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The art of (trade) war: Impact, market fallout, and how Trump won’t fight Canada on second front

The art of (trade) war: Impact, market fallout, and how Trump won't fight Canada on second front

Briefing highlights

  • The impact of the China trade fight
  • Trump excludes EU, others from tariffs
  • Markets at a glance
  • Canadian dollar perks up above 77.5 cents
  • Inflation rate hits 2.2 per cent
  • Retail sales up more slowly than forecast

Donald Trump is going to war against China, and seemingly the markets, as well.

And it's not so much the immediate impact of his latest move, but how China responds and what it threatens where global trade is concerned.

"The biggest concern is that the moves would prompt retaliation from China," warned Andrew Hunter, the U.S. economist at Capital Economics in London.

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"The risk of an escalation of tit-for-tat measures means that the eventual impact could be more severe," he added.

"China may adopt more punitive non-tariff measures, like reducing orders to U.S. firms, which the U.S. couldn't match."

As The Globe and Mail's Adrian Morrow and Nathan VanderKlippe report from Washington and Beijing, the U.S. unveiled tariffs on up to US$60-billion in Chinese goods, firing another shot in a potential full-scale trade war.

The U.S. government initially pegged the number at US$50-billion, but Mr. Trump added a round US$10-billion to it.

U.S. President Donald Trump holds his signed memorandum on intellectual property tariffs on high-tech goods from China, at the White House in Washington, March 22, 2018.

That sent markets tumbling Thursday, with investors chilled by the threat to the global economy.

Beijing then unveiled threatened tariffs on about US$3-billion of American exports but cast the move as one against earlier U.S. trade action.

Here's how things look:

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Impact on the U.S.

"Even if the tariffs were implemented in full, the impact on the U.S. economy would not be that large," Mr. Hunter said.

"They would cover less than 3 per cent of total goods imports, little more than the initial scope of the recent steel and aluminium tariffs," he added.

"Import prices would rise by around 0.7 per cent, but that would have only a small and short-lived impact on overall inflation."

Of course, certain sectors would be hit harder than others, with the tariffs aimed at information technology, aerospace and machinery, Mr. Hunter noted.

"The tariffs appear to target goods for which the U.S. is heavily reliant upon imports from China, and finding alternative suppliers wouldn't be easy," he added.

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"They could also cause significant disruption to firms with supply chains in China. Production could be rerouted through other countries, but that wouldn't happen overnight."

Much also depends on what products are targeted, and how Americans respond, said Mark Williams, the chief Asia economist and Mr. Hunter's colleague at Capital Economics.

"In many sectors there are few alternative suppliers that U.S. buyers could switch to," Mr. Hunter said.

"Consumers may also not be deterred much by the resulting price rises," he added.

"For the typical Chinese product sold in the U.S., the cost of importing it accounts for just under half of the retail price … A 25-per-cent tariff might therefore push prices up by 12 per cent. For many electronics products, that would simply return prices to where they were a few years ago."

Mr. Hunter also noted the opposition to tariffs among American businesses.

"Chinese retaliation would fall hardest on the 'Farm Belt' States that helped Trump win in 2016," he added. In that event, a trade war may be bad politics as well as bad economics."

Indeed, China's move early today included planned tariffs on farm products.

Impact on China

The economic hit to "China will be small, at least from the initial volley, analysts said.

"The direct economic impact is not huge: e.g. a 25-per-cent tariff on $50-billion of imports would be equal to less than 0.1 of GDP (and there could easily be some trade substitution)," said Bank of Montreal chief economist Douglas Porter said in a research note.

"But the ultimate impact of the U.S. measures largely depends on China's next move, and then any U.S. counter-response."

China exported more than US$500-billion in goods to the U.S. in 2017, which Capital Economics estimates drove 2.5 per cent of Chinese gross domestic product.

"The US$50-billion to $US$60-billion of products being mentioned today therefore contributed around 0.25 per cent to China's GDP last year."

Observers also believe the troubles could in negotiations, as we saw from the earlier U.S. action against steel and aluminum. Mr. Trump has given many regions an exemption, including the EU on Thursday.

And as for Beijing, "they may want to appear to be standing up to foreign bullying in the coming weeks," Mr. Williams said.

"But at this stage, they can afford to be fairly relaxed and their response is likely to be limited. China's leaders have no desire to see the global trading system further destabilized."

