On Thursday 2 May, US productivity grew at a nine-year high. The next day, the US celebrated unemployment at a 50-year low. But the following Monday morning brought back a familiar uneasiness for investors as President Trump tweeted he would increase tariffs on Chinese goods, which has led to an escalation in the US-China trade war.
While traveling in China and the US this month, we heard the same thing from opinion leaders: "The other side has more to lose." We don't see either nation in a hurry to reach a deal, and the risk of miscalculation is growing.
China vs. US: 3 key questions on trade negotiations
- While the dispute remains contained to tit-for-tat tariff increases, China can use fiscal and monetary levers to help maintain growth, such as an easing of its reserve requirement ratio or managed currency depreciation.
- China has plenty of economic cards to play against the US, such as potentially selling part of its USD 1.17tr Treasury portfolio, equivalent to 7% of outstanding US debt.
- China could also increase pressure on US corporations operating in China or use unofficial sanctions on businessmen close to President Trump.
- Trump administration hawks believe the national security benefit of disentangling China from US supply chains more than offsets the current economic cost, especially given the country's relative trade independence.
- It is not clear that an ongoing trade conflict alone hurts President Trump's reelection chances as the most impacted states, in many cases, are not swing states.
- The US has its own economic cards to play against China to force a deal. Preparations are already underway to levy tariffs on the remaining USD 300bn of US imports from China, which could be ready to be implemented by July.
- Efforts to offset the economic impact of tariffs are slowing China's desired attempt to rebalance its economy away from state-driven investment. If the US were to impose tariffs on all Chinese goods, it could push China's economic growth well below its 6% target.
- China will want to reduce tension on key technological development areas such as robotics, artificial intelligence, semiconductors, and health-tech.
- Concessions from China could be hailed as an economic boost and a political success going into the next election.
- The flip side is that the president might also look to settle if the economic or political pain is perceived to be too costly.
- China has its own leverage on the global supply chain, with a controlling share of at least 80% of processed rare earth minerals. President Xi Jinping signaled as much with an official site visit to a domestic rare earth producer this month.
- Major US companies have already started restricting business with Huawei. A reduction in Huawei's exports may help shrink the US-China trade imbalance, but it also risks expanding the conflict in a way that disrupts global supply chains. Furthermore, nations may now face difficult choices between supporting the US or China.
Getting to a deal from here
The two sides can still strike a deal. To get there, we think Beijing probably needs to drop its demand that the US removes all tariffs at once, and Washington likely needs to reduce its proposed checks on China’s technological ambitions and downsize its demands for Chinese imports of US agriculture and energy products.
Our base case (with a 50% probability) is that, at the June summit, Trump and Xi only agree to ongoing negotiations. At this point, we think the US will keep options open and conclude the administrative process to apply tariffs on the remaining USD 300bn of Chinese imports but refrain from implementing them while negotiations are taking place. But we are tracking the likelihood and potential impact of other scenarios as well.
With neither side in a hurry to reach a deal, it looks more likely than not that we are in for a period of sustained uncertainty. Against this backdrop we have reduced risk in our tactical asset allocation over the past month. We continue to recommend staying invested for long-term portfolio growth, while taking certain steps to manage near-term downside risks.
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