Another week, another flurry Of trade-war rhetoric

Markets remain hostage to the headlines when it comes to the trade tariff dispute between the United States and its trading partners.

The back and forth of bullish, then bearish; aggressive, then conciliatory comments from the Trump administration continues to buffet markets.

Mid-week suggestions that the Trump administration would fall short of applying the harshest possible measures to China prompted a rally in European equities on Wednesday.

Around the same time, US equities futures sharply trimmed earlier losses after the White House said it would rely on existing laws—rather than new harsher and stricter ones—to restrict Chinese investment in the US.

US Treasury yields reacted to the news, coming off their lows. German government bond (bund) yields also spiked.

Concern about trade tensions shows no sign of going away. The United States is scheduled to impose a further US$4 billion of tariffs on Chinese goods this coming Friday, after which we expect a response of equal value likely from China.

Interestingly, well-informed political commentators have suggested Trump’s shifting priorities and demands have left Chinese officials confused about what the United States really wants. Without clear demands from Washington, we believe Beijing is unlikely to offer much in the way of concessions.

Europe expresses its concern

A number of observers felt European equities’ move higher on Wednesday last week was overdone, and as the week progressed there was a marked pick-up in concerns about the impact of the trade row on Europe.

On Friday, European Central Bank (ECB) President Mario Draghi warned European Union (EU) leaders that trade tensions were having a larger impact in Europe than expected.

Donald Trump chimed in over the weekend, doing little to alleviate concerns. Citing what he called “the car situation”, he said: “The European Union is possibly as bad as China, just smaller… It is terrible what they do to us.”

Auto manufacturers were the real losers last week. A newspaper report on Wednesday detailed dire warnings from the Association of Global Automakers (a group representing foreign automakers in the United States) about the possible impact on US car prices of Trump’s 25% tariff on auto imports.

Both European and US automotive stocks closed the week down more than 4%. From a longer-term perspective, the impact of the current climate looks even more detrimental, as European auto stocks as a group fell more than 12% in the second quarter of 2018.

United States’ WTO exit on the cards?

There was some speculation at the end of last week that the Trump administration was considering leaving the World Trade Organisation (WTO).

President Trump has subsequently insisted he doesn’t plan to exit the WTO, but wants better treatment.

It’s uncertain whether Trump has the authority to order a US exit from the WTO without approval from Congress, where many lawmakers—including Republican proponents of free trade—would likely put up a fight.

This is all just noise at the moment, but still one more thing to be aware of in the coming weeks.

Is the United States primed for a trade war?

At the halfway point in the year, it’s worth noting that there has been a divergence between US equity markets and those in the rest of the world. The United States has outperformed significantly.

It now seems that the policies that Trump put in place before he kicked off the trade-tariff dispute ran the US economy hot. As a result, some observers believe the United States could be in a stronger position to withstand the threat of a full-blown trade war than the rest of the world.

The United States also has the option of slowing down planned interest-rate hikes if necessary. By contrast, although the ECB could delay interest- rate hikes, it would find it trickier to extend its quantitative easing further to ease any pressure, as there are not enough bunds left to buy.

The situation shows no sign of abating. According to well-sourced reports, the European Commission has sent a written submission to the US Department of Commerce, including a detailed response to Trump’s threats of tariffs on imported vehicles.

The submission reportedly notes that that the US administration risks sparking global retaliation against as much as US$300 billion of US products.

This is clearly an acceleration of the situation and we will be watching for further headlines this week.

Last week

Europe

German equities were the clear underperformers last week, dragged down by weakness in the automotive sector as well as by political concerns.

In fact, Germany closed the first half of 2018 as Europe’s weakest underperformer.

The UK equity market outperformed broader markets last week, as the weaker pound mitigated losses among some larger-cap stocks. Utilities and food and beverage stocks proved more attractive as nervousness directed investors towards traditionally defensive names. The oil and gas space outperformed on a relative basis on the back of a sharp rally in crude oil. Outside of the noise around trade tensions, the big story for Europe was Friday morning’s migration agreement between EU leaders.

On Friday the euro rallied on news that politicians had agreed a deal on migrants at the EU summit. Earlier there had been distinct concerns that Italy would hold the summit up until their demands on immigration were met, so this show of solidarity was taken with relief.

The deal still falls short of an overall agreement to revise the EU’s asylum rules, but crucially represents a consensus on the bloc’s most divisive issue. It was hope that this move would ease some political pressure, particularly on German Chancellor Angela Merkel.