Trump's tough trade tactics take their toll

Thought of the day

by Chief Investment Office 11 Jul 2018

Equities and bond yields declined after the US administration revealed a new list of USD 200bn worth of Chinese goods it plans to subject to a 10% import tariff. China’s commerce ministry protested the “shock” decision, warning it would retaliate.

China's CSI 300 index fell 1.7% on Tuesday, the Euro Stoxx 50 was trading 1.2% weaker and the 10-year US Treasury yield slipped 1.5 basis points to 2.83%. This latest escalation in tit-for-tat tariffs increases the probability of the risk case of a damaging trade dispute with significant economic and market impacts:

  • As the scope of tariffs widens, their direct negative economic impact is increasing. We estimate that if the US ultimately imposes a 10% tariff on USD 500bn of goods, US GDP would drop by 0.25 ppt. With the additional 10% tariffs on USD 200bn of Chinese exports, the first round impact on Chinese GDP of US actions so far could increase to 0.3-0.5 ppt during the following 12 months. Assuming the entire burden of these announced tariffs falls exclusively on S&P 500 firms, we would expect a hit to profits of about 2.7% ppt. With earnings on track to grow close to 20% this year, this direct cost might not seem too serious.
  • But second round effects could be more significant. The Federal Reserve has already noted that businesses are citing the impact of trade tensions in delaying investment and hiring decisions, with a knock-on effect on revenues elsewhere in the economy. As the range of goods subject to tariffs widens, supply chain disruption grows, and the ability to substitute goods from alternative origins falls, increasing the impact on consumers. A trade conflict could also have a chilling effect on investor sentiment.
  • The Trump administration's hard line on China gives little reason to expect a conciliatory approach in other disputes. If the US carries through on its threat to increase tariffs on EU auto imports from 2.5% to 20%, we estimate a 15-20% hit to auto sector profits (assuming carmakers can only pass on a 5% price rise) and a reduction in overall MSCI EMU profit growth this year from 7.2% to 6%. 

The strength of the US economy and the stock market could embolden the US administration to continue its aggressive approach. Further escalation remains a risk and has already distracted attention from strong economic and earnings fundamentals. These positive fundamentals should help support equities, but in an environment of increasing trade risk it is prudent to consider downside equity protection and counter-cyclical positions, such as long US Treasuries, that should perform in the risk case.

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