Some Trade Takeaways and Risks

Much of my discussions over the last few days and weeks have focused on trade, especially U.S. policy and what happens now that a U.S. China trade deal seems further away. Key questions focus on the impact on the economy and markets, whether any countries can benefit and the path forward. Here are some of the questions and a few steps towards answers.

Trade concerns for market are likely to remain elevated as Trump administration alternates between putting pressure on China and some of its more developed trading partners like Japan and EU. This will also coincide with more heated debate on the USMCA which is slowly working through the legislative process.  The U.S.  is also comfortable with using more of the tools in its toolkit such as export controls. The recent Autos 301 report has built in time for more negotiations rather than imposing immediate new tariffs, but those deadlines will come up quickly in the fall, reinforcing divides within Europe (between German supply chain and other countries). Given the recent EP results highlight greater fragmentation on many lines (within and between parties, increase to protest parties including the Greens and in select countries the far right) and the timing of selecting a new commission, getting a mandate and the like.

These dynamics are not good for global growth (trade has been flatlining), but a recession’s still not my baseline (US or global slowdown below 3%), Interest rates to stay low, equities to struggle now that one off benefits over, and valuations/profits a key driver, Moderate USD strength vs index as other CBs remain dovish (PBoC, BoJ, ECB, though latter challenged by EUR’s external balance. There is little space for EM to benefit, as rates already relatively low and investors worried about credit driven growth.

There is  much focus on Chinese policy response (government support, trade diversion), especially CNY. There seems to be a public debate on regarding whether China will/should act like a “normal country” allowing its FX to be a partial shock absorber (ie potently allowing the currency to weaken. This is still relatively unlikely given the concerns of over-adjustment, the lack of messaging and other issues. Communication will be key and challenging for the PBoC as the easier stance would argue for a weaker FX. Expect more Chinese government support, especially to targeted sectors, which might mitigate some of the impact of some slow supply chain diversion. China growth likely to be driven by consumption still, with some increase in investment. 
There aren’t many “winners” from the trade disputes, especially the US China ones, but some Asian countries, Vietnam but also a few more developed Asian countries seem to be increasing exports to the U.S. in the Vietnamese case, this may reflect the benefits of TPP related reforms, the fact that the tariffs led companies to push forward plans to expand supply chains there as clusters become more effective. Still, overall, the tariffs are putting more pressure on consumers, making it harder for businesses to assess costs and rules and generally make it harder to predict global demand growth.
The technology competition is likely to increase further with the focus moving beyond Huawei as months go on. It increases the likelihood of a “splinterrnet” or diversion into two or more systems, reinforcing the divides. So far the US is focused on excluding companies and practices (see the tighter policies around CFIUS since 2017), rather than encouraging alternatives (among US or European companies. Developed markets and those with security links to the US will likely go along, but the lack of clear affordable alternatives is an issue. the tit for tat challenge around visas is limited trade and coordination as well as skills transfer and could impact innovation policy going forward.
Until now strong US demand helped to support imports despite trade restrictions, now there are signs that demand is starting to moderate.  Expect little support from U.S. Investment, while there are risks of a fiscal drag. Central banks to remain supportive. Still this is not a story of a recession but more a slowdown. 

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