Macro Monthly | Market Commentary Trade tariffs raise tension

Trade protectionism is at the forefront of global investors' minds. Are there any implications for asset allocation from this tension?

21 Mar 2018
  • Global trade tensions are rising amid the Trump administration’s imposition of steel, aluminum, and Section 301 tariffs
  • Still, country exemptions suggest the administration is using trade steps as a negotiation tool rather than first strike in a trade war
  • Section 301 investigation into China’s use of intellectual property concluded that China engaged in unfair trade practices resulting in USD 50 to USD 60 billion in tariffs on Chinese imports
    • The Trump administration is particularly focused on China given the country makes up nearly 50% of the US trade deficit and is viewed as a strategic competitor. It will not go unnoticed by President Trump that the US-China trade deficit has widened since he took office.

China makes up nearly half of the US trade deficit
(As at Q1 2018)

Source: US Census Bureau, UBS Asset Management

US trade deficit with China has widened since Trump took office

Source: Datastream, UBS Asset Management

  • While these tariffs are likely to be used as a leverage tool in further trade negotiations with China, they also pose a risk of retaliation
  • While not our base case, a full blown trade war would pose meaningful downside for global equities, particularly emerging markets
  • We maintain exposure to US Treasuries and non-USD reserve currencies to hedge against an escalation in trade tensions

The bottom line: Asset allocation

At this point we view incentives within the administration as sufficiently aligned to avoid a major trade confrontation. We thus remain overweight equities given the still constructive macro backdrop and gradual removal of accommodation from central banks. That said, we maintain exposure to US duration in the event of a flight to quality due to trade. In currencies we have a bias to be underweight the dollar versus reserve currencies like the JPY and EUR, which provide a hedge against disruptive developments on the trade front.

The bottom line: Chinese equities and fixed income

While the Section 301 tariffs announced by the US increase the level of uncertainty, it’s worth noting that even if they are executed in full, we estimate the impact on China’s GDP to be just 0.1% - 0.2%. And this figure can be mitigated by further diversification of exports to other countries. Our view is that despite the negative headlines, there are clear signs that both sides have left room for negotiation and compromise. We believe that both the US and China are fundamentally pro trade and keen to avoid a major escalation.

Within China equity portfolios some of our stocks do have a small component of revenue exposure to the US. But overall, these portfolios are predominantly exposed to the theme of China’s economic rebalancing from ‘old economy’ manufacturing toward ‘new economy’ consumption and services. With a focus on the domestic economy rather than exporters we believe we are well positioned to ride out this volatility with key holdings in healthcare, consumers and internet/ecommerce.

Within China fixed income portfolios, our view is that these tensions will ultimately amount to very little. There are some clear lessons from the past. In the 1980s, the US threatened Japan with wide-ranging tariffs to address deficits, open up Japanese markets, and protect US firms’ intellectual property. While various special commissions investigated trade malpractices, what happened then largely boiled down to political noise. We see a similar scenario this time round.

Of much greater significance is the announcement today that RMB-denominated Chinese bonds are to be phased in to the key Barclays Bloomberg Global Aggregate Index over a 20-month period starting April 2019.

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