Trade Wars: Episode II – China strikes back
David Robertson, Head of Economic and Market Research at Bendigo and Adelaide Bank
March-April 2018
The plot of the trade war saga between the USA and China has taken a number of twists and turns this month, which has kept the markets on edge and prone to indecisive price action.
April initially saw US President Trump follow up his threatened $50 B of Chinese imports earmarked for tariffs - which of course drove China to identify the same volume of goods for retaliatory tariffs - with another US$100 B ‘for consideration’. This seemed to vindicate the initial concerns that trade wars may escalate.
Chinese President Xi Jinping diffused the situation by playing to Trump’s weak spot - his ego - by announcing in a speech at the Boao Forum* that China would further open up its domestic economy, including:
- Making the economy more accessible to foreign business
- Strengthening intellectual property rights protection, and
- Increasing import volumes
This included reducing Chinese tariffs on imported automobiles - directly addressing a range of trade issues raised by Trump in recent speeches.
Equity markets responded positively as Figure 5 below indicates, leaving the February lows for the US S&P 500 around 2 550 intact.
Xi received a complimentary Trump tweet in response thanking him for his kind words - and quickly the US focus seemed to move from China to Russia, as Syrian airstrikes followed. Does this mean trade war fears have evaporated?
Unfortunately trade tensions are likely to persist given it will take time for Xi’s words to be translated to actions, but there are two important points to make.
Firstly, risk around this event has primarily been market nervousness and volatility, e.g. the market convincing itself that trade wars will follow, as opposed to the risk that they actually will (which we still suggest is fairly low).
In many respects it is the severity of the risk that matters, rather than the chances that the worst will occur - market movements are frequently driven by perception rather than reality, and often overreact to news alerts (and sometimes to Trump tweets).
Secondly, the more tangible risk in the current geopolitical environment is arguably rising US interest rates, rather than trade wars knocking economic growth for six. Oil as trading at its highest level since late 2014, not helped by tensions with Russia, which brings inflationary risks. On top of this, any increase to tariffs will hit domestic prices in the first instance**
Fortunately Xi’s comments suggest Chinese tariffs may continue to fall, even though they remain above the US and Europe as can be seen in the Figure 6 below.
Concerns of rising US interest rates appeared to drive the initial selloff in stocks in February, so we expect volatility will remain elevated, but suggest that it won’t just be fears of trade wars that keep markets on their toes.
US tax cuts are one reason the Federal Reserve are forecasting higher US interest rates this year and next.*** Stock markets have a lot to think about in these fluid times, but China’s President Xi certainly seems to have placated the US administration for the moment on trade.
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* http://english.boaoforum.org/en/index.html
**wto.org/english/thewto_e/whatis_e/10thi_e/10thi01_e.htm
***federalreserve.gov/monetarypolicy/2018-02-mpr-part3.htm