US-China trade: continuing the talks while making the war

What is your assessment of the potential impact of new tariffs? 

Overall, uncertainty has increased with regard to a risk that most investors and analysts thought had reduced and was on the way to some sort of solution. Higher tariffs will hurt everyone, from Chinese exporters to US consumers. With a possible delay of one or two months, inflation in the US will be impacted as a large number of consumer goods will be subject to the tariffs and as US companies look to change their supply chain. The capacity of US corporates to absorb the increased costs is in doubt, and in any case this would impact their bottom line. However, based on the different degrees of policy interventions, the impact on global growth and trade should be contained to a certain extent, while we do not expect an outright recessionary scenario either in China or in the US. Unlike what happened in 2018, the authorities in China are now better equipped to offset external shocks and local sentiment looks less fragile. On the other hand, the Federal Reserve’s stance is more accommodative than it was last year. A reassessment of the outlook will be necessary should the tariffs on the remaining imported goods (worth roughly $300bn) eventually occur.

Considering the wide spectrum of goods involved (about 6,000 products), we reiterate the view that there may be different channels of reaction to such a decision. The countries more integrated with China in the production chain will suffer the most, while exporting countries that compete with China could benefit, both from increasing their export share to the US and from the production relocation of certain manufacturing sectors. Vietnam and Mexico are among the countries that may benefit, with some caveats related to US foreign policy. Vietnam could be included among the currency manipulators list (if that list is enlarged and some parameters further narrowed), while Mexico is still waiting for USMCA (United States-Mexico-Canada Agreement) ratification by Congress.

Which countries and sectors are most at risk in the Asian region and what could the next issues for investors to watch be, if any?

Increased tariffs could have a significant impact on the Asia region considering both its high correlation with global trade and the economic role of China in the area. The countries most impacted by tariffs are likely to be Korea, Hong Kong and Taiwan, whereas India should be the least affected among the region’s countries. Overall, the globalisation trend has benefitted most of the Asian countries in the past 25 years and now they will inevitably feel the pain of the stalling of this trend. Across sectors, the automotive industry is in the weakest position, together with the rest of the industrial sector.

The level of the main Asian currencies vs. the US dollar is definitely a very relevant factor to monitor. The Hong Kong Dollar (HK$), the Chinese Yuan (RMB) and the Korean Won (KRW) have all started to show signs of weakness recently and, as long as those currencies remain weak, the “risk-off” scenario for emerging markets equities will be in play.

What would you expect the markets to do in light of recent events and potential trade developments?

The escalation of global trade tensions is clearly negative for risk assets. However, the market sell-off seems to have been moderate so far, as investors are perhaps waiting for the result of the talks as they see the continuation of the negotiations as a clue that both parties are still keen to reach an agreement.

So far, albeit talks seem to be proceeding with slow progress, our base case remains that a deal between the US and China will finally be reached. We continue to see some encouraging signals coming from both parties, which allow us to remain confident that negotiations can continue (Xi wrote a “beautiful letter” to Trump, who then said that US-China relations remain very strong and that he feels the China talks will be successful). That said, the path to a final deal could be tougher and longer than was once expected.

We should now expect markets to enter a consolidation phase, while investors try to get to grips with what the next developments might be and whether global and earnings growth will surprise on the upside or downside. In our base case scenario, with the global economy recovering in the second half of the year and central banks remaining accommodative, episodes of market volatility may create attractive entry points in markets with compelling valuations, such as the European and emerging stock markets.

Nonetheless, challenges remain across the board and, at this juncture, we suggest  maintaining a cautious stance. In particular, we believe that a potential escalation of trade tensions (if the US actually applies tariffs on all of the remaining Chinese imports, China announces a further retaliation or there’s a full breakdown in negotiations) is not fully priced into markets yet and, as a consequence, it would impact short-term sentiment and trigger a major sell-off in risk assets. It is clear that recent macroeconomic improvements would also be jeopardised should the negotiations fail, leading us to reassess our current growth and earnings estimates. However, this is not our base case scenario at the moment.