The Trump administration has announced 10% tariffs on $200 billion of Chinese imports, which took effect on 24 September 2018 and this will further rise to 25% on 1 January next year.
In a statement, US President Trump said “if China takes retaliatory action against our farmers or other industries, we will immediately pursue phase three, which is tariffs on approximately $267 billion of additional imports”.
Despite Trump’s fiery rhetoric, Chinese retaliation appears likely, in our view, and the Chinese authorities have already released a potential list of $60 billion of goods from the US that would be subject to tariffs in response.
In 2017, the US imported $505 billion of goods from China while it exported $130 billion in the other direction.
This latest round of US tariffs brings the total amount of Chinese imports taxed to $250 billion - roughly half of all Chinese imports in 2017.
Tariffs tend to have stagflationary effects: they limit growth and drive inflation. Rising prices for consumer goods, in particular, tend to be unpopular.
While the initial $50 billion round of US tariffs had assiduously avoided finished consumer goods from China - and the latest round on $200 billion of goods continue to lean in this direction - this will be increasingly difficult to achieve as incremental rounds of tariffs cover ever more Chinese imports.
All considered, however, given that $250 billion forms only about 1.3% of US GDP, the overall impact on growth and inflation seems manageable at this point.
Over the other side of the pond, the Chinese are cognisant of the impact on China’s economic growth and are already taking offsetting measures, including loosening credit, lowering interest rates, supportive fiscal policies and also allowing its currency to depreciate (although this seems to have hit the limits of tolerance as the Chinese yuan approaches 7.0 level against the USD).
This latest round of tariffs appears to have been somewhat priced in and did not severely shock markets.
The S&P500 closed 0.6% down, which was not a steep decline.
The CNH and Asian equity markets similarly sold off at the open this morning but the magnitudes are limited so far.
The muted reactions from Treasuries and safe havens, such as the Japanese Yen, also reflect fairly orderly investor sentiment.
We note that Asian equities have significantly underperformed the US market over the last six months as tensions escalated, and the divergence is one of the most stark since 2010.
Since 19 March 2018, the MSCI Asia Ex-Japan (MXASJ) Index has underperformed the S&P500 Index by 20%, further widening the valuation gap between the two markets.
The forward PE of the MXASJ index is currently trading at 0.3 standard deviation below its 10Y average level (versus the forward PE of the S&P500 index at about one standard deviation above the 10Y average).
At current levels, the risk-reward for Asia ex-Japan equities appears attractive for investors with longer holding periods, which underpins our move to an overweight position in Asia ex-Japan equities at the start of September.
That said, we caution market volatility will be par for the course ahead as we enter the last quarter of this year.
There is still residual uncertainty over how the other shoe from China will drop in response to President Trump’s latest salvo, and we also do not expect a positive breakthrough in Sino-US trade talks before the US midterms elections in early November.
Latest polls show the Republicans likely losing their house majority, and the Chinese will be keen to see how the political situation evolves before starting meaningful trade negotiations.Disclaimer applicable to recommendation
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