Effects could include reversal of globalisation and relocation of production, impacting jobs and growth
As we had anticipated, tensions over trade policy continued to climb over the summer. However, the US administration sought to concentrate its fire on China, while simultaneously working towards accommodation with Canada and Mexico to agree on a replacement for NAFTA and effectively signing a truce with the EU.
In July, European Commission President Jean-Claude Juncker met for negotiations on trade policy in Washington. Although the EU protested the US’s implementation of steel and aluminium tariffs in Q2, the Europeans have actually been more concerned that the US might impose tariffs on vehicles, under the guise of a Section 301 ‘national security’ review.
The discussion led to an agreement to establish a working group to discuss a number of trade topics, with the declaration that no further tariffs would be imposed while discussions were ongoing. Specifically, the working group would “work together toward zero tariffs, zero non-tariff barriers, and zero subsidies on non-automotive industrial goods…. (and) work to reduce barriers and increase trade in services, chemicals, pharmaceuticals, medical products, as well as soybeans.” The two sides also “agreed …. to strengthen our strategic cooperation with respect to energy. The European Union wants to import more liquefied natural gas (LNG) from the United States to diversify its energy supply.”
Of course, this was really just an agreement to negotiate. But within the statement was also the strong hint of a coalition against Chinese trade practices. As per the statement, “we agreed today to join forces to protect American and European companies better from unfair global trade practices. We will therefore work closely together with like-minded partners to reform the WTO and to address unfair trading practices, including intellectual property theft, forced technology transfer, industrial subsidies, distortions created by state owned enterprises, and overcapacity.”
The US has been pressing the EU on this topic for some time, especially on the issue of China’s IP/technology transfer practices and alleged metals dumping, and used steel and aluminium tariffs as a stick to incentivise cooperation.
In late September, the Trump administration separately reached a deal with Mexico and Canada to replace NAFTA. The new deal – the United States, Mexico Canada Agreement (USMCA) – involves additional restrictions on content and wages in vehicle production, as well as Canadian concessions on dairy produce.
While US trade tensions with the EU, Mexico and Canada might have eased over the summer, the opposite was happening in the US’s relationship with China. We have been of the view that the US administration was not bluffing in its threat to impose tariffs on imports from China, and that it remains determined to see China adjust its practices on market access and intellectual property.
Correspondingly, at the completion of the consultation phase in early September, the Trump administration made good on its threat to initiate tariffs on a further USD 200 billion of imports from China. The tariffs were set at 10%, but will reset to 25% in 2019, providing time for US purchasers to identify and source substitutes. China responded with retaliatory tariffs on USD 60 billion of imports from the US, and filed a complaint with the WTO. China also cancelled proposed trade talks.
Our view remains that the gap between Beijing’s industrial policy direction and Washington’s requested trade practices is too wide to be bridged, so that any resolution to the trade conflict is unrealistic in the short term.
The escalation of trade tensions between the US and China matters to the Treasury and Treasury inflation-protected securities (TIPS) market because:
Escalating trade tensions could also hit US employment and GDP growth over time. Tariffs could cause significant disruption to global supply chains, affecting the prices and availability of basic, intermediate and finished goods. US manufacturing firms would need to find alternatives to Chinese suppliers, where possible. The disruption to prices and supply chains could have an adverse short-term impact on employment, as vulnerable firms would lack working capital to finance adjustment costs.
In the medium term, however, the relocation of offshore production back to the US could be expected to boost US manufacturing employment in some sectors. Longer term, the loss of the advantages from international trade as countries no longer focus on areas of comparative advantage, could reduce potential growth.
This combination of higher prices and reduced long-term growth is a ‘stagflationary’ phenomenon. Put another way, if we see globalisation as having contributed to low inflation and rapid global growth over the last two decades, then a resurgence in protectionism would likely reverse that trend. Ultimately, that would be supportive for breakeven inflation rates and keep long-dated real yields contained.