07 June 2018
In recent months, US trade policy has taken centre stage as President Trump gripes about large bilateral trade deficits. More generally, America is grappling with concerns about China’s state-directed ‘command’ economic model; China’s national champions are supported ‘unfairly’ by its government, while foreign competitors allegedly find it impossible to compete fairly. This creates an inevitable tension that shows no sign of abating - and neither do headlines about tariffs and trade wars. But are these really the biggest threats to global trade? For investors, it’s extremely important to keep these issues in context - and despite the dramatic headlines, there may be bigger things to worry about.
Trade spat may be here to stay, but headlines are overblown
When it comes to the impact of evolving trade policy, it’s worth understanding the headline numbers. For example, reports that Donald Trump will impose a 25 per cent tariff on $50bn of Chinese goods certainly sounds significant, but this tax would account for barely 2 per cent of US imports from China. It would account for comfortably less than 1 per cent of China’s total exports and represents effectively nothing in terms of US or China GDP.
Another example is steel. Headlines suggest that Trump will impose a 25 per cent tariff on steel, with Europe, Canada and Mexico not getting exemptions (and possibly imposing counter-tariffs). Again, the practical implications of this are smaller than they may seem at first glance. The US imports just under $0.5bn of steel from each of Canada and the EU. This is practically a rounding error relative to the $300bn of total goods imports from Canada and $450bn from the EU. The overall macroeconomic impact would be even less.
Indeed, while headlines are likely to continue to flow over the coming months, we would likely need to see counter-tariffs and subsequent escalation several times larger than these before they even start showing up in the US growth-inflation mix, not to mention the rest of the world.
Broader backdrop gives investors more to worry about
But if investors may sleep soundly in the knowledge that these trade wars are unlikely to have a devastating impact on the global macro picture, there is plenty more to keep us awake at night. In our view, global trade is mostly driven by a small number of interrelated factors, including global growth (and China’s in particular), the tech cycle, commodity demand and arguably the US dollar.
First, and perhaps most importantly, overall global growth is showing signs of slowing. We are seeing some signs of a peak in trade after the 2016-17 recovery, and this has clear implications for trade. For example, the Baltic Dry Index, a key global shipping cost index and helpful leading indicator for trade, has fallen meaningfully from the beginning of this year. The global manufacturing PMI suggests that new export orders have fallen dramatically since their peak at the turn of the year, this month giving the weakest reading since August 2016.
Over 50 signals expansion, under 50 signals contraction. Source: Bloomberg, Fidelity International, May 2018.
The tech cycle rumbles on, but looks increasingly frothy - it too shows some signs that a peak may not be far away. Semiconductor prices are starting to flatten, for example, after a significant run-up. Korean exports (a key bellwether for global trade) have been almost entirely supported by its isolated ‘boom’ in semiconductors - which means trouble if the tech cycle does run out of steam.
Another source of concern is the US dollar. Its weakening was a large boon for global growth, commodity prices and emerging markets, but as the US Federal Reserve continues to tighten monetary policy forcefully - while central banks in Japan and the UK continue to drag their heels - it is possible that this one-way trade is over.
All of these factors are likely to weigh on commodity prices, which generate a large proportion of global trade and are disproportionately important for emerging markets (which in turn are disproportionately important for trade and economic growth). While all eyes are currently on rising oil prices, other commodities are not keeping pace. The CRB Raw Industrials Index rallied 25 per cent from its 2015 lows as global trade surged but has been flat since mid-January. China’s Producer Price inflation has been negative in recent months, in contrast to the strong run seen over the prior two years.
Implications for investors
When it comes to concerns about global trade, it’s clear that US tariffs are not the only show in town. In fact, they pale in comparison to broader macroeconomic dynamics which are starting to assert themselves. What does this mean for investors? It’s impossible to predict the course of trade policy, but it’s clear that we are likely to continue seeing some dramatic headlines over the coming months. When allocating capital across global markets and asset classes, it’s as important as ever to look beyond rhetoric and news flow to understand what’s really driving global trade.
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