone’s attention on a downside that was already there,” Chovanec said.

But the future looks volatile: “To the extent that investors can afford to ride out the ups and downs, they’re probably better off staying in the market and doing that,” he added. “But it could be a bumpy ride.”