Blinkmanship: What's next in the Sino-US trade dispute
As the brinkmanship continues to intensify, so too will the obfuscation and misdirection. Until this fog of war dissipates, it is perhaps more useful to consider the range of possible outcomes and their divergent implications, which we have delineated here. Our base case expects the USA and China to ultimately reach a negotiated settlement in the following 6–9 months. Chinese equities could rally 15% over 6 months and USD/CNY should be capped at 7.0.
China or the USA? Which side will blink first in the increasingly complex trade dispute between the two countries? Which side will decide that the domestic cost of the dispute outweighs its perceived economic value and subsequently seek to close out the issue, albeit in the guise of a political victory?
Apparently not the USA. On 13 September, President Donald Trump stated he felt "no pressure" to reach a trade agreement with China despite news the previous day that his administration had extended an invitation to Beijing to hold ministerial-level talks. Furthermore, as expected, the US administration doubled down on 17 September by announcing that tariffs of 10% on the additional USD 200 bn worth of US imports from China would take effect on 24 September with the rate increasing to 25% on 1 January 2019.
How the endgame to this brinkmanship will play out is anyone's guess. Perhaps a combination of pressure from US business and the need to manufacture some positive Mexico-style news ahead of the mid-term elections could see an early positive resolution. Perhaps, alternatively, the dispute could metastasize and deteriorate, ultimately impacting growth in the global economy. But until we are able to get some clarity toward a likely resolution, it is uncertainty, opacity, and concern that will likely dominate investor sentiment.
As such, we present – and discuss – three possible scenarios below, which we hope will assist readers in shaping their thoughts toward the dispute.
Our base case expects – as per 17 September's announcement – the USA imposing a 10% tariff on USD 200 bn of Chinese imports. China immediately retaliates – also as expected – by imposing 5%–10% on USD 60 bn of US imports, but both parties ultimately reach a negotiated settlement in the next 6–9 months. We assign a 50% probability to this scenario. As a result, China's 2019 GDP growth decelerates to 6.2% from 6.5% in 2018 with domestic stimulus – for instance, accelerated infrastructure investment – cushioning the blow. USD/CNY meanwhile should remain in the range of 6.8–7.0. Chinese equities could rally 15% over the subsequent 6 months as earnings are still strong and much of the negative news is in the price after the recent correction.
Our bearish scenario – to which we assign a 30% probability – foresees the USA immediately imposing a 25% tariff on USD 200 bn of Chinese imports and threatening to proceed with another USD 267 bn. China retaliates strongly and both sides fail to reach a deal in the next 12 months. Here, China's 2019 GDP growth is reduced by 1.1%. China could respond with further domestic stimulus but will be limited by the diminished size of the current account surplus. We expect GDP growth to slow to about 6% in this scenario with some downside risk. Additionally, the CNY could weaken by at least 5% to offset the trade negatives with USD/CNY breaching 7.20. Equities could correct by 10%-15% as earnings growth is revised lower.
Our (positive) scenario envisages the USA not imposing further tariffs and reaching a deal with China in the next 3–6 months. We peg the probability of this outcome at 20%. The impact on China's growth outlook will likely be small at only about 0.2% of GDP. Most, if not all, of this will be offset by monetary and fiscal stimulus efforts by the Chinese government. The CNY is likely to appreciate to around 6.50 against the USD. Equities, meanwhile, could rebound by 15%–20%, led by banks.
Historical performance indications and financial market scenarios are not reliable indicators of current or future performance.