Trade brinkmanship – a risky game
What’s going on here?
Markets are again under pressure because of escalating trade tensions, after the Trump administration raised the stakes significantly:
- Harsh rhetoric throughout the spring led to the first actual shot being fired last week, as the administration finalized the initial $50B list of goods, to which 25% tariffs will be attached come 7/6.
- China immediately responded in like measure, matching tariff levies dollar-for-dollar.
- Trump responded, asking the U.S. Trade Representative to draw up another list of $200B in imported goods, to which a 10% tariff would be applied, and he promised to continue building on that list should China again retaliate.
Why does it matter?
The tariffs alone are relatively inconsequential for the United States, representing less than 0.2% of the roughly $20T U.S. economy.1 Fiscal policy, through tax cuts and government spending, dwarfs the economic impact of tariffs. China faces greater consequences from these trade barriers, but even so, they fall well short of crippling.
That said, if China retaliates to the latest list, valued at $200B (which they have pledged to do), we would be adding another straw to the camel’s back. With further escalation, the risk of a tit-for-tat process, where the final straw will eventually break the camel’s back, should not be completely dismissed.
From an investor’s perspective, here are the things to watch:
- We expect the Trump administration to focus its efforts on China, but similar actions could impact trade relations with other nations – North American Free Trade Agreement (NAFTA) is particularly vulnerable.
- For multinational companies with global supply chains, this infuses an extra dose of uncertainty, which could hurt business confidence and lead to more caution on business capital spending, otherwise expected to be an important driver of the economy this year.
The market response has thus far been relatively modest – for good reason. First, fiscal policy provides a cushion to absorb the impact of tariffs. Second, tariffs will take time to come into effect. But, the stakes are now higher, and some pockets in the market are more sensitive than others.
Emerging markets: The emerging markets complex has borne the brunt of the action. Currencies and equity markets are down, bond yields up. We expect this trend would likely continue alongside trade action.
Size: U.S. small caps have been a relative haven from trade rhetoric throughout the year, as they are somewhat insulated from the global economy and the potential damage of protectionism.
Risk assets: Admittedly, the longer the trade issue drags on, the more challenging it will be for risk assets generally, small caps included. Treasury bonds would likely benefit, should we reach a tipping point and experience a severe flight to quality.
1. 25% on $50B is $12.5B and 10% on $200B is $20B, bringing the combined tariffs to $32.5B. That represents <0.2% of the $20T+ US economy.
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The North American Free Trade Agreement (NAFTA) is an agreement among the United States, Canada and Mexico designed to remove tariff barriers between the three countries.
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