Jason Todd, CFA, and Macquarie Wealth Management Investment Strategy team
Friday 13 April 2018
Trade tariffs - a storm in a Trump-cup?
Jason Todd, CFA, and Macquarie Wealth Management Investment Strategy team
- Improving demand rather than rising trade protectionism should remain the key driver of global trade in the near term. Trump is fulfilling his campaign promises, and while raising policy uncertainty, it doesn't collapse the fundamental story at this time.
- A trade war is possible but remains a tail risk. The US is granting exceptions and carve outs with tariffs remaining product-specific. China's response has so far been measured and we think any retaliation will be more symbolic than aggressive.
- Trade tensions add another headwind for equity markets alongside rising bond yields. It’s possible that we’ve already passed the point of peak optimism as evidenced by the collapse in Bitcoin and more recently the sell-off in Facebook. However this limits upside and is likely to keep markets range-bound rather than driving a more widespread and sustained correction.
- Australia won’t be immune to an escalation in trade tensions particularly if China is involved. Negative trade developments will weigh on domestic equities and the Australian dollar despite not being directly in the crosshairs.
- A worst-case scenario is a combination of rising trade protectionism alongside rising interest rate pressures but this is not our central case. We stick with our long equites allocation but would not add more risk exposure. We continue to like offshore growth stocks for exposure to improving demand.
Following the recently announced tariffs on steel and aluminium imports into the US, President Trump has upped the ante, taking aim at China by proposing 25% tariffs on Chinese imports totalling US$50 – US$60bn per year. We believe the direct effects of Trump’s trade proposals should be relatively contained, affecting only 2.5% of total Chinese exports. Similarly, the proposed policy would be imposed on goods representing only 2% of total US imports, with negligible direct effects on either growth or inflation.
We have little transparency on the policy response function from China or other nations. Our base case assumption is that the current measures are unlikely to prove particularly disruptive. While it raises the level of policy uncertainty, which is negative for financial markets, a full-scale trade war would require a significant Chinese retaliation and a more broad-based imposition of US tariffs. Both are possible, but remains a tail risk rather than a central case outcome. Given the relatively small impact on the Chinese, we tend to side with the view that the response function is more likely to be symbolic rather than large-scale economic.
Trade protectionism has been rising for a decade – Trump didn’t start this trend and he won’t end it
The global financial crisis brought an end to the era of globalisation (as measured by the free movement of labour, capital and goods). The past decade has been characterised by greater localisation and regionalisation.
The Trump administration’s proposal to adopt stronger protectionist measures reflects the continued ebb of global economic and political thinking towards more insular, nationalistic and populist policies. We see the rise in populism as a direct reflection of disintegrating labour markets and rising income and wealth inequalities. As a consequence, nationalism is increasingly taking precedence over globalism in driving economic and political agendas. Australia won’t be immune to these secular shifts. Historically Australia has been aligned with the US, but its economic future is tied to China and the rise of other regional heavyweights.
Global trade relative to GDP peaked over 10 years ago
Source: WTO, Macquarie Research, March 2018
What’s next and should we be worried?
Historically, rising protectionism has tended to accompany periods of economic weakness rather than economic improvement (i.e. it’s been used as way of attempting to support domestic growth and/or industry). On the positive side, we’re confident in the global economic recovery and take the view that it’s global demand rather than global protectionism that will hold the key to maintaining our pro-cyclical stance. In response to recent tariff announcements:
- China has warned of the potential harm to the global trading system and the global economy. Our China economist is of the opinion that China’s policy makers have made it clear that they’re not ready for a trade war.
- The EU has also warned that it will retaliate with tariffs on US imports to ensure global trade remains fair and to protect domestic employment, but also emphasised that it doesn’t want a trade war.
If Trump’s objective is to materially reduce the US trade deficit, our global economic team think that it’s unlikely the administration will be successful. However, if the true Trump game is to get trade concessions from China, it’s possible the end game will be far less problematic than currently looks possible.
US compares favourably on the level of tariffs
Source: WTO, Macquarie Research, March 2018
Trade war is a tail risk, with the Chinese response likely to be measured
According to our economics team, a global trade war represents only a tail-risk scenario at this stage. However, there are several factors that could contribute to the US increasing tariffs, resulting in retaliation from its trading partners, including:
- The US has comparatively low trade barriers, particularly relative to China. Trump could justify further tariffs on the basis of perceived “fair trade”.
- The US has a large trade deficit, which Trump believes represents “losing” in global trade and can be reduced by increasing the cost of imports through tariffs.
- The US may impose significant trade restrictions on China in response to findings of the Section 301 investigations of alleged intellectual property theft by China.
Our China economist believes that the most likely outcome is that China will concede. He expects in the next few months, the Chinese government will roll out a series of reforms to open up the services sector, including healthcare, education and finance, and for lower tariffs in certain areas such as auto. Moreover, he believes China will take steps to address the key concerns from the US on technology transfers and entry barriers.
The key development to watch is how China retaliates. If China confines the retaliation to only agricultural and manufacturing goods, it would confirm the view that it has no intention of escalation. But if it retaliates through dumping US treasuries or allowing sharp depreciation of the RMB than things could get much worse.
Trump tariffs not the signal to get bearish equities yet
Assuming things don’t get out of hand, the US will likely benefit from a spat with its trading partners. In theory, if Trump’s tariffs lead to a reduction in the US trade deficit, this will increase domestic spending and lead to upward pressure on wages. The tariffs themselves are inflationary, but in this case, it will be a minor one-off hit, rather than a permanent increase in the rate.
Perhaps the most significant indication as to how this situation will evolve will be the outcome of Trump administration investigations into Chinese technology transfer and intellectual property theft under Section 301 of the Trade Act 1974. If China is found to have acted unfairly, penalties would likely include a combination of tariffs and restrictions on Chinese investment in the US. This might include an indemnity for cumulative losses from past violations, which would be rare, if not unprecedented, and something China would reject outright.
Trump's rhetoric - and China's verifiably severe violations on intellectual property - could produce across-the-board tariffs of a sort that the US has not imposed since the Nixon shock. That would be a game changer in Sino-American tensions. For now, we maintain our pro-cyclical stance towards risk assets (overweight equities and underweight bonds and rate sensitive areas).
While downside risks have risen due to higher interest rates and the threat of more aggressive trade measures, we think it reduces the upside risk for markets rather than creating a strong signal to sell at the current time. However, we would not be adding to our risk exposure and at the margin, for those who take a more negative interpretation, the shift would be towards cash rather than assuming we’ll see a sharp and sustained move down in bond yields.
The perfect storm for markets would be if inflation started to print on the high side while at the same time trade tensions began to escalate, impacting business and consumer confidence. This would leave central banks with little wiggle room to keep rates unchanged as trade-driven growth headwinds pick up. North Asia is more exposed than ASEAN to a trade war with technology (telco and data equipment) the most exposed industries. Our preference for offshore- exposed stocks has not changed. We like Aristocrat, Boral, James Hardie, CSL, Reliance and Treasury Wines.
Links to research reports:
The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Limited ABN 94 122 169 279 AFSL 318062 ("MGL") and its related entities (the "Macquarie Group", “We” or “Us”) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. No part of the compensation of the analyst is directly or indirectly related to the inclusion of specific recommendations or views in this research.
This research has been issued and is distributed in Australia by Macquarie Equities Limited ABN 41 002 574 923 AFSL 237504. It does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider if it is appropriate for you. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. It has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person.
Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. We accept no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research.
We have established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements, which sets out how we must seek to identify and manage all material conflicts of interest. Our officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. We may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. Our employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research.
Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.