Global Macro: Direct impact mostly on inflation, but watch financial conditions and confidence – US president Trump re-escalated the trade dispute with China over the weekend, with a pair of tweets threatening to raise the tariff on USD200bn of China imports to 25% from 10% by this Friday, and potentially imposing a 25% tariff on the remainder of China imports (c.USD325bn) further down the line. This repeats a threat Trump had made before the temporary truce was announced last November. While it is unclear what prompted the latest threat, and how China and the US will proceed from here, what we can do is look at what the macro effects might be should the threat be followed through upon. The most direct and easily quantifiable impact would be on US inflation. A 25% tariff imposed on all Chinese imports would boost core inflation by a cumulative 30bp over 2019-20. This impact may seem modest, but it reflects a number of factors: 1) that the impact is likely to be blunted by yuan depreciation versus the US dollar; 2) that core goods has only a 25% share of the core CPI basket (the remainder being services), and 3) that Chinese imports represent around 18% of core goods consumption. As with higher wage costs, it is possible that businesses try to absorb these higher prices, particularly if they do not believe the tariffs are permanent and could be revoked once an agreement is reached between the US and China. As such, the impact might be even less than the 30bp indicated.
The impact on growth is much less clear. The direct effects on US growth amount to a rounding error for the near-term, given that Chinese imports represent just 2.5% of US GDP, that a tariff rate of 25% is hardly prohibitive, and that there would be compensating factors (for instance, diversion of trade to other exporters, higher domestic production). For China, the direct impact on growth would be more significant (the US still is China’s largest export destination, with a share of almost 22% in 2018). That said, we would expect Beijing to come with more policy easing to keep the fall-out as limited as possible. In fact, the PBoC today implemented additional targeted RRR cuts for rural commercial banks. In any case, risks to our 2019 growth forecast of 6.3% would certainly switch to the downside if the trade conflict would re-escalate (before Trump’s latest tweets, risks were tilted to the upside in our view, with increasing signs of improving momentum over the past few months).
In addition, the experience of 2018 – which saw a significant decline in global trade growth, and a stagnation in global manufacturing – might be illustrative of the more pernicious indirect effects, namely through the financial conditions and business confidence channels. It is hard to disentangle the impact on financial conditions of the trade war from tighter Fed policy and Chinese domestic deleveraging, while monetary and fiscal policy in both the US and China are now more growth-supportive than last year. However, the violent market reaction to President Trump’s tweets at the weekend (which saw Chinese stocks fall close to 6%) suggests the trade war could lead to a significant tightening of financial conditions, in turn dampening business confidence, even if policy might be more of an offset this time around. In such a scenario, the current malaise in manufacturing – only now showing tentative signs of recovery – would persist for longer, in our view, and likely cause us to review our base case scenario of a recovery in global growth in the second half of 2019. (Bill Diviney & Arjen van Dijkhuizen)