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US-China trade war sends unsentimental markets hunting for winners to get behind, and losers to ditch

Neal Kimberley says the US-China trade war will affect goods, services and currencies across the globe, but there are also potential opportunities for investors in ‘safe havens’, and we can count on markets not to let a crisis go to waste

PUBLISHED : Tuesday, 17 July, 2018, 11:00am
UPDATED : Tuesday, 17 July, 2018, 10:34pm

“You never want a serious crisis to go to waste”, said former US president Barack Obama’s chief of staff Rahm Emanuel back in 2008. In truth, markets never do. And because markets understand China’s importance to the world economy, there’s a lot of time and energy being expended on how best to play the deterioration in China-US trade relations. 

That’s not to say markets are callous, merely that they aren’t paid to be sentimental, they’re paid to make money.

One obvious market focus is the yuan. If it chose to, China could allow the yuan to depreciate materially further than already seen, in an attempt to focus US minds. Cheaper Chinese exports, in US dollar terms, would certainly get Washington’s attention but it probably wouldn’t be in Beijing’s longer-term interests to pursue that option.

Such a move, aside from potentially triggering undesired capital outflows and increasing imported inflation, wouldn’t sit well with China’s intention to establish the yuan as a leading international currency that reflects the country’s economic clout.

With that in mind, the attention of currency market participants might alight on other currencies that could also be vulnerable amid worsening China-US trade tensions.

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Noting how the Korean won and Taiwan dollar had reacted to the prospect of the US placing 10 per cent tariffs on an additional US$200 billion of imports from China, Goldman Sachs wrote on July 11 how, given the circumstances, the market might currently prefer to hold US dollars in preference to either the won or Taiwan dollar.

One of the reasons, according to the US firm’s economic research team, was that both South Korea and Taiwan are “plugged into Chinese supply chains”. Yet, if that’s the case for Seoul and Taipei, why not Japan?

Japanese manufacturers have huge investments in China, and a lot of that investment has been, for example, in the assembly of goods for onward export to the US. But if it’s “made in China” and the product falls within the scope of US trade tariffs, those tariffs will be applied.

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Meanwhile, separately, US tariffs on steel imports continue to be applied to Japan.

Perhaps the recent yen weakness reflects market awareness that Japan is pretty exposed economically to deterioration in China-US trade relations, at the same time as the yield differential between US Treasuries and Japanese government bonds continues to be heavily skewed in the US’ favour.

As regards US Treasuries, bond market participants may have drawn the conclusion that a bear flattening of the US yield curve, where yields at the short end of the curve rise faster than those at the longer end, is a natural consequence, at least for now, of the rise in China-US trade tensions.

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While the short end of the curve may be influenced by the Federal Reserve’s continuing commitment to rate hikes, the long end may be being influenced by “safe haven” demand.

With reference to the flatter US yield curve, Federal Reserve chairman Jerome Powell said last month that “in a risk-off environment, people want to own US Treasuries and you see, you know, Treasury prices go up, rates go down quite a lot”.

From the viewpoint of US bond market traders, the sight of the two largest economies in the world squaring off against each other over trade might well induce a feeling that investors will be somewhat more risk-averse. In that sense, positioning for a bear flattening of the US yield curve could make good sense.

In the case of equities, the US’ resort to tariffs on goods imported from China is likely to have a material impact on a number of US-listed corporations, as a piece from Goldman Sachs’ equity research team made clear last week.

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To take one example, the list of products that will be affected if the US adopts a 10 per cent tariff on a further US$200 billion of goods imported from China later this year will include all furniture, a market worth some US$28 billion, according to the Goldman analysts.

Given that, according to the US firm, “China supplies 65 per cent of furniture imported into the US”, it could be quite a headache for some listed US furniture suppliers.

An understanding of how widespread the consequences of deteriorating China-US trade relations are has driven markets to take a granular approach, to identify potential winning trades.

The worsening in China-US trade relations isn’t just a major news story. It also represents a huge trading opportunity across asset classes.

Neal Kimberley is a commentator on macroeconomics and financial markets