US-China tariff war impacts global economic growth

China and the United States are engaged in a trade war as each country continues to dispute tariffs placed on goods traded between them. The US President Donald Trump had promised in his cam­paign to fix Chinese longtime abuse of the broken international system and unfair prac­tices. The economic disputes occurred before China’s entry to World Trade Organization but former Presidents George H W Bush, Bill Clinton, George W Bush and Barack Obama all failed to solve the problems.

The United States filed a request for con­sultation to the WTO, in regard to concerns that China was violating Intellectual property rights.

At the end of 2018, the global economy looks poised to slow moderately from 3.8% to 3.5% in 2019, led by deceleration in the US and further softening in China. But with growth still above potential in most DM economies, we look for continued labor market tightening, gradually rising core infla­tion, and in many cases higher policy rates. n Our Fed call remains hawkish relative to the market, with five more 25bp hikes to a terminal 3¼-3½% funds rate at the end of 2019. While higher rates and tighter financial conditions should help slow growth to its potential rate over the next year, we expect a decline in the unemployment rate to 3% and a rise in core inflation to 2¼% by early 2020. n We think concerns about the global impact of tighter Fed policy are overdone. Spillovers to EM are real, but the market has already priced 11 of the 13 hikes we expect for this cycle, so most of the adjustment to more normal US interest rates is probably behind us.

The main risk to this view is a more sub­stantial US overheating that eventually forces steeper rate hikes. n China has slowed quite sharply in 2018, on the back of slower credit growth and fears about a more damaging trade war. With monetary and fiscal policy now in easing mode, we expect only a modest further deceleration. The macro impact of increasing tariffs is also likely to remain man­ageable, even under our call for some further escalation in early 2019. n Although growth in Europe and Japan has decelerated in the course of 2018, it remains above trend. This should put further downward pressure on the unemployment rate and keep the recent upward trend in wage growth intact.

The US decision to impose tariffs on $200bn of Chinese imports marked a serious escalation in its hostilities with Beijing over trade. Yet economists believe protectionist measures will have only a modest impact on global growth provided the bilateral conflict does not turn into an all-out multilateral war. The economic impact of the intensifying trade war between Washington and Beijing appeared to deepen last month with factory activity and export orders weakening across Asia, but analysts warned the worst was yet to come. In a sign conditions for exporters and factories were deteriorating, manufacturing surveys showed marginal growth in China, a slowdown in South Korea and Indonesia and a contraction in activity in Malaysia and Taiwan.

Those figures follow weaker-than-expected industrial production data from Japan and South Korea on Wednesday, with output in the latter shrinking the most in over 1-1/2 years. By contrast, the US ISM manufactur­ing survey was expected to show a much faster growth pace than in Asia, albeit a tad slower than in September, supporting the outlook for further Federal Reserve rate hikes.Worryingly, the prospects for higher U. rates could feed back more market pain for the region’s externally vulnerable economies Indonesia, India and the Philippines, which have already been forced to raise rates to mitigate a sell-off in currencies, stocks and bonds. You have a tightening of monetary conditions around the world, a slowdown in Chinese demand, and financial market tur­moil that affects sentiment and investment decisions, said Aidan Yao, senior Asia EM economist at AXA Investment Managers. Yao said many orders from abroad are still front loaded in anticipation of yet more tariffs and the impact is still mostly indirect, through the business confidence channel. The real economic shock is yet to come, he said.

China’s manufacturing sector barely grew last month after stalling in September and export orders contracted further, according to a private sector manufacturing report. An official survey on Wednesday showed the manufacturing sector expanding at its weak­est pace in over two years, hurt by slowing demand both externally and domestically. Japan showed more resilience, with activ­ity picking up, though at a slower rate than in a previous flash estimate. The world’s third-largest economy faces pressures in other areas with its central bank trimming the inflation outlook on Wednesday, flagging external risks.

Its tech-specialist neighbour and Southeast Asian economies look more exposed, how­ever.

A DBS analysis of Asian supply chains for products bound for the United States shows the biggest exposures in machinery and elec­trical equipment in South Korea, Singapore, Malaysia, the Philippines and Taiwan. South Korea’s minerals and petrochemicals exports were also exposed, as well as Indonesia’s transportation industry, according to the DBS report, which looked at the correlation between China’s imports from Asia and its US exports.

The pressure on China’s economy is not just external. Economic growth cooled to its weakest quarterly pace since the global financial crisis at 6.5 percent, exhibiting lacklustre domestic demand by Chinese standards. Washington has already imposed tariffs on $250 billion worth of Chinese goods, and China has retaliated with duties on $110 billion worth of US goods in a row sparked by US President Donald Trump’s demands for sweeping changes to China’s intellectual property, industrial subsidies and trade policies. But absent any deal between Trump and Chinese leader Xi Jinping, who are expected to attend a G20 summit this month in Buenos Aires, the recently introduced 10 percent tariffs on $200 bil­lion of Chinese goods will be raised to 25 percent and other tariffs may be placed on the remaining $250 billion-or-so of Chinese products which escaped the initial rounds.

As everyone anticipates a further tariff hike…there is still a lot of front-loading going on. After Jan. 1, we expect many trade and economic activities to tumble, said Kevin Lai, senior economist at Daiwa Capital Markets. That all bodes ill for Asian financial markets, with many of the region’s curren­cies and bourses deep in the red this year. Those economies with high current account deficits have been particularly vulnerable to capital flight. The rate hikes that central banks deployed to stop rapid declines in their currencies might also further slow activity. I would argue it to be wise to remain wary of EM currencies into those trade discussions a few weeks hence, and lean towards the US dollar instead, said Michael Every, senior APAC strategist at Rabobank.

Vietnam was another standout economy in the region, showing an acceleration in manufacturing activity in October. The country’s labour base is still cheap by regional standards while its trade ties with the United States remain clear of the kind of disputes with which its larger Asian peers are wres­tling. As such, it’s seen as potential winner from the Sino-US trade war as companies consider rebasing and re-routing their supply chains away from the crossfire between the world’s two largest economies. Vietnam, by our estimation is the least impacted country in Asia…because if global companies have to move, Vietnam is a viable option, AXA’s Yao said. But it will take a long time for Vietnam to take up some of the market share that China leaves behind.

The latest economic data adds weight to the argument that the slowdown in China’s economy is getting worse as the trade war with the United States dampens consumer confidence and hurts sales of goods such as cars and electronics. The figures suggest there is growing economic pressure on China to seek a deal to end the trade war when Chinese President Xi Jinping and US President Donald Trump meet on December 1 in Argentina. However, it is unclear that this economic pressure will prompt Xi to offer sufficient concessions to reach a deal to end the trade war.

Analysts said that Xi and Trump could agree a ceasefire so that an increase in US tariffs scheduled for January 1 would be put on hold. Chinese economic growth slowed in the third quarter to its lowest in 10 years, while data from October – the first month of the fourth quarter – indicated that economic growth had slowed further. A slowdown in car sales, property, and consumer electronics was recorded in October. Total vehicle sales dropped 11.7 per cent from a year earlier to 2.38 million last month in the world’s biggest auto market, according the China Association of Automobile Manufacturers this month.

Real estate floor space sold in square metres, a proxy for property sales volume, fell by 3.1 per cent year-on-year in October, ac­cording to the National Bureau of Statistics.

Published in Melange Intl. Magazine in January 2019.

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