Market alert: Should investors be afraid of Trade Wars?

For 4 months markets were fed with the news that “trade negotiations with China are going great” and that “there will be fantastic trade deal”. Well, that changed drastically on Sunday as president Trump tweeted about tariffs increase. Investors better hope this is just a negotiating tactic because consequences for the global economy could be very serious.

Summary:

  • Full blown trade war would cause global slowdown
  • US economy is not immune
  • Chinese reaction seen as critical
  • Markets were overbought ahead of the news

Trade conflict could be very costly

At the beginning of 2019 the World Economic Forum estimated that a full blown trade war would subtract 0.7 percentage points from the global growth. The biggest cost was estimated for Asia, followed by Europe and the US. The scenario assumed 25% tariffs on the whole Chinese exports to the US (exactly the threat made by Trump) and the Chinese 50% retaliatory tariff.  The Chinese trade data for the first quarter provide a clear answer on the balance of the trade conflict. Despite the official GDP growth of over 6%, the Chinese imports contracted within that period in y/y terms. The US was the biggest loser but exports powerhouses like South Korea and Japan were also affected. The only clear winner was Brazil as the country took advantage of the conflict to ship more agricultural products to China.

US economy not immune

President Trump has been selling tariffs as being positive for the US economy. This confidence might have been supported by a relative performance of the US economy so far but president Trump might miss the point here. Yes, the US economy is relatively less exports dependent but it’s not completely immune to global tendencies. While the labour market – the lagging indicator – has been robust so far, business surveys point to deceleration of growth in the US and global headwinds are among the factors. Going forward, if growth in Asia evaporates it could intensify US slowdown and that together would trim growth everywhere else.  

The US economy is already slowing and trade conflict could add pressures. Source: Macrobond, XTB Research

What next with Trade Talks?

Potential economic damage is large and thus it’s critical to interpret the meaning of the latest move made by president Trump. Is this merely negotiating tactic in the final stage of talks or will it freeze relationship for months? How will China react, will it bend to more US demands or play tough? It’s still too early to tell. China plans to send a delegation to the US in a goodwill gesture but if Trump delivers on his threat this Friday, relationship may sour for months.

How are markets reacting?

(1) US imposes tariffs on steel and aluminum (2) 1st round of tariffs on China (3) 2nd round of tariffs on China (4) US and China agree on truce to negotiate a deal (5) trade negotiations begin (6) Trump announces additional tariffs on China. Source: XTB Research

Markets have been clearly caught off guard and the major US and European indices reacted with declines around 2%. It’s important to notice that indices were in the overbought territory ahead of the weekend and were unprepared for the news. Looking at 2018, tariffs on China clearly did not help the markets as they were applied in the final stage of the rally (points 2 and 3) while hopes related to trade negotiations were among catalyst behind a huge rally this year (point 5).    

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