22 Jun 2018
In the previous edition of the Global Risk Radar ("Look beyond the noise"), we argued that investors need to be cognizant of some of the market risks that could potentially end the global business cycle. But just as importantly, investors need to look through short-term news that may affect market sentiment but not impact their portfolios over the relevant time horizon.
The risk of rising protectionism offers a bit on both ends. On the one hand, protectionist policy could become a strong economic force wreaking havoc on global risk assets and, potentially, even causing a global recession. On the other hand, all of the tariff announcements that have moved markets in recent weeks are poised to have no discernible impact on the global economy.
On Friday 15 June, the US administration released the final list of imports from China that will be subject to 25% tariffs in response to the Section 301 investigation on Chinese intellectual property (IP) practices. The previous list of goods announced in April has been scaled back from USD 50bn to USD 34bn and will go into effect on 6 July. An additional group of new products (worth USD 16bn) will undergo further review and public consultation before it is implemented. Overall, the two lists refocus the target on key fields within China's "Made in China 2025" industrial policy as robotics, aerospace, energy vehicles, semiconductors, and high-technology equipment. According to the US Trade Representative, the list "does not include goods commonly purchased by American consumers such as cellular telephones or televisions," highlighting a preference to tax intermediate goods over consumer goods for the moment.
A few hours after the US announcement, China responded firmly by posting its own retaliation measures. Apart from declaring that all trade deals achieved during the previous negotiations will become ineffective, China released a first list of USD 34bn worth of US agricultural products and automobiles subject to a 25% tariffs, effective 6 July. While the first group will clearly put pressure on US farm states – President's Trump support base – the 25% tariff on a second list of USD 16bn will target chemicals, medical equipment, and energy products, and will be implemented at a later stage.
- US: The tariffs imposed by the Trump administration thus far should have a very minimal impact on US growth and inflation. The USD 50bn of imports from China account for only about 2% of all US imports, and the latest USD 12.5bn in tariffs (25% of USD 50bn) is less than 0.1%of the US economy. The effect on inflation is even more modest. We estimate that the effect of all tariffs imposed so far will increase inflation by 0.03 percentage point. But with the Fed's preferred measure of inflation, core PCE, already close to its 2% target, and with factors such as the large fiscal impulse increasing the upside risks, any incremental inflation may force the Fed to raise rates faster than investors currently expect. If concerns about a trade war persist, the drag on economic growth could increase, albeit slightly, because uncertainty over the final outcome could delay or deter corporate investment. The effects on growth and inflation will be amplified if a second round of a 10% tariff is imposed on USD 200bn of goods. The cost to GDP could be 0.2–0.3 percentage point, while the impact on inflation should remain modest at less than 0.1 point.
- China: The first round of bilateral tariffs (USD 50bn) is around the corner, despite China's efforts to avoid escalated tension at the very beginning. China's goods exports to the US accounted for about 19% of total Chinese goods exports in 2017, and the 25% tariffs on USD 50bn of Chinese exports may lower China's GDP growth by about 0.1% as a first-round impact. However, if the US extends the tariff list to another USD 200bn or above, the overall impact on China's GDP growth would be amplified. On top of economic implications, trade tensions could negatively impact supply chains, weigh on investment sentiment, and potentially revive geopolitical risk in the Korean peninsula. As a result, China may ease monetary and fiscal policy to offset an economic downturn amid a potential negative impact from external trade.
Protectionist policy through the lens of a global tactical investor
As with other market risks, the relevance of rising protectionism to a global investor with a tactical horizon of 6–12 months depends on the economic impact of the implemented protectionist measures. We broadly classify protectionist policies into three categories, according to their potential impact on a global portfolio:
- Bilateral tariffs on standard goods: Bilateral (isolationist) tariffs are targeted against a single exporter, while a standard good is produced by many exporters and traded in a global market (e.g. steel, crude oil, soy beans, etc.). A bilateral tariff on a standard good should not reduce global trade noticeably since the importer can source the good from elsewhere.
- Bilateral tariffs on nonstandard goods: When the targeted goods are not easily replaced by imports from other producers (e.g. Harley Davidson motorbikes), profits of the exporter will likely be impacted. The magnitude will depend on the size of the tariff and affected sector.
- Multilateral tariffs: Multiple countries may apply a tariff against a single exporter (e.g. sanctions on Iranian oil exports), or implement broad-based tariffs against multiple trading partners (i.e. a trade war). When a single exporter is targeted, global economic impact will depend on the exporter's size; however, the exporter will always be affected much more than its trading partners.
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