Markets have woken up to the threats posed by the Trump administration during the past few weeks. Trump’s initial tariffs on steel and aluminium were enough to upset markets, but they have since been followed up by a plan to impose 25 per cent tariffs on approximately $60bn (£42bn), or 15 per cent, of China’s total exports to the US.
While the timing surprised many in the markets, president Trump’s protectionist instincts will not come as a shock. The president has argued for a more protectionist trade policy as far back as 1987, when he took out full page advertisements in the New York Times, Washington Post and Boston Globe, stating that the world was laughing at US trade policy.
Until recently, however, his protectionist rhetoric appeared to have been held in check, with markets focusing instead on the impact of tax reform, as well as other pro-business parts of his agenda.
Increases in tariffs will undoubtedly have a negative economic impact, but markets will focus mainly on how the rest of the world reacts now. There are encouraging signs here. The response thus far has been limited, with trading partners like China and the EU announcing surgical retaliation, rather than an indiscriminate response. The Chinese have been particularly careful to target Trump’s rural base, while leaving open the potential for further damage from tariffs on soy imports. This should constrain Mr Trump for the meantime, particularly with mid-term elections due later this year.
Encouragingly, good progress is also being made on renegotiating Nafta, with press reports suggesting positions between the US, Canada and Mexico are converging. We may see greater restrictions on trade during the next year, but this does not yet look like an unravelling of the trade liberalisation that has occurred over the past 25 years.
The danger is that the risk of miscalculation – by either side – is high. Mr Trump has ordered the Treasury to come up with a plan to impose new restrictions on Chinese investment in sensitive US technology sectors within 60 days, as well as ordering officials to launch a case at the World Trade Organisation (WTO) into China’s biased technology licensing rules. If the Chinese feel the need to respond to these measures as well, we could be seeing the beginning of a trade war.
China also runs its own risks in undermining the strength of feeling in the US. Chuck Schumer, the Democrat leader in the Senate, has supported Mr Trump on China, saying he is “doing the right thing”, while the US can likely count on international support from countries such as Japan when it comes to its WTO case on technology licensing rules. It may require compromise on both sides to neutralise tariffs as a risk to markets over the long term.
The existing proposals around tariffs are unlikely to knock equity markets for a prolonged period, considering the strong growth backdrop. The risk for equities is if we see a global tit-for-tat trade war, which would slow growth and disrupt global supply chains.
The performance of Mexican assets since Trump’s election victory serves as an example of what investors might expect: a sharp sell-off in response to negative developments, followed by a gradual recovery punctuated by sharp up/down moves on the back of news flow. I remain overweight equities for now, but investors should prepare for greater volatility ahead.