2019 H2 Outlook:
Building for resiliency
Sébastien Galy, Sr. Macro Strategist at Nordea Asset Management
With a trade war likely intensifying between the United States and China, we suggest building for resiliency by choosing a product mix that either reduces risk somewhat or diversifies it, such as some long-short equity strategies. We see ahead of us a G20 meeting that is a make or break for the US-China trade war and the odds are that it is a break. China’s population is being warned of a Long March, code words for great hardship, while official papers iterate “Don’t say that we didn’t warn you”, words first said before China attacked India. A widening of US tariffs to all of China’s exports would likely trigger a devaluation of the renminbi that would start a chain reaction. The US would likely intensify tariffs and some factories would move out of China.
The clash of Titans
The conflict between China and the United States is that of two vast giants vying for supremacy which means that commercial considerations can become secondary to national security ones. As we head to the G20 meeting, neither side seems to be softening its stance and yet the threat of extending the tariffs to China’s total exports to the United States stands in the balance. An olive branch is possible, e.g. the promise of buying soybean, but is unlikely to make much headway. The impact on Chinese growth would be sizable if we postulate that actual growth is around 4.5%. Estimates of the impact of the tariffs vary from less than 1% to 2% over two years.
The clock has started ticking for low margin Chinese producers. Take for example a t-shirt produced in China: a 25% tariff wipes out the profit margin of the US retailer while the local manufacturers likely have a limited ability to absorb the extra cost. Now think of industries that are uncertain if tariffs will be modulated up or down in the next few years — they will also look for alternative production sites such as Vietnam, itself at risk of being branded a currency manipulator. Faced with such a ticking clock and lower export demand, China is likely to let its currency weaken most likely by ten percent – not enough to create a dollar debt repayment crisis but partially stemming a credit crisis. This would lead Asia Pacific currencies to weaken and the dollar to rise. Currency intervention would limit imported inflation in countries such as Indonesia. Such consequent dwindling demand for short-dated US Treasuries should have a limited impact.