Is this the tipping point for the global economy and global equity markets, where we find ourselves in the next phase of slower global economic growth and global investors get increasingly risk-averse?
President Trump recently threatened China by directing the US Trade Representative to prepare additional tariffs of 10percent on $200billion (R2.68trillion) worth of Chinese exports to the US if China refuses to change its practices. In addition, in response to the latest US threats, China warned that it will respond with strong countermeasures - whatever it may be. This followed after the US decided to go ahead to impose 25percent additional tariffs on $50bn of Chinese imports, and China retaliated by matching the US’s move. This mystic “elephant in the room” also threatened that he will double-up if China retaliates again.
Both sides have various reasons for their actions, but it is not a question of whether they are empty threats - the additional tariffs on $34bn of the initial $50bn will already take effect on July 6.
To put things into perspective: In the first quarter of this year the US was China’s second largest trading partner behind the EU, accounting for $142bn of which $100bn was exports. On an annualised basis it means that should the US stand by its threats more than 60percent of China’s exports will be affected by increased import duties and tariffs.
In contrast, 30percent of the US’s exports to China will be affected should China go ahead with its threat. Should President Trump decide to go ahead to include another $200bn worth of Chinese exports it will mean that virtually all exports of China to the US will be subjected to additional tariffs and duties. China’s trade with the US is also equal to 42percent of China’s industrial profits, annualised.
Chinese proverb: Dig a well before you are thirsty. Make sure to plan ahead so that you can be prepared for anything that may come your way.
Preparing for worst
That is exactly what China is doing. They have suspended all the previous agreements through recent trade talks and are preparing for the worst. Indications from the Politburo in April are that China would combine the acceleration of structural adjustment with the continuous expansion of domestic demand.
It is apparently the first time since December 2014 that the idea was mentioned at a Politburo meeting. Consumption is high on the agenda and boosting demand will be crucial in the possible fallout of China-US tensions. Furthermore, the People’s Bank of China cut the reserve requirements of banks in China, which will effectively, after repayment of loans, enforcing banks to set aside the extra $62bn in their coffers to boost small and micro businesses, agriculture, rural areas, rural residents, and poor areas.
The possible impact of an imminent trade war is vast. US companies will need to search for new locations and production aside from China. Chinese companies will need to find other more friendlier and open markets to offload their wares.
Unfortunately for the sellers it will result in lower prices and increases the likelihood of lower inflation rates, if not prolonged deflation in certain major economies. The markets are probably right in their anticipation that Chinese business sentiment is under pressure and Chinese equities are feeling the heat already.
The increased protectionism measures by President Trump may backfire on the US, as the import prices of commodities and other products may jump in the short-term - as they have already done - as US based companies cover their imports ahead of the increased duties and tariffs resulting in higher inflation.
The Federal Reserve may not like it and unless influenced by the presidency may bring interest rate hikes forward, especially in a country experiencing near-full employment. Although the longer-term impact of increased trade barriers and protectionism may lead to a shift in the employment curve, the US consumer should prepare for a tougher environment.
Unfortunately, emerging markets and other commodity-based countries will bear the brunt of the trade war as risks down the line have increased.
Slower growth in China, a faster approach by the Fed to tighten monetary policies and resultant lower demand for commodities and related products will severely impact on those economies.
Their high interest rates adjusted for inflation will be less attractive than before, and their trade balances and balance of payments will come under immense pressure while their budget deficits will increase. The recent market movements are typical of what can be expected when global growth slows down.
Emerging market bond yields are rising, bond yields in developed economies have topped out, emerging market equities are in a downward spiral, compared to developed market equities, gold bullion is outperforming emerging market equities, and emerging market currencies are in a downward spiral compared to hard currencies. Consumer staple stocks in the developed markets have also started to outperform the overall market indices.
Only time will tell whether the markets are right in their expectations, but the warning signals were already there a few months ago and I propagated that we found ourselves at the “fade risk” phase in the investment cycle. It could well be that the markets are overreacting, as the final implementation of Trump’s decision may be months away, while the two superpowers may in the end reach agreement.
But what does it mean for the South African economy? While most commentators are fuming, because of the weakness of the rand, at long last the currency is working in favour of the South African economy. The economy just could not afford a strong rand and its negative impact contributed to the slump in economic growth in the first quarter of this year.
The weaker rand may in fact contribute to economic growth in the second quarter, and a technical recession of two successive quarters of negative growth may be averted by higher metal prices in terms of US dollars, coupled with a weaker rand are likely to boost export earnings.
The metal and mineral producers and other exporters of primary goods are likely to benefit most, but probably most importantly it will limit job losses, especially in the precious metals industry, and relieve the pressure on the budget deficit as the higher profits or the return to profitability will lead to higher tax revenue.
It is uncertain how the MPC of the SA Reserve Bank will react to the weaker rand, but given the country’s weak economy, it will be better to put interest rate hikes on hold and to maintain a dovish stance. “Dig a well before you are thirsty” certainly makes sense.
Ryk de Klerk is an independent analyst. Contact [email protected]
- BUSINESS REPORT