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Trade war may end in a draw, but Pythonesque markets could lose more than an arm

Peter Warnes  |  28 Sep 2018Text size  Decrease  Increase  |  
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Global financial markets continue to trade with seemingly little distraction from the heightening stakes in the US/China trade war. The initial shot, the implementation of a 25% tariff by the US on US$50bn of Chinese imports, was matched by China. The second, a 10% tariff on a further US$200bn, pushed markets higher over the past week, as expectations were the tariff on the significantly wider and more consumer-oriented product range would be 25%. There is a distinct possibility the rate will be lifted at a future date. The US has threatened to widen the net by a further US$267bn should China fail to capitulate.

The US administration is convinced escalating tariffs will alter China’s behaviour. The hope is manufacturing will ultimately return to the US and the US trade deficit with China will shrink meaningfully. The jury is still very much out on the subject. Capitulation is certainly not on the Chinese agenda.

The air is filled with complacency. The reactions of financial markets remind me of the fight between the Black Knight and Arthur king of the Britons in the 1975 classic Monty Python and the Holy Grail. One may substitute financial markets or even President Donald Trump for the Black Knight—“I move for no man”. After losing one arm, “tis but a scratch”—the first US$50bn in tariffs, then a second arm, “it’s a flesh wound”—the 10% tariff on US$200bn instead of 25%. The fight continues with the Black Knight losing one leg and then the other and finally suggests “we’ll call it a draw”.

The trade battle may ultimately be a called a draw, but much blood will be spilt, transfusions required while each side claims victory. Victory perhaps, but pyrrhic in nature. Even if you don’t agree with the analogy, have a look at the skit (Google—“Black Knight Monty Python”), just three minutes and you will laugh and feel much better for it.

As the US November mid-term elections draw closer, expect the China-bashing knob to be tweaked further. While US farmers have been affected, very significant subsidies have provided an offset to the loss of some Chinese markets. It seems the administration is willing to sacrifice some ground here, while focusing on reinvigorating the manufacturing sector. Canada still has not joined a reset NAFTA. Eventually prices will move higher as tariffs add upward pressure and companies protect margins from higher input prices.

China is likely to retaliate on several fronts, which could include imposing tariffs, depreciating the currency to protect exporters and scaling back on the purchase of US debt. The bazooka would be selling US debt, forcing US bond yields substantially higher. The impact of that blunt interest rate instrument would reverberate throughout the US economy. Treasury would be unwilling to add to already sharply mounting government debt to stimulate the economy and the Fed has little ammunition, despite tightening over the past two years.

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

 

 

 


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is Morningstar's head of equities research.

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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