Impact on markets

Well, how did you like yesterday, with the Dow Jones industrial average sinking by almost 3 per cent, the S&P 500 losing 2.5 per cent, and the S&P/TSX Composite shedding 1.8 per cent?

"The book of wisdom tells us that trade wars are bad for equities, but not such a big deal in bond and currency markets," said Kit Juckes of Société Générale.

"Profits suffer, sentiment is hurt, and while they are negative for growth, they push inflation up," he added.

"The [foreign exchange] market itself isn't sure it cares too much about the book of wisdom, and its reaction to risk-off and lower bond yields across the board is to buy the yen and the Swiss franc. These are the two [foreign exchange] 'winners' since the Fed decided to hike rates."

The market slump moved into Asian and European exchanges today.

"Despite Trump claiming that the tariffs would make the U.S. 'a much stronger nation,' the markets are keenly aware that there will be no winners to a trade war," London Capital Group said today.

"Worse still, the tit-for-tat responses that we are now seeing, and can expect to see more of, between the world's two largest economies is damaging for their economies and the broader global economy."

Though investors still don't know what the Americans plan to target, with a hit list to be drawn up over the next couple of weeks, the U.S. move should not have been a surprise given the tariffs were expected, said Elsa Lignos, Royal Bank of Canada's head of foreign exchange strategy in London.

And, she noted, China's response was "muted" to start with.

"If Trump can hit China where it hurts, and prompt capital flight out of the country, even China's big holdings of U.S. Treasuries may not help," added IG chief market analyst Chris Beauchamp.

"Between now and then however, we may still see a lot more volatility. Still, these kinds of opportunities do offer the chance for patient investors to go bargain hunting, and it will be interesting to watch which sectors do well today, as a sign of possible recovery."

Markets, of course, hate uncertainty. And that's what they're in for over the next few weeks, at least.

"While retain the view that China is willing to negotiate and is likely to offer concessions, uncertainty and the fear of escalation will likely hold back market sentiment in the short run," said Johanna Chua of Citigroup.

Ms. Chua also warned that the currencies threatened the most are those "of the small open North Asian markets," notably South Korea's won and Taiwan's dollar.

"But a rise in generalized risk aversion could even spread further," Ms. Chua said.

"For instance, the most vulnerable currencies in Asia are IDR, INR and PHP, which face current account deficits and a dependence on external portfolio flows," she added, referring to Indonesia's rupiah, India's rupee and the Philippine peso.

"Crucial," too, in all this is the reaction of China's currency, the yuan or renminbi, or CNY and RMB by their symbols.

"While trade tensions could hurt RMB sentiment, we do not believe that Chinese authorities will look to retaliate with a currency devaluation," Ms. Chua said.

A "more rational concern" in all this, said RBC's Ms. Lignos, is Mr. Trump's ouster of national security adviser H.R. McMaster and his replacement with John Bolton.

Add Bolton to the fact that Mike Pompeo was recently named secretary of state, and you're heading for "a far more hawkish U.S. foreign policy," Ms. Lignos noted.

"Bolton is best known for being a chief architect of the Iraq war," she said, noting his comments a few years ago that an attack on North Korea would be "perfectly legitimate."

"It raises the risks of a fall-out if the Trump-Kim summit goes badly."

Impact on Canada

Mr. Trump already appears to have taken his eyes off his northern neighbour, sparing Canada and Mexico from the steel and aluminum tariffs, at least temporarily, and giving in on a key piece of a redrawn North American free-trade agreement.

As The Globe and Mail's Mr. Morrow and Greg Keenan first reported, U.S. negotiators surrendered earlier this week on the auto content provision of NAFTA, a key sticking point for Canada.

Why?

As Avery Shenfeld, chief economist at CIBC World Markets, sees it, there were a few possible reasons.

First, Mr. Trump is about to lose his authority to negotiate a locked-in deal without going back to Congress by the first of April for an extension.

Mr. Shenfeld's comments came before Thursday's move against China, but he noted they were expected and how Mr. Trump "needs to show less-protectionist Republican allies that he's not launching a trade war on every front simultaneously."

Of course, NAFTA is yet to play out, with the next round of talks scheduled for early April.

And As The Globe and Mail's Barrie McKenna writes, some Canadian companies may now have a leg up in the U.S., moving in on sectors like clothes, aerospace and rail cars.

Ditto our farmers moving into China.

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