US/China Trade Tensions Back in the Forefront

US President Trump announced a new tariff escalation via Twitter Sunday, saying negotiations were proceeding too slowly.  He said “10% will go up to 25% on Friday” in reference to $200 billion in Chinese imports. (Tariffs remain at 25% on an initial $50 billion since July 2018). He noted further tariff increases on the remainder of Chinese imports could follow.

While the announcement has stunned world markets following many optimistic comments from both sides, Trump’s announcement may be a pressure tactic to conclude negotiations as soon as this week. However, the situation is fluid as Chinese Vice Premier Liu He reportedly may cancel meetings scheduled to begin in Washington DC on Wednesday, May 8.

News reports have surfaced regarding China backtracking on structural reforms such as forced technology transfers and enforcement mechanisms. It is not clear if the latest tariff escalation is a sign that no final deal will be reached.

World equity markets have rallied nearly 17% in the year-to-date, reversing half of their valuation contraction of 2018 when monetary policy and trade fears overwhelmed rising corporate profits. Stronger-than-expected data from both the US and China in the first quarter may be spurring both sides to strike harder bargains. However, Citi analysts see signs throughout the world economy that trade remains a key vulnerability.

Other international disputes are also on the front burner

• The US is seeking global compliance with oil export sanctions on Iran, including China’s. Citi analysts consider potential financial sanctions a larger economic risk than movements in petroleum costs.
• China should be expected to announce its own tariff retaliation if this week’s trade talks are postponed.
• Markets await US recommended actions on autos trade under section 232 of US trade law (national security grounds) particularly as it pertains to EU/US trade.  Fears may rise over the course of US/China talks.
• The US-Canada-Mexico Free Trade Agreement and other categorical trade disputes have yet to be settled.

Break or make time for US/China trade negotiators

It is possible that financial markets will again greet a successful round of negotiations with relief. However, after a large year-to-date rally, Citi analysts are urging more caution as markets approach mid-year.

As Figure 2 shows, the second quarter is the only one that averages a negative return for global equities. More generally, periods of illiquidity and reduced end-investor participation during summer months often result in weaker outcomes than in the late and early months of calendar years. The latest trade news may exacerbate this pattern.

Implications

Citi analysts urge investors to carefully focus on the longer-term portfolio consequences of near-term decisions in what is typically a volatile mid-year period. Higher quality fixed income is ideally a portfolio buffer for those not already hedging equity exposures. Volatility related to US/China relations is likely a long-term fixture for the investment landscape and is not the only international risk.