How worried should investors be about tariffs?
Markets are getting nervous about tariffs but can they derail economic growth?
3 min read
We think a fully-fledged trade conflict is unlikely despite bellicose headlines and that economic fundamentals will ultimately win through against nervous sentiment.
What’s at stake?
As with any conflict, both sides have something at stake. The US wants greater access to China’s market and adequate compensation for American intellectual property rights, for example in technology which has benefitted China’s rapid development in recent years.
China, in our view, will be striving to maintain the status quo as far as possible. This will protect its role in the global supply chain, which has grown dramatically, and leave it to pursue its domestic agenda.
For the world at large, a material and prolonged trade war could be very bad news. On Wednesday, the head of the International Monetary Fund Christine Lagarde warned that the current system of world trade was “in danger of being torn apart”.
A trade war, she said, could disrupt global growth and hit consumers hardest. She urged countries to use domestic policy, rather than trade barriers, to address any imbalances, and to use international forums to settle disputes rather than tit-for-tat tariff raising.
Jaw-jaw not war-war
We don’t see the current spat escalating into a full-blown conflict. It’s most likely that negotiation, which continues in private between China and the US, will lead to concessions from China that will let Mr Trump claim victory. Meanwhile, China’s place in the global economy will remain sheltered from major adverse effects, allowing it to re-orient itself with a stronger, service-based economy based on domestic demand.
Last week, Chinese President Xi Jinping reiterated earlier promises to open up the Chinese economy to foreign financial services companies, reduce limits on foreign investment in the auto, shipbuilding and aviation industries, and lower import tariffs on cars.
Mr Trump has offered a conciliatory response, and we believe that the frictions are unlikely to escalate before both sides evaluate the results of any negotiations.
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The market nerves over the battle drums have seen a rise in negative sentiment, contributing to sell-offs in equities and bonds at the higher-risk end of the credit spectrum.
Emerging markets and export-oriented economies – such as Germany, Sweden, Korea and Taiwan – may suffer the most in the short term, although local currency weakness may act as a counterbalance. The technology, mining and commodities sectors may also see some softening as they are likely to be targeted by sanctions or a slowdown in Chinese activity.
On the positive side, government bonds may benefit from ‘risk-off’ activity and companies with a domestic focus, rather than exporters, may begin to look appealing to investors.
In the longer term, we see the effect of this bellicosity declining as the parties reach consensus and the longer-term market fundamentals re-establish themselves. Economic growth and corporate earnings should support investor confidence once more.
War is over, if you want it?
The chance of an entrenched trade conflict is small in our view. If this were to happen, the US administration could push hard for deeper concessions than the Chinese are willing to accept, piling on further punitive measures. In response, China could make long-term changes to its structure to make it more self-sufficient and less dependent on the US.
In this extreme scenario we could see disruption to global trade leading to some of the darker consequences suggested by Ms Lagarde and others. Valuations could fall and corporate earnings could be negatively affected. Exporters and cyclical sectors would be the most vulnerable, and high yield bonds could become much more risky. Safe haven assets – government bonds, the US dollar, gold – and defensive, domestic sectors would become the places to be.
A breakdown in global trade is not in the interest of either China or the US, as the main actors in this drama are well aware. Mr Trump prides himself on his ability to make a deal, and we believe that China will be able to make sufficient concessions without sacrificing its economic growth.
Markets have been nervous about the prospects for global trade since President Trump announced tariffs on aluminium and steel in March. We don’t think a full-blown trade war is likely – all parties involved have too much invested in trade to let it happen. In the short term, a period of ‘risk-off’ sentiment will most likely support bonds, while domestic-focused stocks could benefit at the expense of exporters. However, in the long term, global growth will continue to support quality equities.
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