The US/China trade tensions escalated last month, with the Donald Trump administration announcing 10 per cent tariffs on an additional $200bn of Chinese goods. 
With the US trade deficit vis-à-vis China reaching new highs in July, there are good reasons for Trump to not back down at this stage – especially ahead of the US mid-term elections. In total, half of China’s imports to the US are now ‘tariffed’, with Trump threatening to tax all imports from China if Beijing opts for retaliation. The trade war is currently living up to its name.
At the same time, a 14-year high in US manufacturing confidence and the performance supremacy of US equities is an impressive demonstration of how immune the US economy and markets currently are to the trade tremors. As long as Trump’s popularity among Republican voters stays strong, we do not expect trade headwinds to fade meaningfully.
No incentive for relative winner Trump to de-escalate
Globalisation, as well as a rising China, contributed to American workers receiving a smaller share of the economic pie.
Consequently, dampening China’s rise in the global economy should also contribute to Trump’s popularity domestically. From a ‘Trumplateral’ perspective, risks to the US grand strategy on trade and China therefore seem manageable, the upside considerable.
China, on the other hand, has weaker cards at hand. First, Trump’s approval rating climbed as the trade conflict heated up in the first half of the year. Secondly, Dr. Copper’s steep fall signals growth weakness in China, the world’s largest consumer of the commodity. The bottom line is based on the current state of play, there seems to be little incentive for the US to change its trade policy. China, with its vulnerable economy, can only react.
So far, market reaction and the desynchronised slowing of the world economy are clearly pointing at the US as the relative winner of this conflict. It is difficult to argue rising protectionism creates winners in absolute terms. But in relative terms, the picture is different. Based on market action, the US is the clear winner of the recent trade conflict with China. This is not surprising, as China has benefitted much more from exports to the US than the US has benefitted from exports to China.
In addition, while US growth is supported by tax cuts in the near term, Chinese growth is dragged down by slowing credit creation, contributing to a desynchronised slowing of the world economy. Consequently, the US is the best performing equity region year to date, while China and emerging markets are on the other end of the scale, wiping out last year’s impressive outperformance within a few weeks.
Seek safety in defensive assets
Despite the US being so far largely immune to the trade tremors, trade remains the biggest ‘known unknown’ for markets for the remainder of 2018, as the rest of the world is all but immune. While the muted short-term market reaction to additional tariffs on $200bn of Chinese goods suggests a lot is already priced in, additional tariffs are more likely than not over the coming months.
Source: Nordea Asset Management
The trade war therefore will continue to put a lid on risk appetite, favouring US equities over regions with high beta to global trade. The US dollar should strengthen further, as capital is flowing from these high-beta regions back into the US. Defensive asset classes like core fixed income should also be increasingly sought after.
As a trade war might be inflationary in the short term, but deflationary in the medium to long term, we expect the US yield curve to flatten further, putting the Fed and markets on heightened ‘inversion alert’.
Witold Bahrke is a senior macro strategist at Nordea Asset Management. The views expressed above are his own and should not be taken as investment advice.