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China trade war threat – it’s not over until it’s over

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The G20 summit has resulted in a temporary ceasefire in the trade war between China and the US but tensions “will reach their peak in 2019”, according to Jacob Vijverberg, co-manager of the Kames Diversified Monthly Income Fund.

The war of words between the two nations escalated this summer when US President Donald Trump announced sweeping tariffs on $34 billion of Chinese goods. Under the tariffs, goods such as medical devices and aircraft parts would be subject to a hefty 25% border tax when imported into the US.

The largest trade war in economic history?

China responded by imposing its own tariffs on US goods including soybeans and cars, accusing the US of starting the largest trade war in economic history.

The US increased the stakes by creating a second set of tariffs covering $200 billion of Chinese imports. These imports are subject to a 10% rate initially, which will increase to 25% in January. This increase has now been postponed by three months to give negotiators time to reach a deal.

Trump says he wants to support corporate America and improve the fairness of trade. Vijverberg explains:

“According to Mr Trump, the United States is at a disadvantage on various trade-related levels, via theft of US intellectual property by Chinese firms. What started as campaign rhetoric is now being implemented by the Trump administration. Its approach is very confrontational, but concerns about Chinese trade practices are widely shared across the political spectrum and by other western countries. It is therefore much more likely that he can keep pressure on China to change.”

Vijverberg believes the US will be unlikely to implement other tariffs on its allies as there is little political support for that.

“The Chinese tactic seems to be to gain time, in the hope that political or economic events will redirect the focus of Trump,” he adds. “However, the US administration is well aware of this tactic. Therefore we expect that they will keep pressuring China. “In our base case, we foresee intensifying trade tensions with China, which will reach their peak in 2019, and expect the global economy to be mildly negatively impacted by this.”

China trade war: are markets ready?

It has been many years since investors have had to consider the implications of a trade war, and it is unclear what a new deal may look like. So far the prospect of a China trade war has yet to knock the US’ strong economic momentum off course, with its economy expanding without interruption for an incredible 110 consecutive months – the second longest expansion phase on record. Indeed, the economy is now more than 15% larger than it was before the financial crisis.

But the effect of the trade tariffs will likely be felt going forward. Vijverberg says: “the tariffs now involve a substantial part of America’s total imports, therefore we have revised down our forecasts for growth.”

He thinks 2019 will be a crucial year as the benefits of tax boosts to US corporates subside and the adverse impact of the China trade war tensions start to subtract from growth. A short-term negative effect will also likely be felt in China, where lower growth rates are already expected as the country shifts to a more services-oriented economy.

Vijverberg expects trade tensions to intensify in the coming months, but adds that the he thinks some form of compromise is likely to be reached. However: “Risks are clearly skewed to the downside as a further escalation of trade tensions could have truly negative effects on the global economy.”

Further reading for Armchair Traders:

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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