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US-China Trade Tension Just More Bad News for Emerging Markets

US-China Trade Tension Just More Bad News for Emerging Markets


Tuesday, 19 June 2018 11:08 AM Current | Bio | Archive

So far, we still have a trade skirmish between the U.S. and China, which until now didn’t matter very much economically.

The taxes (tariffs) that President Donald Trump is charging U.S. consumers will largely be avoided. The taxes (tariffs) that cannot be avoided are designed to be largely invisible to the U.S. consumer, and the products involved are easily substituted, which means that trade patterns may shift, but global trade overall should not be meaningfully affected by this.

However, the idea that a further $200 billion of goods "finished" in China may be the target of additional taxes at 10 percent raises a couple of concerns.

On the trade side, these goods may be less easy to substitute, and the tax may become more visible to the U.S. consumer.

A tariff of 10 percent on a pair of sport shoes is more visible than 25 percent on the metallic parts of a washing machine, perhaps.

And then there is the question of Chinese retaliation.

Of course, there are goods and services that can be targeted, but there is also the “nuclear” option of retaliating via the capital account.

Anyway, the Chinese Ministry of Commerce has released a statement saying: "If the U.S. loses its senses and publishes such a list ($200 billion of Chinese goods), China will have to take comprehensive quantitative and qualitative measures," and labeled the U.S. move "extreme pressure and blackmail," and said it would retaliate with counter measures.

Former U.S. Treasury Secretary Lawrence Summers said in an interview: "Its psychological effects, its effects in increasing uncertainty, could be very serious and we’re certainly getting later in a cycle of escalation."

Financial market reactions have been relativel muted and not catastrophic given the threat of damaged business confidence, a blow to China’s growth prospects and ripple effects through China’s supply chains.

All that said, safe havens that include the Japanese yen, U.S. Treasuries (higher prices equals lower yields), as well as the dollar all moved higher.

Now it’s also a fact that “if” markets seriously thought there was going to be a trade war with real global trade falling as a share of global GDP, then the equity market reaction would need to be a lot larger than it is so far.

Most trade is conducted by large listed companies. Trade is global. Non-Chinese companies, including U.S. companies, are just as likely to be affected by tariffs (taxes) on goods finished in China, given the complexity of modern supply chains.

Emerging Markets

The escalating trade dispute between the U.S. and China is obviously bad news for the emerging markets as among other things the dollar and the Japanese yen are the only two main currencies that are moving higher.

Currency crises in Turkey and Argentina in recent weeks as well as a more hawkish Federal Reserve and political risks escalating across Europe have also soured sentiment.

One could easily say, if it’s not Turkey, it’s Italy and if it’s not Italy then it’s the trade wars. Yes, there seems to be reason after reason for emerging markets to sell off.

The South African rand’s substantial plunge was exacerbated by Japanese retail investors who turned back to the safety of the yen, notwithstanding it didn’t seem that any South African domestic fact was behind the huge sell-off. Net long positions held by Japanese individuals in the South African rand ‘against’ the Japanese yen were last week at the highest since 2016.

During Q1 of this year, South African government bonds returned investors a stunning 13 percent return in Rands, which was the best performance out of 25 major emerging markets. Now, rand-denominated debt has lost 17 percent since the beginning of April, which is the most after Argentina and Turkey.

The South African 2026 bond yield could rise as high as 9.5 percent if the global risk-off environment intensifies.

Unsurprisingly, the Turkish lira also dropped while the yield on 10-year government debt climbed above 17 percent, which is a record level.

One of the mean reasons here is uncertainty over the direction of policy after the Presidential and Parliamentary votes on Sunday, and the risk of prolonged political instability if there’s no clear winner in the first round.

There will come a moment to step back into “selected” emerging markets and not at least into their bonds, but we aren’t there yet.

Be patient, that’s the message.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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There will come a moment to step back into “selected” emerging markets and not at least into their bonds, but we aren’t there yet.
china, us, trade, emergin, markets
Tuesday, 19 June 2018 11:08 AM
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