Market Perspectives: In the News

Update on Tariffs and Trade with China: Mind the Gap

China US Trade banner

The following report was originally written and published by Yung-Yu Ma, Ph.D, Chief Investment Strategist, BMO Wealth Management – U.S. For more information on BMO Wealth Management, click here.

Where We Stand

We now have tit-for-tat, and another tit-for-tat. After the U.S. tariffs on steel and aluminum were announced on March 8, China’s response came weeks later when it announced tariffs on 128 U.S. products such as fruits, nuts, pork, and wine that consist of approximately $3 billion in U.S. exports to China. Then on April 3, when the U.S. Trade Representative Office announced long-discussed tariffs on another $50 billion in Chinese goods (emphasizing industrial and hi-tech goods), China took only hours to respond with its own announcement of 25% tariffs on 106 U.S. products worth about $50 billion annually including soybeans (see Figure 1), aircraft, autos, beef, corn, wheat, cigarettes and chemical products. Following the announcement, the Chinese government’s official news mouthpiece, Xinhua News, ran an article on April 4 titled, “China calls for constructive way to solve trade challenges,” with China’s Vice Finance Minister stating, “We don’t want a trade war because that will only bring losses to both sides.” Furthermore, China’s implementation of this second round of tariffs will depend on the date of implementation of the U.S. tariffs. That timetable currently stands at May 22 for U.S. companies to voice concerns about the proposed U.S. tariffs, and then another 180 days for the administration to decide whether to go ahead. That basically lays out the negotiating period.

The Disconnect
“Mind the Gap” (Hong Kong subway platform announcement)

According to the Wall Street Journal, “[T]here remains a gap between what China is willing to offer and what the Trump administration will accept.” From the Trump administration standpoint, the recent tariffs on $50 billion in goods from China are in response to decades of intellectual property theft. It is difficult to imagine that the narrative in China centers on correcting its long-standing misbehavior.

To the contrary, the U.S. actions are more likely to be seen through a lens of America’s attempt to keep China down, which is a common refrain in the Middle Kingdom. So, with each side viewing the other as the clear instigator, there is added difficulty in reaching an acceptable agreement.

The Path of Most Resistance
“I too have a Nuclear Button, but it is a much bigger and more powerful one than his…”
(President Trump, Twitter post on 1/2/2018 in reaction to North Korean leader Kim Jong-Un)

In the instance of trade with China, here too does President Trump have a bigger button because U.S. imports from China dwarf U.S. exports to China by a factor of more than three. President Trump could come up with a number that China simply cannot match. The recent $50 billion tit-for-tat represents about 10% of U.S. goods imports from China, but a whopping 38% of China imports of goods from the U.S. President Trump’s fighting instincts may be inclined toward even greater escalation (or threat of escalation) before sitting down at the negotiating table. Such threats would likely rattle the markets further. Such a “bigger button” approach to the negotiations is also likely to be misplaced, because if push comes to shove the question is not so much who can dish out more pain (the U.S. can, clearly), but which side can take more pain (unclear, but a costly question to answer). Additionally, whereas in the U.S. there will be strong push-back from many industries and companies against the tariffs, in China the corporate push-back will be minimal. Further escalation would be unwelcome and increase the risk of a policy mistake.

Base Case and Conclusion

Our base case is for cooler, economically-minded heads to prevail. That would mean progress in negotiations that include commitments on China’s part for more intellectual property protections, modest incremental purchases of U.S. goods, and the U.S. dropping the proposed tariffs. Greater concessions from China would probably require the U.S. offering up something that China values. This could come in the way of fewer investment restrictions, but could also involve questions relating to U.S. policies and legislation that pertain to Taiwan. An optimistic spin on the recent developments would be that China’s swift response could lead to a quicker resolution of the trade and tariff issue than would have otherwise been the case.

