Trade war risks aside, a truce is most likely

Steve Mnuchin will not hold any formal meetings with China at this weekend’s gathering of G20 finance ministers in Buenos Aires. This is despite the US treasury secretary indicating last week in Congress that he was prepared to reopen talks on trade issues if Beijing was willing to pursue “serious efforts to make structural changes” to its policies. This potential snub is a concern to investors hoping that the issue could be wrapped up in the next few months. Many in the market think that the current machinations are aimed at galvanising support behind the Republican Party ahead of the key midterm elections. This is the “base case” for many investors – but are we being too complacent on the issue? Will Donald Trump really back down to stop markets being hit?

This week, Citigroup became the latest bank to express its belief that the issue will be resolved over the next two months: “Our base case is for negotiations to continue and for trade deals to be done ahead of the November US midterm elections.”

Reassuringly, officials from the US treasury have indicated a back door has been left open. Although no formal meetings are scheduled in Argentina, it is hoped there will be “ample opportunities” for Mnuchin to talk to Chinese officials in other, more informal settings.

Both sides have now implemented tariffs on $34bn (£26bn) of each other’s exports. The US is particularly concerned about technology transfer – and for good reason. The global dominance of the US – and its equity markets – is based on its technological achievements. It’s not just Nasdaq that is tech-heavy – technology related businesses make up more than a quarter of the S&P 500 by weighting. So far, equity markets have taken this threat in their stride. However, this week the International Monetary Fund warned of “complacency” over the issue. It said that the escalating trade confrontation is the “greatest nearterm threat to global growth”, and in the worst case could cut 0.5pc off global GDP. With global growth expected to be in the order of 3pc this year, this could actually be a price worth paying for Trump.

Indeed, Trump is now threatening to impose 10pc tariffs on $200bn of other goods from China. Should this come to pass, the impact on market sentiment could be significant.

We have already seen sharp falls in the price of copper, which is down almost 18pc since early June. The metal is regarded as a key indicator of the global economy because of its wide range of uses. Soya beans, which have been targeted by China, are down almost 19pc in price since late May.

Any escalation of the trade war is likely to see such falls spread into other markets.

Chinese growth is a major driver of the global economy, accounting for about 16pc of global GDP in 2017, and Citigroup has calculated it was responsible for 35pc of global growth over the last five years. Growth in the country has been moderating for some time, but it appears that exporters to China are now starting to bear the brunt of this slowdown. This week we saw GDP growth ease to 6.7pc in the second quarter, from 6.8pc in the first three months of the year, its slowest rate of growth since 2016.

A significant amount of this easing is down to a deliberate tightening of financial conditions, as authorities attempt to tackle excessive credit and bad loans.

Fortunately, we are already seeing signs of some compromise from Chinese authorities. They are downplaying the contentious “made in China 2025” policy that is targeting leadership in robotics, biotech, aerospace and clean energy vehicles.

This attempt to move the country up the value chain by transitioning to “smart manufacturing” has really stoked the US administration’s ire. To ease fears that the project aims to replace foreign companies operating in China and take them on globally, authorities have said that the policy is open to non-chinese businesses too.

The Chinese ministry of finance has also announced an easing of restrictions for pharmaceutical companies, financial services and vehicle manufacturers. But are these compromises enough?

A trade war-induced slowdown in GDP is the most important downside risk to equities over the coming months. However, it is clear Trump and Mnuchin watch markets closely to assess the impact of their deeds. This is why the most likely outcome remains some sort of resolution before Nov 6. But political risk for investors clearly remains elevated.

‘It is clear that Trump watches markets closely to assess his impact’