China Unlikely to Give In to Trump’s Demands Despite New Tariffs

Fundamental analysis of Forex market
  • Trump is expected to implement the second round of tariffs on an additional USD200bn of imported goods from China either later today or tomorrow.
  • Trump’s purpose seems to be to put China under pressure, forcing them to give in to his demands. That is unlikely to happen in our view, as the Chinese government does not want to negotiate with a gun to its head.
  • Difficult not to see the trade war in the light of the US mid-term elections and a deal seems unlikely before well into 2019. The risk is that it drags on.
  • While the trade war is negative for growth, it is not going to derail the global expansion, in our view. The risk is that we have underestimated the impact on business confidence over time.

Trump set to announce second round of tariffs soon

US President Trump is expected to implement the second round of tariffs on Chinese imports either later today or tomorrow. That would bring the total value of imported goods from China covered by Trump’s tariffs up to USD250bn or roughly 50% of total US imports from China. In contrast to what was previously feared, Trump is rumoured to be about to impose only a 10% tariff rate and not 25%, perhaps due to the negative feedback during the hearing process. While this is positive, we are still dealing with an escalation of the trade war.

Trump’s purpose seems to be to put China under pressure, forcing them to give in to his demands. The thinking is that the trade war is hurting China’s economy and stock market much more than the US’s, which would force them to ease its negotiation stance. The Chinese government has said it will continue to retaliate one-to-one to any US measures taken them. China has previously released a list of USD60bn worth of goods they are considering imposing tariffs on. The problem for China is that they import less from the US than they export so they also need to find other ways to retaliate. One way is to make life more complicated for US companies producing (like Apple) in China by restricting sales of materials and equipment to them, see Bloomberg, 17 September. The downside is that it probably hurts e.g. Chinese employment. This is another example of the argument that there are no winners in trade wars.

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Last week, it was made known that the Trump administration (or at least US Treasury Secretary Mnuchin) has invited the Chinese government to Washington for trade talks. The talks are scheduled to take place in Washington 27-28 September. In our view, it is difficult for the Chinese government to accept the invitation, as it will not negotiate with a gun to its head, although we have not had an official view yet. As we wrote in our China Postcard: Trade war to drag out but still lots of potential, 12 September, the Chinese government is now thinking the trade war is going to drag out and is not going to scale back its Made in China 2025 plan. This is also one reason why the Chinese government has eased economic policy (CNY has weakened and Chinese rates have declined).

Trump may become more hawkish on China after mid-term elections

Last time it took around five weeks from Trump’s decision to implement tariffs until they came into effect. That means the tariff will most likely come into effect before the US mid-term elections on Tuesday 6 November. It is also difficult not to see the trade war in the light of the election and what happens next and it may also depends on what the outcome of the US mid-term is. If the Democrats win one of the chambers (our base case), Trump becomes a ‘lame duck’ domestically, meaning he needs to focus on foreign and trade policy, where the US President has more power to act without Congressional approval. The risk is that a ‘lame duck’ Trump will be even more hawkish against China. If the Republicans win both chambers, Trump’s focus may shift to domestic policy, as the Republicans would get another chance to make tax cuts or repeal Obamacare. For more details on the US mid-terms see US Midterm elections: Mostly a political event with limited implications for markets and the economy, 3 September.

Trade war does not seem to be derailing the global expansion

Our base case is that the Trump will eventually strike a deal with China but we think it is likely to get worse before it gets better and that a deal will not be within reach until well into 2019. The risk is that it drags out for longer.

What are the economic implications? While the trade war is negative for growth, it is not going to derail the global expansion, in our view. In our view, the main transmission channel is through business confidence and investments. So far we have not seen a significant decline in US confidence in anticipation of Trump’s second round of tariffs. China has eased both monetary and fiscal policy in order to offset the negative impact of trade uncertainties on the economy so we expect a soft landing in China. The risk is that we are underestimating the impact on business confidence and hence investments.