The trade conflict between the US and China has escalated. From the G7 meeting in France, US President Donald Trump said the conflict was "in many ways…an emergency." That followed moves late last week by the US and China to raise tariffs on each other's goods. After the market close on Friday, President Trump announced that tariffs on USD 250bn of Chinese goods would be set at 30%, up from 25%, and a new series of tariffs on a further USD 300bn of Chinese goods would be levied at 15% rather than 10%.

The trade dispute is moving fast and could improve as swiftly as it has deteriorated. But the threat to both the global economy and markets is clearly increasing. In response, we are reducing risk in our portfolios, by moving to an underweight in equities to lower our exposure to the political uncertainty. We still favor carry strategies in credit and foreign exchange markets, which benefit from central bank easing in a low-growth environment. Overall, our mix of underweight equities, hedges, and long yield brings us close to a risk-neutral position.

In this highly fluid situation, we will be monitoring the following factors to assess the need for further changes.

So while we are not bracing the portfolio for a recession or the next Global Financial Crisis, we believe it is prudent to take action to neutralize part of the event risk from the trade conflict, pending greater clarity on the outlook. As a result, we have made several changes to our US tactical asset allocation.

We close our overweight to US equities, where US-China trade risks overshadows relatively attractive valuations vis-à-vis government bonds. We initiate an underweight to emerging market stocks, while reducing our underweight to international developed market equities. This brings our overall position in equities to underweight.

We also initiate an overweight in US-dollar-denominated emerging market sovereign bonds. Finally, within our FX strategy, we adjust our overweight to select higher yielding emerging market currencies. We remain overweight the Indian rupee and Indonesian rupiah versus the lower yielding Australian and Taiwan dollars. But we remove the overweight to the South African rand versus the New Zealand dollar from this basket, due to increasing trade tensions and idiosyncratic risks.