US-China Trade Spat sees US Announce Fresh Tariffs: Market Reaction and Analysis

- Fresh Sino-US trade skirmishes ahead of weekend

- Markets remain remarkably sanguine

- Analysts don't see deterioration into full-scale trade war

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The trade spat between the United States and China has taken another twist as the US announces the intention to widen the scope of tariffs on Chinese goods to include a further 1,300 Chinese products worth 100bn USD per annum.

This is an increase from the previous 50bn and now includes Chinese imported consumer goods.

The move is a reaction to China's response to the United States' initial tariff move; clearly the ball is now back in China's court.

Remarkably, the US justified the latest set of import taxes on the notion that China's retaliatory move was "unfair".

"Unfortunately, China has chosen to respond thus far with threats to impose unjustified tariffs on billions of dollars in U.S. exports, including our agricultural products.  Such measures would undoubtedly cause further harm to American workers, farmers, and businesses.  Under these circumstances, the President is right to ask for additional appropriate action to obtain the elimination of the unfair acts, policies, and practices identified in USTR’s report,” says United States Trade Representative Robert Lighthizer in a statement on the moves.

Overall the market appears to be taking the news remarkably in its stride and the heavy selling witnessed in response to China's announcement of counter-tariffs has been avoided. "The market's beta to trade war headlines may be easing as issue fatigue sets in," says a note to clients issued by TD Securities.

Nevertheless, financial markets still fell in reaction, with S&P500 futures down 19 points on Friday morning, and Asian markets dipping at the open.

Japan’s Topix was down 0.28 per cent in early morning trading, while South Korea’s Kospi was off by 0.29 per cent and Australia’s S&P/ASX 200 by 0.23 per cent.

In FX markets the primary driver appeared to be yield. The Dollar was marginally up by 0.06% on Friday morning, EUR/USD was down -0.08%, GBP/USD was flat and USD/JPY was down -0.03%.

Currency markets have actually been quite sanguine about the trade issue and there is yet to be a notable and conclusive instance of a currency pair tracking the to-and-fro's of this trade tennis match.

The greatest volatility appeared to be in bond markets with the US 10-year bond yield falling by -0.39% to 2.821, the UK 10-year gilt down -1.13% to 1.402 and the German 10-year yield down -2.67% to 0.51%. This suggested FX volatility was due to yields more than news of escalating trade wars.

Part of the reason for the lack of volatility could also be thinning liquidity ahead of arguably the most impactful release on the economic calendar in the form of US Non-Farm Payrolls later today.

Many investors will be standing aside to see what the reaction to the data is before deploying.

Future Scenarios

Beijing's retaliation mid-week appears to have been carefully targeted and aimed at causing the maximum political and economic damage to President Trump and the US, according to commentators.

The imposition of tariffs on soya beans, for example, will mainly hit states which voted overwhelmingly for Trump and constitutes a massive export crop for the US as a whole. The news alone caused the price of soya beans to cascade 3.0% on Wednesday.

Trump's communique on Thursday evening suggested the Chinese had found a soft-spot:

"Rather than remedy its misconduct, China has chosen to harm our farmers and manufacturers," said Trump, adding:

"In light of China's unfair retaliation, I have instructed the USTR (United States Trade Representative) to consider whether $100bn of additional tariffs would be appropriate... and, if so, to identify the products upon which to impose such tariffs."

On Friday morning a Chinese government spokesman retaliated that China was prepared to adopt “comprehensive countermeasures” in its dispute with the US, adding:

“China doesn’t want a trade war, but we’re not afraid to fight a trade war.”

In a straight-up fight the US probably has the upper hand because it imports more from China than China imports from the US.

"In view of the fact that in 2017 China only imported goods worth USD 154bn from the US so that it is unable to hit back to the same extent, Trump is obviously hoping that it can bring China to its knees," says Antje Praefcke analyst at Commerzbank.

China, however, owns 37% of all US Treasuries (which it keeps under the umbrella of FX reserves) and many fear it could start a US bond rout by dumping them, however, analyst Amy Yuan Zhuang of Nordea Bank does not think this will happen.

"We do not expect a full-blown trade war. Neither do we believe that the FX reserves and the currency will be used as a weapon to retaliate the US. The long-term rivalry between the two countries will likely continue. That could be bad news to globalisation," says Zhaung.

The latest US trade data showing the trade deficit at its widest since 2008 does not make the US look vulnerable too.

In February the deficit reached a nine-year high of $57.6bn according to the US commerce department. The goods deficit with China alone stood at $34.7bn.

Scandinavian lender Danske Bank are expecting only a "limited escalation" of the Trade conflict for their base case scenario, and if this is the outcome emerging markets will do fine.

"However, a more pronounced and widespread trade war will hit global growth and hurt the export-dependent emerging markets, notably in the Asian region, which is exposed to the US both directly and indirectly through the global value chain going through China," says Jakob Ekholdt Christensen, chief analyst and head of EM at Danske.

"Asian currencies were the main losers against the USD after the tariff announcement together with LATAM currencies like Uruguay, Brazil, and Colombia as well as Turkey, while waning concerns about an immediate NAFTA push supported the MXN," says Christensen.

ING Bank's FX strategist Viraj Patel, meanwhile, sees the eventual result of a trade war will be a weaker US Dollar and Stronger Asia FX as markets reach a new equilibrium level.

Ultimately it may be some time before actual concrete decisions are made concerning tariffs, and it could be months before US Trade Representative decides on the additional tariffs on 100bn of 1,300 Chinese exports, so there may be more twists and turns before any final legislation is passed.

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