Tariff wrecking ball to hit global growth

Pivoting back to China, there is little hint of progress on the US/China trade front as the situation continues to worsen. Both sides continue to blame the other for the breakdown in negotiations an impasse that is unlikely to be rectified until Trump and Xi meet in Osaka at the G20 summit. It remains apparent that trade is a mere sideshow to the unfolding fight for technological and economic supremacy, and we should be ready for a long and protracted battle between the US and China.

As if the threats to rare earths are not enough to illustrate the growing US/China rift, the Chinese Ministry of Commerce announced that it would be establishing its own list of “unreliable entities” late Friday. This is a clear retaliation as tensions have risen since the US blacklisted Huawei. The list will target “foreign businesses or individuals that do not abide by market rules or contractual agreements as a result of economic sanctions imposed against China or severely damage the legitimate interests of Chinese industries” said Ministry of Commerce spokesman Gao Feng. Expect companies that cut ties with Huawei, China’s tech champion, to be targeted. 

Shortly after, China’s state-run news agency Xinhua reported that China is opening an investigation into FedEx. According to Xinhua, FedEx failed to deliver express packages to designated addresses in China, “seriously damaging the lawful rights and interests of its clients and violating laws and regulations governing the express industry in China.” This probe comes as Huawei raises concerns that packages destined for addresses in China were diverted to US without authorisation, another retaliation for the US' moves against Huawei.

Over the weekend China released a white paper on trade blaming the US for the breakdown in negotiations, stoking nationalist sentiment and outlining a firm stance on protecting Chinese sovereignty. The white paper states that at the most recent talks in May, the US used “intimidation and coercion” and “persisted with exorbitant demands, maintained the additional tariffs imposed since the friction began, and insisted on including mandatory requirements concerning China’s sovereign affairs.” The paper goes as far as to troll Trump’s 2016 campaign slogan saying the escalating trade war hasn’t “made America great again”.

The paper also lays down Beijing’s prerequisites for reaching a trade deal, including the US removing additional tariffs, realistic purchases of US goods and a balanced agreement. This is a far cry from President Trump’s current stance –“TARIFF is a beautiful word” – so on that basis alone a deal on trade seems a long way off. 

As escalating trade tensions across the globe cause growth expectations to be altered lower, risk-off sentiment will remain and volatility will likely increase from here. The implications of a permanent shift in the US/Chinese relationship are hard to fathom as globalisation has profoundly entwined supply chains, but investors should not dismiss the notion of a splintering US/China relationship and the effect this could have on risk premiums. And now we have potential tariffs on Mexican goods to contend with also, another nail in the coffin of higher risk premiums.

Despite all this, the Fed continues to preach patience given a strong US economy. Even perma-dove Kashkari is “not quite there yet” on rate cuts. But bond markets are screaming the opposite, and equities are finally waking from their complacent climb to date propelled by dovish coos from central banks.

But as trade tensions continue to escalate, financial conditions tighten, business confidence is dampened and supply chains are forced to unravel, a dovish chant will no longer be enough to support growth. The bond market sniffed this growth slowdown out sometime ago, equities are catching on and once the Fed wakes up, rates will likely be cut.

Our view remains that until we see a more robust macro environment and confirmation of a self-sustaining re-acceleration in economic growth, it’s time to move into capital preservation mode. Global markets remain vulnerable as they are yet to fully price in the unfolding fight for technological supremacy between the US and China, let alone a new dimension of uncertainty as Trump wields his tariff stick on Mexico under the guise of national emergency.