Trade tensions between the U.S. and China have broad economic implications that go beyond bilateral trade. Our base case is that they will not escalate into a trade war.
We see the trade actions implemented so far as limited and unlikely to derail the benign economic and market backdrop–as long as they do not worsen into a trade war that could harm global growth prospects.
Components from abroad represent nearly half of Chinese manufacturing exports. For Chinese electronics exports–a key sector likely to be affected by any U.S. tariffs–three-fifths worth of the value added is created beyond Chinese borders. The U.S., Europe and Japan are all big component and intellectual property suppliers to China for goods to be re-exported and sold elsewhere. On the flip-side, the U.S. supply chain is much more homegrown. U.S. tariffs on China–and any resulting retaliatory measures–could cause widespread economic fallout by affecting such global supply chains if tensions escalate.
No trade war for now
The U.S.’s new transactional trade approach runs counter to the rules-based global trade system it has long championed–and is a key risk to the global economy and markets. A trade war would likely have a knock-on impact on confidence and hurt emerging market (EM) exports, which stand to benefit from a business spending recovery underpinning global trade.
Yet recent U.S. negotiating tactics have followed a consistent pattern: headline announcements spooking markets, followed by compromises and narrow implementation. Most major U.S. trading partners are now exempt from what were initially global steel and aluminium tariffs. U.S. President Donald Trump’s tariffs on Chinese goods triggered another bout of market volatility. Yet the order contained no immediate action and left the door open for talks.
We expect that China will negotiate to avoid a trade war, as it would challenge its growth outlook and undermine policy priorities such as deleveraging. A few options are available for making the trade relationship more reciprocal–a key U.S. demand–and helping trim the U.S. trade deficit. These include opening up service sector foreign ownership limits; reducing import taxes; loosening technology transfer requirements for direct investments; and increasing U.S. imports. Such measures may let the U.S. claim victory without hurting the global economy. Markets may breathe a sigh of relief and rally. Yet the path to such an outcome may be bumpy–and we see trade as both an upside and downside market risk.
What triggers would make us more worried? These include: the U.S. implementing broader trade actions; experienced trade pros at the helm of U.S.-China talks losing control of negotiations; or China retaliating with meaningful trade measures or–much less likely, in our view–with currency devaluation or selling of U.S. Treasuries.
Trade tensions and U.S. fiscal stimulus widen the array of potential economic outcomes in 2018, yet our base case is a steady expansion underpinning risk assets. We outline our thinking, update our themes and detail our asset preferences in our new Q2 2018 Global Investment Outlook, and read more market insights in our Weekly commentary.