The US Republican administration escalated trade wars with another round of tariff threats aimed solely at China. While market pundits have agreed in the past that the trade wars have not observed numerous tariff increases to put a dent in the global growth, with every round of escalation that view comes into question. Market pundits have coined the word ‘trade war’ to depict the nature of the action of the two largest economies of the world and also how each nation retaliates to the other.
In the US, the large-cap stocks are vulnerable to tariff retaliation due to their globally complex supply chain, delivery point and cash flows. It is likely that some specific companies may get hit hard. But from the equity index perspective, some small-cap indexes have strongly outperformed the larger caps. Another corporate impact in the US is the uncertainty over trade policies. This has started to impact the second half investment plans. Some projects are getting delayed while others are getting indefinitely postponed. This is going to impact the US real GDP in the second half of the year.
Now here’s the catch. The second quarter GDP may register 4%. This figure, when released at the end of July, depicts a growing US economy. Unfortunately, the improving number may disappear as in the second half of the year, US corporate investment and likewise earnings will slow down due to trade war uncertainties. In the first half of the year, the numbers received a boost from corporate tax cuts which slowly wear off. Also, the Federal Reserve is on the verge of raising rates further until the end of the year. This signifies that the second half real GDP will come down to 2 -2.5%. But the positive aspects of the tax cuts are being negated by the uncertainty of the trade war.
In the overseas market, Chinese stocks are getting hit much harder than the US stocks. The Chinese economy still has a significant dependence on exports. Hence, there is no question that the trade war is taking its toll. From a political perspective, the trade war may strengthen bolster the popularity of the Chinese President, Xi Jinping as he takes a stand against the US trade war. From the Chinese perspective, they have the political ability to match the US-tariff for tariff and also the incentive to aim retaliation at products produced by the US.
Meanwhile European stocks have also suffered. The political will of the EU to stand up to the US tactics is quite strong. Europe is also aiming at a tit for tat tariff for products and companies from the US. The chances of compromise may increase after the US congress elections in November. That is when China and EU may perceive that their ability to impact the political sentiment in the US is diminished because the elections will be over. On the FX front, the big movers have been the Chinese Yuan. This is a direct implication of the slower growth of exports; part and parcel of the weaker economy coupled with declining stock markets.
Metals have had some action too. Gold is generally known as a hedge against political risks. But gold has not worked as a hedge in this trade war. Gold prices have been weakened by the Federal Reserve raising the rates, since gold does not bear any interest and loses shine as the rates rise. Additionally, the two largest consumers of gold jewelry - India and China are observing a slump in demand. In India, millennials are not buying like their parents did while in China, it is due to the slowing economy. Copper has also been negatively impacted by the trade war and in part due to the slowing demand from China. US agriculture is a top pick for tariff retaliation. China is a huge consumer of the soybean market to feed chicken and hogs and ironically the US is the largest producer and exporter of the product. The problem for US farmers is severe since Brazil and Argentina are formidable competitors. China is the largest customer for the US soybean but China has choices. Mexico imports corn from the US markets but these markets have also suffered from the trade wars.
The US is escalating the trade war which is now serious enough to slow global growth. The 4% US GDP attained in the second quarter seems unlikely to sustain in the remaining part of the year due to the trade war. The tit for tat retaliation is gaining political popularity in China and Europe. The games have unfolded but the results are yet to be decided!
Vivek Risal is associated with Mercantile Exchange Nepal Limited in the capacity of Manager in Research and Development Department. He can be contacted at r&[email protected]
