Global Daily – Trade war fears strike back

by: Bill Diviney , Arjen van Dijkhuizen , Nick Kounis , Aline Schuiling

Global Trade: Navigating the US-China trade spat – Following a period of conciliatory rhetoric and negotiations between China and the US in May, tensions have once again flared up between the two sides. It started last week with the US announcing that it would follow through on its 25% tariff threat on $50bn of Chinese imports. After China’s proposed retaliation (conditional on US implementation), tensions have since re-escalated with President Trump’s threat of an additional 10% tariff on $200bn of imports (and potentially a further $200bn if China retaliates). It is easy to get lost in the many numbers thrown around, but the 10% tariff is much lower than the 25% rate we assumed when the President threatened an additional tariff on $100bn of imports back in April – before the two sides started negotiating.

We cannot know whether the latest round of escalating rhetoric will again lead to negotiations, or whether it will lead to a follow-through on threats, but in the meantime, we believe investors should focus on two key factors: 1) what is actually being implemented, rather than threatened, and 2) how business confidence is responding.

First, in terms of implementation, tariffs are due to be imposed on 6 July on $34bn of imports from China (6.7% of 2017 imports from China), with a further tariff on $16bn still subject to consultation. China has not yet implemented its proposed retaliatory measures, which are conditional on US implementation. As such, we currently remain within the base case outlined in our Trade war scenarios report, with a broadly constructive global growth and trade outlook in tact.

Second, in terms of business confidence, while there appears to have been some impact in Europe from a separate trade spat, there has been no lasting impact from trade tensions in the US and China, although equity markets (particularly in Asia) have been hit. The recent escalation in rhetoric could well change matters – by for instance causing companies to delay or cancel planned investments – but we have yet to see evidence of this. Should business confidence start to fall significantly, however, we believe this would be enough to cause the Fed to pause in its rate hike cycle (see here) and for the Chinese authorities to further soften their targeted tightening campaign (see here).

The latest escalation in tensions certainly moves us closer to our ‘negative’ trade scenario, and markets are responding in a classic risk-off manner, with safe havens outperforming. However, despite the fiery rhetoric, we remain within our base scenario for the time being. (Bill Diviney & Arjen van Dijkhuizen)

ECB View: Draghi points to uncertainties to growth and inflation outlook in Sintra speech – In his speech during the ECB Forum on Central Banking in Sintra today, ECB president Mario Draghi pointed to the uncertainties surrounding the ECB’s forecasts for growth and inflation. Mr Draghi broadly repeated the ECB’s policy decisions and his press statement of last week’s Governing Council meeting (see here), but also mentioned that ‘uncertainty permeates the economic outlook’. In his Sintra speech, Mr Draghi referred to some temporary supply-side factors, such as weather conditions, that supressed Q1 growth. However, he also said that some supply-side factors might be of a more persistent nature, such as capacity constraints that are related to a lack of capital deepening (i.e. fixed investment growth) during the current economic recovery. The ECB expects these supply-side factors to slowly unwind over the medium term. However, in the nearer term, closer attention needs to be paid to developments on the demand side of the economy, according to Mr Draghi. In highlighting the increased uncertainty surrounding the growth outlook, he mentioned downside risks coming from three main sources: the threat of increased global protectionism (see also above), rising oil prices triggered by geopolitical risks and the possibility of persistent heightened financial market volatility.

In addition, the central bank president mentioned that ‘the reaction of inflation dynamics to accelerating growth has been atypically slow in recent years’, which has ‘injected quite some uncertainty into understanding and forecasting wage dynamics’. Overall, as was also mentioned after the June Governing Council meeting, the ECB sees ‘grounds to be confident that the sustained convergence of inflation towards our aim will continue in the period ahead, and will be maintained even after a gradual winding down of our net asset purchases’, but Mr Draghi’s Sintra speech suggests that the level of confidence is not very high. Indeed, we think that given the uncertainty about the economic outlook and weak underlying inflationary pressures, the balance of risks is skewed towards the ECB waiting even longer for its first rate hike than our base case of September 2019. (Nick Kounis & Aline Schuiling)