When US-China trade rhetoric turned sour in March, we acknowledged this was likely to dominate the news headlines throughout 2018, but unlikely to be the big driver of market sentiment. However, the noise has gotten harder to ignore these past couple of weeks and it certainly has dented market confidence.
Risks are rising from this game of chicken. Markets are not yet ready to trust the Trump 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.
We still believe the two biggest players are likely to swerve from their collision course and avoid a truly damaging outcome.
Broadening the battle
How far could this go? On the face of it, quite a long way. Peter Navarro, trade advisor to the White House, said ‘China has much more to lose than we do’ and ‘may have underestimated the strong resolve of President Trump’. He seems to be suggesting because China exports $500bn of goods to the US and only $130bn 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, as well as the joint ventures US companies have established there, do very good business – north of $250bn worth, according to most estimates. China’s biggest weapon in a trade war probably is not tariffs, but finding ways to close down Apple stores, for example, or otherwise making life difficult for those US businesses. That is 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, said ‘all kinds of monetary tools’ are at the ready to support domestic markets, and China ‘has room to face all sorts of trade friction’.
The US has its fiscal stimulus buffer, and it has to be said US market reaction has so far been muted. But in the event of continued escalation, would the White House be prepared to see 10% 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. That incentive is particularly acute for President Trump, looking for strong headlines leading into the November polls. Some argue China’s initial offer to ramp up its purchases of US goods was not only a little too vague, 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, markets have not really discounted the possibility we end up with lower global tariffs once the dust settles. For example, we recently saw some of Germany’s biggest auto manufacturers back the idea of eliminating the 10% tariff on US autos going to Europe and the 2.5% 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 Trump’s White House is prepared to inflict self-harm to make a point about China’s economic model. There is also a risk the four months leading up to the US midterms leave 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 Amato, president and CIO – equities at Neuberger Berman