When US-China trade rhetoric turned sour back in March, we acknowledged that this was likely to dominate the news headlines throughout 2018, but unlikely to be the big driver of market sentiment. We urged investors to focus on the clear signals coming from the major central banks and try to filter out the noise.
Well, the noise has gotten harder to ignore this past couple of weeks and it certainly has dented market confidence. Risks are rising from this game of chicken, as well as renewed frictions between the US and other trading partners such as Canada, Mexico, and the European Union.
As we suggested in our earlier Perspectives, markets are not yet ready to trust this administration on trade negotiations. The next few months will be a vital proving period for that trust, during which the noise and anxiety are likely to increase. The time is right, therefore, to clarify why we still believe the two biggest players are likely to swerve from their collision course and avoid a truly damaging outcome.
On June 15, the US confirmed tariffs of up to 25 per cent on $50 billion (Dh183.5 billion) worth of Chinese goods, beginning on July 6. This had been in the pipeline since March, and in itself was not very material. Most economists reckoned it would knock one-tenth of a percentage point off both US and Chinese GDP, at worst.
More worrying was that, in confirming the tariffs, the US spurned China’s reported offer to purchase an extra $70 billion of its products over the next year. China responded to the tariffs almost immediately with its own, on $50 billion worth of US goods. The US, in turn, met that with talk of a new set of measures covering as much as $200 billion worth of products.
That could take the economic hit up from one-tenth to three-tenths of a per cent of GDP. And it sounds an awful lot like tit-for-tat.
Broadening the theatre of battle
How far could this go? On the face of it, quite a long way.
Peter Navarro, trade adviser to the White House, says that “China has much more to lose than we do” and “may have underestimated the strong resolve of President Trump.” He seems to be suggesting that, because China exports $500 billion of goods to the US and only $130 billion of goods goes the other way, China will run out of things to slap tariffs on before the US does.
While this is true, China could easily broaden the theatre of battle. Subsidiaries of US companies operating in China, and the joint ventures US companies have established there, do very good business — north of $250 billion worth, according to most estimates. China’s biggest weapon in a trade war probably isn’t tariffs, but finding ways to close down Apple stores, for example, or otherwise making life difficult for those US businesses. That’s before we even consider consumer boycotts, or more dramatic actions regarding China’s currency peg or its reserve holdings of US securities.
Moreover, while China arguably has “more to lose” in a trade tussle, it may have a higher pain threshold. Yi Gang, governor of the People’s Bank of China, says that “all kinds of monetary tools” are at the ready to support domestic markets, and that China “has room to face all sorts of trade friction.”
The US has its fiscal stimulus buffer, for sure, and it has to be said that US market reaction has so far been muted. But in the event of continued escalation would the White House be prepared to see 10 per cent or more come off US equity markets running into midterm elections, or agricultural commodity prices continue to weaken into harvest season?
Swerving to save face
Both sides have an incentive to back down in a way that saves face, then. That incentive is particularly acute for President Trump, looking for strong headlines leading into the November polls. Some argue that China’s initial offer to ramp up its purchases of US goods was not only a little too vague, but also that it simply came too early and too easily for the White House to accept. It would have lacked the drama of taking the game of chicken to the brink. When the timing is more propitious, the argument goes, a similar offer with more detail and clearer enforcement mechanisms will break the deadlock.
Finally, the markets have not really discounted the possibility that we end up with lower global tariffs once the dust settles. For example, last week saw some of Germany’s biggest auto manufacturers back the idea of eliminating the 10 per cent tariff on US autos going to Europe and the 2.5 per cent tariff on European cars going to the US.
For these reasons, we still believe we are experiencing short-term volatility right now, rather than the start of something much more damaging. There is a real risk that Trump’s White House is prepared to inflict self-harm to make a point about China’s economic model. There is also a risk that the four months until the US midterms simply leaves a lot of time for things to get out of hand. But for now, for all the drama, we still expect the swerve to come.
— Joseph V. Amato is the president and chief investment officer equities and Brad Tank is the CIO Fixed income for Neuberger Berman.