Has trade war gone from rhetoric to reality?

On Friday Donald Trump, the 45^th President of the United States, escalated his rhetoric against China, announcing his intention to slap tariffs on all $505bn of goods imported from China.

Markets weakened on the news – delivered via a television interview – with the S&P 500 finishing marginally lower at 2,800 points and the UK following suit. China bounced off lows, the Hang Seng climbing sharply on the day, but the market is down nearly 10% in the last month as trade tensions simmered.

Shares in the US and elsewhere are yet to revisit peaks seen in January this year, with the trade war the latest headwind for investors to negotiate.

Experts warned if last week’s escalation was a sign of further things to come, equities faced a very uncertain future.

For Olaf van den Heuvel, Chief Investment Officer, Aegon Asset Management (Netherlands), the current scenario continues to be seen as a form of negotiation by Trump, but he warned it had the potential to get out of hand quickly.

“So far the Trump trade policy was more about creating leverage in a negotiation than it was about levying actual tariffs,” van den Heuvel said. “Of course, as in a game of poker, you sometimes have to up the ante. The risks are high at this level. The impact on world economic growth of a levy of this magnitude will be severe and will likely have a strong negative impact on markets.”

Will Hobbs, Head of Investment Strategy at Barclays Smart Investor, added: “It is so far still difficult to discern the impact of escalating trade tensions in the economic data. Front-loading of orders and shipments ahead of the imposition of tariffs will likely distort our view for a while yet too.

“Nonetheless, emerging market assets, particularly in Asia, have underperformed the rest of the world seemingly in anticipation of these negative economic effects. We need to be wary of overconfidence here. We cannot pretend to know for sure that this is all part of a crude negotiating strategy on the part of the US administration. However, this sharp escalation makes sense in such a context, particularly with the midterm campaign trail on the horizon. The White House needs to force their opponents to swerve first in this game of trade chicken.

“On the other side, the political nature of the tariffs threatened to date, such as soybeans, suggests that the Chinese administration see a potential weakness in the President’s approaching moment of indirect electoral accountability.

“As November’s US midterm elections loom larger, we see economic and political self-interest helping to de-escalate the scrap. In the meantime, the potential for capital markets to be dragged into a disciplinary role suggests investors will again need to call upon their stores of composure to see this through.”

Ramifications of the trade war are likely to be felt far more widely than just China and the US.

Edward Rumble, Co-manager of the RWC Continental European Equity fund, said the current focus could quickly shift to Europe, and in particular Germany, which has a very large trade surplus with the US.

“The potential for more restrictive trade between nations may be a serious threat to global growth, and the steady increase in rhetoric and retaliatory actions was already worrying prior to these latest comments,” Rumble added.

“One thing for European investors to consider is that, if Trump is obsessed with China, it does at least temporarily keep his sights off Germany and other European nations. However, given Germany has a €100bn trade surplus with the US, at some stage he will likely come for them as well.

“Such actions represent a reversal of a 50-year trend to more liberal trade that has helped fuel economic prosperity around the world for decades. Not surprisingly, many companies are not well prepared for such a scenario, indeed they have been taking advantage of the open environment to optimise manufacturing efficiency on a global basis. In many cases, the current structure will not be optimal if trade barriers require local production in end markets to ensure competitiveness. We are evaluating the potential impact on all the positions in the portfolio to ensure this change will not have a material impact on our investment thesis.”

The next important indicator for markets is Friday’s US GDP data, with US growth expected to have been given a boost from trade.