Vontobel Multi Asset Boutique
Donald Trump loves a good deal. Xi Jinping also likes a firm handshake. Yet both presidents are currently playing a cat-and-mouse game. Will the rivals, like Tom and Jerry of cartoon fame, keep inventing ruses that fail to produce a winner? We hope not. Nevertheless, investors must consider this possibility.
Relations between the United States, the world’s major consumer, and China, its outsourced workbench, have long been pragmatic. No longer. The ongoing war of words and tariffs has the potential to unsettle global markets.
Like so many of Tom’s pursuits of Jerry the mouse, America’s chase may end in pain for the predator. It all began in 2018, when the US slapped import tariffs on solar panels, washing machines, aluminum, and steel. Later that year, Washington made it clear that China was the main target. More serious was the adoption of punitive tariffs of 10% on 200 billion US dollars’ worth of imports in September 2018 – and the recent increase of that rate to 25% – which lifted the US average tariff to 4.6%. This is a level some emerging economies use as a shield against cheap imports.
Further measures would hurt even more. Washington is mulling a 25% tariff on additional imports worth 300 billion US dollars from China, and on shipments of cars and car parts from global suppliers. This would put the US in the same league with protectionist countries such as Venezuela, Congo or Mali (see chart). The Trump administration must decide by November 2019 whether it really wants to join this club.
It has been smooth sailing for the US economy so far. The amount of imports affected by the escalating trade conflict is too small to have a noticeable impact on GDP or inflation.
American consumers may yet get a glimpse of future trouble when inflation spikes after the recent May 10 tariffs hike. However, this is far from certain, as some US businesses may swap Chinese suppliers for other low-cost producers. However, imposing a surcharge on imports of cars and car parts, and on Chinese imports that so far have not fallen into Donald Trump’s disapproving gaze, would change the picture. This could lower US GDP by 1 percentage point in an adverse scenario.
Beijing was surprised by Washington’s mad scramble, but its damage control has prevented the worst. The world’s second-largest economy announced retaliatory measures applying to 60 billion US dollars’ worth of US-sourced imports, a modest figure by comparison. Starting in June, US exporters will face an average tariff of 14% on their Chinese-bound deliveries, up from the previous 7%.
Given that China is the weaker side in the conflict – its exports to the US far exceed US shipments to China – it is running out of options in terms of additional tariffs. Nevertheless, just like Jerry suddenly producing a hammer while stuck in Tom’s tight grip, China is far from defenseless. As the world’s largest buyer of US Treasuries, Beijing could decide to sell a meaningful position of these bonds. While this would most likely be felt on financial markets, we believe the impact would be limited. Alternatively, China may interfere in American companies’ business on its home turf, for instance by snagging a possible sale of US-made planes to a Chinese airline.
Currently, we estimate a potential GDP reduction of 0.3 percentage points per year, which would still allow the Chinese economy to grow at slightly above 6%. This rate could drop below 6% in the event of a full-blown trade war. At the same time, China’s measures to stimulate the economy may offset some of the negative impact. It is also worth noting that the country has decreased its dependence on exports in the past few years. Chinese inflation, also in light of the People’s Bank of China’s recent communication, should be capped at 3%.
Europe plays the part of Mrs. Two Shoes – the middle-aged lady often suffering the consequences of Tom’s and Jerry’s mess. The European Union’s retaliation against the Trump administration’s imposition of aluminum and steel tariffs lifted the EU’s weighted import tariff rate by a tiny 0.03 percentage points. A further escalation could boost the EU’s average rate by 0.5 percentage points to 2.3%– a level still in line with that of a typical industrial country. Currently, the trade conflict is more damaging to market sentiment in Europe than directly to GDP or inflation. But weaker sentiment will at some point dent investment and consumer spending, lowering growth.
When two economic superpowers trade tariffs like insults, we should be worried. Fortunately, we also see stabilizing global growth, signs of recovery in some important economies, and the major central banks’ recent switch to more generous monetary policies. Thus, we are in a different place than at the end of last year. Therefore, we stick to a slight “risk-on” view. We remain underweight bonds (underweighting government bonds while overweighting investment-grade corporate paper as well as emerging-market hard-currency bonds) and neutral equities. Furthermore, we keep our overweight in gold. However, we are generally “less short USD.” We neutralized long CHF versus USD and go long USD versus EUR.
While the trade row may escalate further, we remain confident that America and China will come to their senses. After all, “it doesn't matter if a cat is black or white so long as it catches mice,” as a Chinese saying goes.DOWNLOAD