Trade tension: First direct shot at China
The US government plans to impose 25 per cent tariffs on US$50-60 billion in annual imports from China, as President Trump on 22 March, signed a memorandum on the planned actions related to an investigation by the United States under Section 301 of the 1974 Trade Act.
Section 301 allows the US president to take unilateral action against countries found to have unjustified, unreasonable or discriminatory policy with regards to US trade.
The US Trade Representative will deliver a proposed list of products subject to higher tariffs within 15 days, targeting 10 key sectors identified by the “Made in China 2025” plan, including robotics, aerospace, information and communication technology, and machinery, followed by a 30-day period for public comment.
The US Treasury will also unveil a detailed plan regarding US investment restrictions on China within 60 days.
China took its first retaliatory action by announcing a list of 128 products, with total value of $3 billion, that China plans to impose additional tariffs on US imports, in response to US tariffs on steel and aluminum.
Initial assessment of Trump’s first shot at China
According to our Chief Economist Richard Jerram, a 25 per cent tariff on $50 billion of imports is just under 10 per cent of total imports from China.
So far, there are not too many details on the sectors.
The US will just buy from the next cheapest provider, not make them in the US.
It is estimated to be about 0.25 per cent of US GDP, so a small impact - slight negative for growth, marginal boost for inflation.
The outcome is bad for China but not a disaster - by value-added about 4 per cent of China's GDP is exports to the US, and the tariffs directly affect one-tenth of this.
What could China do?
So far, the initial measures from Trump and China are relatively muted. It could be far worse.
The bigger impact is whether it escalates. China needs to calibrate its response carefully to cause some discomfort, but without provoking another round of retaliation.
The room for miscalculation seems to be high, both in terms of provoking Chinese retaliation or taking measures that end up hurting the US economy.
The hope is that there is rationality from both parties.
Hopefully, the Chinese would be pragmatic and their reaction to any product-specific tariffs will likely be restrained and proportional to avoid escalation.
However, in the case of more serious US trade actions, they could retaliate against major US exports including aircraft, autos and agricultural products.
Scenarios for US-China trade tensions
Historically, imposing tariffs is not the main goal of a Section 301 investigation. It is more of a negotiation weapon to force an agreement in favour of the US.
In most cases, the investigations led to new trade agreements shortly after, with overarching outcomes involving the target country (Japan or China) opening up its domestic markets, reducing subsidies to exports or committing to IP protection.
At this juncture, we are at the beginning of how section 301 can be used.
There are various ways in which section 301 can evolve.
1. Not Bad: Bilateral agreement to cut the US-China trade deficit by a sizeable amount, say US$100 billion, over a sensible time frame, resulting in a de-escalation of the situation. It may involve China ensuring IP protection and opening its domestic markets to US firms.
2. Bad but no disaster: Targeted use of Section 301, levying a 25 per cent tariff on US$50-60 billion of Chinese high-tech products and a measured response from China (with measures broadly compatible with WTO rules). Chinese policymakers may step up efforts to reduce imports from the US. This could include cutting imports of US agricultural products and transportation equipment, restricting domestic sales of some US products and raising tariffs in selected sectors.
3. Ugly: Aggressive use of Section 301, resulting in a broad-based tariff hike across all Chinese goods, and a commensurate response from China. Moreover, the impact would extend and be amplified by global value chains and only be partially offset by easier policies, resulting in a material drag on global growth.
It is difficult to assign a probability on how the situation will evolve.
Trump has argued for decades that the movement toward trade liberalisation has shortchanged US workers. He made this an important theme during his election campaign.
If Trump’s anti-trade stance is taken seriously and he behaves “irrationally”, the probability of a trade war cannot be ignored
Market impact depends on next move
Trade friction is not good for markets. Historically, stock markets underperform during past episodes of trade conflicts.
Rising trade tension is not positive for Asian equities as Asian markets are higher beta markets and would be more volatile when risk aversion rises.
More importantly, Asian corporations are well integrated in the network of global supply chains and depend largely on global trade.
Markets are bad at pricing geopolitics and trade tensions. It is hard for markets to price and predict what China and US would do.
The uncertainty is whether Chinese will retaliate further and how Trump respond from there.
To be sure, there is still considerable uncertainty over the outlook for trade policy, which could weigh on business confidence.
However, underlying demand conditions are still well supported, particularly the strong capex cycle, and will matter more to growth for now.
Investment strategy – Be nimble and manage risk
There is a need to manage risk from an investment strategy perspective.
Investors should be nimble to adjust positions should the situation deteriorates.
At this stage, investors should stay engaged.
From a portfolio context, we maintain our overweight in cash so as to tide through this period of uncertainty.
Buying portfolio protection through put options makes sense.
Additionally, on equity exposure, investors can manage risk by rotating out of companies – with high exposure to US-China trade - that are vulnerable to trade risk.Disclaimer applicable to recommendation
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