Trump’s tactics dangerous: Watch actions not words
United States President Donald Trump has said he is ordering the US Trade Representative to consider imposing tariffs on an additional US$100 billion in Chinese imports.
This raises the possibility of an escalation in the trade conflict after China’s tit-for-tat response to Trump’s earlier 25 per cent tariffs on US$50 billion of Chinese goods.
Trade risk rising – brace for a bumpier ride
If we were to take Trumps’ US$100 billion claim seriously, a 25 per cent increase in tariffs on US$150 billion in goods - the US$50 billion already proposed in addition to Trump’s new US$100 billion - could tax a substantial amount of China’s exports to the US.
If China retaliates with the same magnitude, China doesn’t import enough US goods to match Trump’s latest proposal (See chart below).
At that level of escalation, tariffs imposed will bite economically.
Trump appears to believe he can win this argument through aggressive tactics while limiting economic damage.
However, each execution of his hard tactic (tariffs) creates the risk of further escalation, with the potential for miscalculation from either party.
Negotiation path more likely
The potential trade war is the biggest risk for markets now.
Our base case remains that negotiation and deescalation will be the rational path.
This is because the stakes are high. With US midterm elections in November, it is unlikely that the Trump Administration would want to go into a trade war with China which will be economically damaging.
Trump could be using the recent tough trade talks to gain political support from his constituents.
If Trump is rational and does not escalate the situation to a trade war, he can win economically and politically on three fronts – North Korea’s denuclearisation, trade concession with China and fulfilling his anti-trade promises to his electorate, all of which can be gained through a getting a good deal from his negotiations with China.
Watch for what Trump does, not what he says.
Remember last year, Trump was talking about total destruction of North Korea. Now he’s planning to meet with its leader.
What China could do next
While China's earlier tariff measures are proportionate in size to match that of the US, comments from Chinese policymakers were relatively measured, emphasising the importance of negotiations, and that China does not wish to enter a full-blown trade conflict.
How this conflict develops will depend on China’s next move.
On hard options, Chinese officials clearly have become more vocal, quickly announcing aggressive retaliation in response to the US 301 tariffs.
But it is seen as a precursor of how painful a full-fledged trade conflict will be for both sides, rather than being seen as simply the reciprocal to the US 301 actions.
On the softer approach, China wants to solve the conflict through dialogue and consultation.
In particular, President Xi has plans to continue to reform China’s economy and to further open its domestic market to foreign goods and companies.
It is in China’s interest to make some concessions in terms of tariff reductions and market opening, which will likely pave the way for a bilateral deal and avoid an all-out trade war.
What to watch out for
The next key development to watch will be responses from domestic constituents in the US over the impact of the tariffs.
Tariffs on products like soybeans and pork impact economic conditions in areas of traditional political strength for Trump and the Republicans.
Should Republican Congressmen start to make a meaningful legislative push, we could see the US administration adopt softer tactics such as an extended timeline for negotiation.
The planned tariffs in US remain under public consultation, and US companies could raise objections by May 22.
Meanwhile, a public hearing on the issue will also take place on May 15.
While both the US and China have acknowledged talks, and even some areas of common ground (tariff reduction, changing IP rules, China import liberalisation), few specifics (including negotiating timelines) have been discussed. Specifics may help dampen market fears that this conflict is becoming unstable.
Bear with the noise, trade war not base case
Trade rhetoric between the two countries may increase in the near term at least until May, and there could be a rise in market volatility during this period.
Eventually, we should see bilateral negotiations taking place.
Chinese policymakers have indicated their intention for further dialogue with the US to settle the trade issues, in the press conference following China's tariff announcement.
As the US proposal will take 60 days of public review before taking effect, we believe it will provide a window for further bilateral negotiation.
Incidentally, the US and North Korea talks are scheduled to be within this 60 day window.
One trump card that China has in this negotiation is North Korea.
China can make North Korea halt its nuclear ambitions, as North Korea is highly dependent on China for economic subsidies.
Investment strategy - Stay nimble, stay invested, stay diversified
Our base case remains for no trade war.
However, with the rise in trade tensions, 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 invested and diversified across asset classes.
From a portfolio context, we maintain our overweight in cash so as to tide through this period of uncertainty.
Remember that higher volatility is one of our key themes for 2018.
Additionally, on equity exposure, investors can manage risk by rotating out of companies with high exposure to US-China trade and also those that are vulnerable to trade risk.
While no markets will be spared from a trade war, Southeast Asian markets like Indonesia which are more domestically orientated, may be more insulated from rising trade risk.Disclaimer applicable to recommendation
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