A look at the US-China trade war and its impact on markets

The impact escalation will have

The impact escalation will haveThe focus of the market on the China-US trade war is acute due to China’s and the United States economic weight. In 2018 the US’s GDP was above $20 trillion and China’s GDP over $14 trillion, which makes them the world’s two largest economies by nominal GDP.

Furthermore, consider that when you add these two countries GDP together, they account for more than 40% of the world’s entire GDP. So, the first point to grasp is that the significance of a US-China trade war is really a global growth problem.

When you factor in the alliances and trade partners of both countries, the legitimate concern is that a China-US trade war spills over across the entire globe and slows down the entire world economy.

Trade between the US and China

The current state of affairs between the US and China

The current relationship between the US and China, at the time of writing, is constructive. As of September 18, there has been a gentle walking back from recent trade war escalations by both the US and China.

On September 12 Bloomberg reported that Trump’s advisors were wanting to find an interim deal with China as they were concerned that a trade war was weakening the American economy.

The deal would involve delaying some US tariffs in exchange for China’s commitments on intellectual property and agricultural purchases. On September 11 China announced that it was exempting 16 American product types from tariffs for one year and Trump announced a tariff increase delay to October 15 from October 01.

However, although recent relationships are de-escalating, this is a repeated pattern that we have seen in the US-China trade war. An attempt at de-escalation quickly breaks down. So in the event that US-China relationships deteriorate again, which seems most likely, what might we expect the response be from the markets?

streetscapeImpact on Global Indices

The initial impact would be an immediate fall in not only the US indices but also indices around the world. The S&P 500 would fall instantly on the news, and that would have a ripple effect across the Asian and European markets.

With the US-China trade dispute a global growth problem, we can expect a downturn in global indices as equity investors rotate out of positions on risk aversion. The main group of individual stocks likely to find support in such times would be the traditional defensive stocks that provide essentials, like food products and energy supplies.

Impact on bond prices

Bonds would become attractive to investors as they would seek the security of fixed bond returns in an uncertain landscape. In fact, the highest-rated Government Bonds around the world, Gilts and Bunds, for example, would find bids as investors across the globe look to exit the riskier asset classes, like equities, in favour of fixed returns.

So, a break down in the current US-China calm will result in bond prices rising (and bond yields falling).

Gold

Impact on Gold

Gold will find bids as its safe haven status comes to the fore in a breakdown between the US and China. Furthermore, with global interest rates falling around the world, J will be bid strongly as a place of value in an increasingly uncertain and valueless landscape.

The typical reluctance to invest in Gold, due to its lack of yield, will be offset by the environment of low global yields. If growth can’t be found in equities or currencies, then Gold shines just that little bit brighter when you add a trade war into the mix.

Impact on Oil

Oil has been bid recently after attacks on two Saudi Arabian oil plants caused concerns over a major global oil shortage. Those concerns were ultimately unfounded, and Saudi Arabia’sEnergy Minister explained that the impact of the attacks was not nearly as bad as it was originally feared.

This sent Oil down again. If US-China trade relationships worsen again, the concern will be that global growth as a whole will slow and this will result in a lack of demand for oil, thereby pushing oil prices down further. Similarly, on global growth concerns, metals involved in construction like Copper and Iron Ore will also fall.

Impact on JPY and CHF

The repeated pattern that we have seen when relations sour between the US and China are instantbids into safe-haven currencies.  Even though both the Swiss National Bank and the Bank of Japan have negative interest rates, their currencies are considered to be the safest currencies to buy in the result of a crisis. Expect JPY and CHF strength on any threat of new tariffs from either US or China.

AUD/JPY chart

Impact on AUDJPY

The pair that stands out for sellers on a break down in US-China relations is the AUDJPY pair. AUDJPY would be particularly badly hit for three reasons:

  1. The RBA have recently stated they are open to further easing
  1. Around 30% of Australia’s GDP is made up from trade with China, and the AUD is often traded as a proxy for the yuan. What’s bad for China is bad for the AUD.
  1. The JPY would be bid on a safe haven play adding extra weight to AUD/JPY shorts.

So there you have it, the market impact that we would see on any return to strained relationships between the US and China. Remember, it is more likely than not that relationships will break down once again and it more a question of when they will rather than if they will, so be ready to act.

This article was submitted by CMS Prime.