Even though the latest tariff hike (from 10% to 25% on $200bn of Chinese imports) is likely to have a modest direct impact on Chinese and US GDP (-0.2%), neither side has any interest in seeing the trade war intensify for two main reasons.
The first being that China has had to implement a major stimulus simply to stabilise its growth and second the effects of tax cuts are waning in the US. As such, more protectionist measures could push growth below its potential level and severely damage the job market just before elections.
The increase in tariffs from 10% to 25% will only apply to newly imported goods. It does not affect goods already in transit. Thus the economic impact of new tariffs will most likely be felt until June of this year. This leaves China and the US with time to reach an agreement. The fact that the Chinese did not leave the negotiating table following Donald Trump’s Tweets is good news from this perspective.
Last week’s modest market correction was a result of investors believing that the outcome of negotiations between China and the US will ultimately be that of a deal. Nonetheless, the Tweets posted by Donald Trump just before the Chinese delegation’s arrival in Washington demonstrate that diplomatic relations between the China and US are not getting any easier.
Donald Trump still has a careless way of dealing with diplomatic relations. This will probably maintain an unpredictability risk premium. At any moment, the US President could unceremoniously knock over the negotiating table (Although this is not our base case scenario).
Three possible scenarios of the trade war outcome are as follows:
Base case scenario: a US-China trade deal is achieved within weeks (say, 1-2 months) and tariff hikes are reversed fairly speedily (a few months).
Intermediate case scenario: trade negotiations drag on, tariffs of 25% on $200bn US imports from China remain in place throughout 2019. China imposes reciprocal tariff and/or non-tariff barriers on US goods and potentially other measures aimed at US companies operating, or planning to operate, in China.
Worst case scenario: trade negotiations break down, US imposes 25% tariffs on all goods arriving from China. China reciprocates through various channels.
The tensions between China and the US does not point to easy negotiations with Europe, even if these will probably be postponed because of strains with China, since Donald Trump is unlikely to take the risk of attacking two trade fronts at the same time.
In my opinion, Donald Trump can play for time in the trade war as long as the US consumer continues to benefit. He will not take the risk of sharply eroding consumer confidence a little more than a year before the Presidential election. Consumer confidence is currently shored up by accumulated wealth effects since the start of the year thanks to the equity market rally, and the strength of the job market.
Emerging equities appear to be the asset class most at risk today for many reasons. Numerous inflows have been recorded in recent months and profits could be taken. The USD is back in a smile configuration, with the risk of an appreciation amid a search for safe havens or because of an uptick in inflation, and investors will question the Chinese economy’s resilience in the face of this new shock.
To conclude, investors who think that Donald Trump’s Tweets are more a way to put pressure on negotiations than to ruin China-US trade relations and that China will respond with a new stimulus plan have more interest in opting for European stocks exposed to China since they would avoid currency risk.
Disclaimer: This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.