What’s the deal with US and China?


Investors may be familiar with the phrase “sell away and go away in May” as the well known financial adage seems to ring true. The sell-off that occurred this month was not without good reason.

US President Donald Trump once again showed the level of power he wields over financial markets with just a couple of tweets.

The May 3 tweets of his frustration at how slow-moving the China-US trade negotiations triggering a global sell-off in risky assets.

From the start of May, the S&P 500 Index and CSI 300 Index fell by 2.5% and 7.4% in local currency terms as of the time of writing.

The Chinese equity markets appear to have taken a worse beating as many believe the US has an upper hand in a prolonged trade war, given the outsized value of goods (over US$500 billion [RM2.08 trillion]) the Chinese exports to the US each year.

The Trump administration will increase the current 10% tariff rate imposed on US$200 billion worth of goods to 25%, effective May 10.

Chinese exporters have already been paying 25% levies on US$50 billion worth of technology and machinery- related goods.

Besides amplifying the pressure on China, the US noted it reserves the rights to impose additional tariffs on the remaining US$325 billion worth of Chinese goods that currently remain untaxed.

Beijing has said it would implement tit-for-tat countermeasures but has not mentioned how.

Tariffs of such proportion will have significant debilitating impact globally.

We analyse the impact in three scenarios. The first is an increased tariff from 10% to 25% on US$200 billion worth
of Chinese goods.

Our second scenario assumes the 25% tariffs on the US$325 billion in goods to be implemented within 2019 and the final scenario takes into account of China’s retaliation.

We project the escalation of trade dispute to shave off US year-on-year (YoY) GDP growth by 0.25%, 0.65% and 1% for the first, second and third scenario respectively.

Current consensus estimation for US’ 2019 annual GDP growth is 2.6%. For China’s case, we anticipate a -0.3%, -1.2% and -1.5% cut on YoY GDP growth for the first, second and third scenario respectively.

Current consensus estimation for China’s 2019 annual GDP growth is 6.3%.

Closer to home, Asean countries have a prominent role to play in the global value chain.

On average, domestic value added in exports accounts for more than 60% of the gross value exported, and about 33% as a share of GDP in the Asean region. Looking from a growth attribution perspective, Malaysia and Thailand are expected to witness a greater magnitude of impact compared to Indonesia.

The latter relies a lot less on exports to generate growth compared to the aforementioned nations.

As stipulated above, for Thailand, we anticipate a -0.3%, -0.8% and -1.6% cut in YoY GDP growth for the respective scenarios.

As for Malaysia, we foresee a -0.4%, -0.9% and -1.9% impact on YoY GDP growth for the respective scenarios.

Indonesia could witness a -0.1%, -0.3% and -0.5% cut in YoY GDP growth for the respective scenarios.

We recognise that there was no grace period given by the US unlike last year as this latest round of tariffs took the market by surprise.

However, the new tariffs only apply to goods which leave China’s shores last Friday. Given the average shipping duration for goods from China to the US of around two to three weeks, the tariffs will only affect prices after the said period.

What this means is an extension of current deadline and a creation of a “soft” deadline for a deal to be potentially brokered between the two nations.

Should a deal be struck within the next two to three weeks (before the new batch of Chinese goods arrive), the impact of a 25% tariffs might be effectively nullified.

The situation is fluid and could develop for the better or worse. Investors should not be too deterred. In the scenario, we could be looking at another bull run for markets,

Should trade tensions escalate, we could see a sharp fall for equities. Right now, markets have yet to price such a scenario in with stock indices merely retreating from healthy gains this year.

Furthermore, the Chinese government has yet to announce how they are going to retaliate.

Business confidence could be affected once more and this could lead to risk aversion in markets.

However, when comparing 2019 to 2018, we had to deal with China deleveraging and the US Federal Reserve tightening amid the trade tensions.

In 2019, central banks have turned dovish, China is stimulating and only trade tension is escalating but a full-blown trade war could stoke recessionary fears again.

Thus, although there could still be some market volatility ahead as the US and China battle back and forth, we might not retest 2018’s lows unless it evolves into full-blown economic war.