The impact of deteriorating trade relations between the US and trading partners

investment viewpoints

The impact of deteriorating trade relations between the US and trading partners

Charles St-Arnaud - Senior Investment Strategist

Charles St-Arnaud

Senior Investment Strategist

The risk of a full-blown trade war is high — not least because both sides believe strongly that they are in the right. The dispute has already, in our view, affected investors’ risk tolerance, leading to the underperformance of many risk assets. There is significant potential for a period of tit-for-tat retaliations.

President Trump has signalled his next move: a tariff on the imports of cars into the US. If imposed, this would primarily hit Canada, Japan, Mexico, Germany and Korea. The biggest impact would likely be on Canada, Mexico and Japan, as car exports to the US represent 11%, 7% and 6% of their total exports, respectively1.

The shock to Canada’s economy would be particularly severe and the country could be plunged into recession. Though not quite as exposed as Canada, Mexico could face a similarly painful outcome. For Germany, while the auto sector is very important for the economy, its direct trade with the US is smaller than the other countries, shielding it somewhat.

In terms of economic growth, the potential direct impact of the tariffs enacted thus far remains modest. But the risk arises from the signals being sent to markets, which have started to focus on the possibility of a severe escalation. Investors need to monitor carefully their exposure to risk assets, especially equities and emerging markets.

However, it is important to note that the underlying fundamentals of many segments within developing economies are much stronger than they were in 2013. If external risks stabilise, we would expect a sharp rebound in risk assets, based on both valuations and fundamentals. The strategic thesis for accessing emerging markets risk premia remains strong.

The NATO Summit in July will provide an occasion for President Trump to engage his counterparts. Whether we get a repeat of the confrontation of the recent G7 or a more conciliatory tone will be key for the markets.

 

Investment implications

  • Markets are beginning to focus on the possibility of a severe escalation in the trade dispute between the US and its trading partners
  • Investors need to monitor carefully their exposure to risk assets, especially equities and emerging markets assets
  • If the US follows through on its threat to impose tariffs on car imports, Canada and Mexico would likely be worst hit. We believe both countries could face recessions
  • We believe there is a significant risk that trade relations will deteriorate further, with damaging consequences for global trade and the global economy
  • However, if signs of a compromise emerge, we would expect a sharp rebound in risk assets, based on both valuations and fundamentals

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1Source: UN Comtrade

 

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