Dan Scott: «Markets React on Fears of a New Trade War – Justified?»

Dan Scott: «Markets React on Fears of a New Trade War – Justified?»

The recent announcement of new tariffs on Chinese imports led to market uncertainties due to fear of a trade war. What can Asian investors expect?

By Dan Scott, Deputy CIO Vontobel Wealth Management in Zurich

When Donald Trump spoke at the World Economic Forum in Davos two months ago, he fleshed out a new doctrine for U.S. economic trade with the rest of the world. Rather than building trade barriers, the new doctrine was to create a level playing field between the U.S. and its counterparts.

Since then, he has announced tariffs on steel and aluminum, has raised the prospect of further taxes on finished goods, such as automotives and last week announced the levy of new tariffs on as much as $60 billion of Chinese imports.

Investor’s Sentiment Rattled

These recent actions have raised fears of a global trade war and have rattled investors’ sentiment as witnessed by last week’s sharp drop in global equity markets.
Indeed, the main driver for equity markets – global synchronized economic growth – which results in strong corporate earnings would be at risk in case of a global trade war.

Whilst markets are correct in pricing in a higher degree of uncertainty, a full trade war as suggested by the recent sharp drops in global equities seems unlikely.

Reasons Behind

Firstly, we should not forget that Trump gearing up for the mid-term election. The recent election result in Pennsylvania, a State held by the Republicans for 15 years and where Trump had a 20 percent margin over Hillary Clinton, suggests that U.S. Congress could shift to the Democrats in November.

This explains why Trump is using a more aggressive rhetoric namely versus China, which he had accused of stealing U.S. manufacturing jobs during his campaign, hence making him very popular with voters in the «rust belts». This rhetoric is likely to continue as the mid-term election campaign gathers pace.

High Degree of Flexibility

Secondly, Trump has shown a high degree of flexibility with regards to various trading partners. Whilst he had announced tariffs of 25 percent on all steel and 10 percent on all aluminum imports three weeks ago, he has since exempted all EU countries, Canada, Mexico, Brazil, Argentina, South Korea and Australia.

This suggests, that the Trump administration is aware of the potential damage a trade war could have on the U.S. economy and is keen not to harm economic growth. The latter is a key ingredient for Trump’s popularity with U.S. voters.

Strong Advocate of Free Trade

Thirdly, the appointment two weeks ago of Larry Kudlow as Trump’s new top economic advisor suggests, that the U.S. President is neither a die-hard protectionist nor against free-trade.

Indeed – Kudlow, a former Chief Economist of Bear Stearns, who became a commentator on «CNBC», is well known for being a strong advocate of free trade and was the first to criticize the tariffs on steel and aluminum stating that they would only harm the U.S. economy.

Lastly, the new U.S. tariffs represent only small percentage (approximately 10 percent) of Chinese imports to the U.S. It is therefore unlikely that China, which is keen on protecting its economic growth would enter in a fully blown trade war with the U.S. This explains China’s measured response to the U.S. tariffs.

Important to Remember

In conclusion, whilst the current discussions over tariffs are rattling investors’ nerves, a global trade war, which would hurt all parties and reduce global economic growth therefore affecting corporate earnings, seems unlikely.

It is also important to remember that the U.S. economy is more open (i.e. less tariffs and import barriers) than the EU’s and Chinese economy. Should the new U.S. doctrine of trade «reciprocity» lead to more open economies at the U.S.’ key trading partners, rather than being a hindrance, this would be a benefit for global trade and therefore global economic growth.