Brewing US-China trade war spooks asset managers
Potential threat to equities, US bonds and Chinese banking system highlighted
Chris Flood
A full-blown trade war between Washington and Beijing could lead to falls of up to 50 per cent in equities, instability in the US Treasury market and damage to China’s banking system.
That warning from BNP Paribas Asset Management coincided with an escalation in tensions after President Donald Trump said on Thursday that the US would consider imposing an additional $100bn in tariffs on imports from China, ramping up the dispute that has unsettled financial markets worldwide.
Mr Trump’s move followed a threat from Beijing to impose tariffs on $50bn of US imports shortly after Washington revealed plans for a 25 per cent tariff on imports of 1,333 Chinese products.
BNP said that if the Trump administration decided to pursue an aggressive trade war against China, this would raise questions over whether Beijing might sell down its vast $1.2tn holding in US Treasuries and diversify its foreign exchange reserves into other currencies.
Such a shift would push up US bond yields and weigh on the dollar, which in turn could pose risks to Chinese banks that have used the eurodollar market as a source of funding to aggressively expand their balance sheets.
BNP said the probability of a full-blown US-China trade war was “low”, so there was no immediate need to adjust portfolios to a fully defensive strategy, but the trading environment had become riskier and investors should buy protection against increased volatility and the threat of a broader sell-off.
Jan Dehn, head of research at Ashmore, the specialist emerging markets manager, said Mr Trump’s unilateral imposition of tariffs mirrored the start of the breakdown of trade relations that followed the 1929 US stock market crash.
“Trump’s America appears bent on abandoning free trade which has been such a key pillar of Western prosperity,” said Mr Dehn, adding that European economies were also likely to be damaged by US protectionism.
“The timing could not be worse. The EU is only just pulling back from the brink of the Eurozone debt crisis. The UK is similarly vulnerable to US protectionism,” he said.
Volatility rose across financial markets globally last week even as policymakers attempted to defuse investors’ concerns.
Wilbur Ross, the US commerce secretary, said on Wednesday that the world recognised that China’s behaviour on trade was “out of control” but that the escalation in tension was “not World War III”.
Mr Ross said: “Even shooting wars end with negotiations.”
BlackRock, the world’s largest asset manager, urged its clients to hold their nerve.
Richard Turnill, BlackRock’s global chief investment strategist, said the US actions targeting Chinese imports were “an opening gambit for negotiations” rather than the start of a full-blown trade war.
“We expect Beijing to try to address its trade deficit with the US by opening up Chinese markets in the medium term.”
Mr Turnill added that BlackRock could change its position if the US implemented harder-hitting measures leading to a retaliation by China or a sharp devaluation of the renminbi.
China hit back on Friday at the US threat, warning that the US stood more to lose politically from the dispute.
The Ministry of Commerce said China was prepared to adopt “comprehensive countermeasures” in its dispute with the US, and added: “China doesn’t want a trade war, but we’re not afraid to fight a trade war.”
Mark Haefele, global chief investment officer at UBS Wealth Management, said: “The risk of a major disruption remains real and rhetoric can boost market volatility.”
UBS has told its clients to stay invested while global growth and corporate earnings remain supportive of further equity gains.
But it is also holding more defensive positions, including an overweight in US 10-year Treasury bonds as well as exposure to the Japanese yen, which it expects to perform well if there is a broader downturn in stock markets.
In the final week of March, US short-term government bond funds attracted their largest amount inflows since early 2016, according to data provider EPFR, suggesting that some investors have already adopted a more defensive stance.
A trade war could present investment opportunities but not in the manner intended by Mr Trump, according to Hans Ulrich Jost, a portfolio manager with GAM, the Swiss fund house.
Forty years of under-investment has left US steel production facilities “inefficient, obsolescent and incapable of competing” with overseas rivals, regardless of a tariff on imports, said Mr Jost.
This could present opportunities for competitor steel manufacturers based in Europe but America’s aerospace, car and other heavy industries would simply have to pay significantly higher input costs.
“It is also worth bearing in mind that any retaliatory measures taken by China are likely to involve the levy of much greater premiums on Chinese-produced electronic components on which the US is highly dependent,” said Mr Jost.
Beijing has not yet set a date when its tariffs will become effective, suggesting that Chinese policymakers still see room for extending the current negotiations, according to Raoul Leering, head of international trade analysis at ING, the Dutch bank.
“It is likely that China will, in the end, cut its losses and be willing to give Trump something, given the large dependency of the Chinese economy on American demand,” said Mr Leering.
He added that Mr Trump was “playing a dangerous game” but could still emerge as the winner in the noisiest trade quarrel seen in decades.
“This would get him in the voters’ good books in the run-up to the US midterm elections in November,” said Mr Leering.
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