US China Trade Wars Round 2

Principal Economist View

What a difference a year can make. This time last year, President Trump’s focus was on delivering large-scale tax cuts. Tax cuts that finally passed Congress in December and are responsible for the strong, above-trend economic growth currently being experienced in the US economy. However, after focussing on fiscal stimulus for much of 2017, President Trump’s attention has shifted to trade protectionism in 2018. With minimal progress on trade negotiations with China, the US this week commenced Round 2 of President Trump’s trade war.

On Monday, the US announced an additional 10% tariff on around US$200 billion of imports from China, across 5,745 product lines, commencing 24 September. While this move was less than had been threatened by Trump, the tariff rate will increase to 25% from 1 January 2019. The tariffs predominately target capital and intermediate goods, although around ¼ of the tariffs (by value) are directed towards consumer goods. Telecommunications equipment (particularly modems and routers), computer parts and accessories, furniture, seats, auto parts, lamps and luggage/handbags are just some of the products that are heavily exposed to these Round 2 tariffs.    

As expected, China retaliated to the US tariffs, although the retaliation was in a less-than proportionate manner. China will impose tariffs on US$60 billion of imports from the US, with around three-fifths of the imports facing a 10% tariff rate and two-fifths a 5% tariff rate. Although China refrained from stating whether it would retaliate to the tariff hike on 1 January 2019, we expect the Chinese authorities would escalate the 10% tariffs to a combination of a 25% and 20% rate and lift some of the 5% tariffs to a 10% rate. Such tariffs were previously flagged by Chinese authorities when the US was considering its tariff hike.         

Financial markets have responded to the tariff announcements in an orderly fashion, largely because the hike was at the lower-end of market expectations. As a result, the S&P 500 rose 0.9% over the week to Thursday, reaching a new record high and US 10-year government bond yields increased by almost 10bps to 3.06%, the highest level seen since May. Chinese equities also rose over the week to Thursday, with the CSI 300 up 2.3%. Nonetheless, Chinese equities remain under pressure from the trade wars and slowing momentum in the economy, with the market down almost 25% since the peak in late January.  

What is the economic impact of the latest tariff announcement? In our view, the latest tariff hike (including the escalation in January 2019), would wipe off around 30-50bps from the level of US real GDP after 3 years, with a similar impact to Chinese activity. The lower-end of the range incorporates our modelled impact of the pure tariff hike, while the upper-end of the range also incorporates the impact of higher risk premiums (to date there is little evidence of a significant increase in risk premiums in the US, although there is some evidence that higher risk premiums are evident in China and other emerging markets). 

Adding the estimated impact from Round 1 of the tariff war, the economic damage to the US and Chinese economies would be in the range of 45-65bps after three years. If President Trump continues to up the ante and commences Round 3 of the trade war, whereby the US places a 10% tariff on the remaining US$270 billion of imports from China and China retaliates in a tit-for-tat fashion, then the total economic damage from the trade war is estimated at around 100-120bps for both the US and Chinese economies.   

Australia is not immune from the escalating US-China trade war. Reflecting weaker growth in the world’s two largest economies and tighter financial conditions, the damage to the Australian economy from Round 1 and 2 is estimated at around 20-25bps after three years. Should the US commence Round 3, then the impact on Australia is forecast to be around 50bps. 

Significant uncertainty remains around the fallout from the trade war and, of course, it will depend crucially on the response by US and Chinese authorities from here. Should China seek to mitigate the impacts of their trade war with the US by embarking on a domestic stimulus program, or by continuing to lower import taxes from a range of countries as has been suggested by Chinese authorities, the economic damage to Australia could be less than what we have estimated.

Nevertheless, the problems with wars, even trade wars, is that they have the tendency to quickly get out of hand and ensnarl other countries. Were the US to continue to push for increased trade protectionism, be it via abandoning NAFTA, raising auto tariffs, or targeting more countries than just China, the economic damage to a small open economy like Australia could be much worse. Such an outcome would not be viewed as benignly as the market reaction this week, with a bear equity market a distinct possibility. For a President intent on citing the equity market as a barometer of success, avoiding a global trade war would be a wise choice. 

Table 1: Financial market movements, 13 – 20 September 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,930.8

0.9%

US

3.06%

9.3 bps

US Dollar Index (DXY)

93.91

-0.6%

Nikkei 225

23,674.9

3.7%

Japan

0.12%

1.1 bps

USD-JPY

112.49

0.5%

FTSE 100

7,367.3

1.2%

UK

1.59%

8.1 bps

GBP-USD

1.327

1.2%

DAX

12,326.5

2.2%

Germany

0.47%

4.8 bps

EUR-USD

1.178

0.7%

S&P/ASX 200

6,169.5

0.7%

Australia

2.72%

11.1 bps

AUD-USD

0.729

1.3%

 Source: Bloomberg

 
For economic update by region, click here.

 

 

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