The longer this trade and tariff issue remains unresolved and creates uncertainty for businesses, the greater the potential for harm to the broader economy. Continued frictions or escalations could lead businesses to take a wait-and-see approach to capital expenditures, which would dampen the positive effects of the tax package that are widely expected. A poor resolution to the tariff and trade issue would likely lead to the conclusion that President Trump’s days of positive impact on the economy and markets are behind us now that the tax package and budget deal are completed, with negative implications for market sentiment. In the late evening hours that followed Trump’s presidential election victory, the futures markets and international markets were down sharply before U.S. equity markets opened. Those concerns have re-materialized in the past few weeks and the risks to trade are now front and center. We continue to believe that ultimately the President’s deal-making instincts will lead to an acceptable negotiated outcome, while acknowledging the increase in risks and the formidable gap that remains between the U.S. and China positions.

 

Download PDF

 

Disclosure
This report contains our opinion as of the date of the report. It is for general information purposes only and is not intended to predict or guarantee the future performance of any investment, investment manager, market sector, or the markets generally. We will not update this report or advise you if there is any change in this report or our opinion. The information, ratings, and opinions in this report are based on numerous sources believed to be reliable, such as investment managers, custodians, mutual fund companies, and third-party data and service providers. We do not represent or warrant that the report is accurate or complete.
To the extent this report contains information about specific companies or securities, including whether they are profitable or not, it is being provided as a means of illustrating the investment manager’s investment thesis. The investment manager may or may not have invested in these securities at the time this report was prepared or is accessed by the reader. References to specific companies or securities are not a complete list of securities selected and not all securities selected in the referenced timeframe were profitable.
Other Bank of Montreal affiliates, and their agents and employees, may provide oral or written market commentary or trading strategies to clients that reflect opinions that are contrary to the opinions expressed in this report. These same persons and affiliates may make investment decisions that are inconsistent with the recommendations or views expressed in this report. We and our affiliates, directors, officers, employees and members of their households, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities referred to in this report. We and our affiliates, directors, officers, employees and members of their households, may have positions in the securities mentioned that are inconsistent with the views expressed by this report.
This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, a recommendation to buy, hold or sell securities, or a recommendation of any investment manager or investment strategy. Do not use this report as the sole basis for your investment decisions. Do not select an asset class, investment product, or investment manager based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.
Any forward-looking statements in this report involve known and unknown risks, uncertainties and other factors that may cause the actual performance of future markets to differ materially from the projections depicted in the report. Past performance is not indicative of future results and current performance may be higher or lower than that shown in the report. There can be no certainty as to the extent or depth of any market downturn, nor any assurance regarding the nature, extent or timing of markets rebounding. When evaluating the report, you are cautioned not to place undue reliance on these forward-looking statements, which reflect judgments only as of the date of the report. Investment returns fluctuate, and investments when redeemed, may be worth more or less than the original investment.
Standardized performance returns include reinvestment of dividends, other income and capital gains, which depict performance without adjusting for the effects of taxation or the timing of purchases and sales. Performance data is presented without deducting the investment advisory fees and other charges that may be applicable. The deduction of such fees and other charges (and the compounding effect thereof over time) will reduce portfolio return. Unless otherwise indicated, traditional investment performance data generally represents a composite or representative portfolio return and is shown gross of the investment manager’s advisory fees. Unless otherwise indicated, alternative investment performance data is shown as net of fund expenses, management fees, and incentive fees. Index performance data is shown as total return. You cannot invest directly in an index. Due to a system conversion, the ability to manipulate or restate client specific performance data prior to December 31, 2007, may be limited.
Any discussions of specific securities, investment managers, or strategies are for informational purposes only and should not be considered investment advice. The report does not constitute an offer to sell or a solicitation to buy any security or investment product. Any offer to sell or solicitation to buy an interest in any private security, investment product or fund may only be made by receiving a confidential private offering memorandum, prospectus, investment advisory agreement or similar documents from the investment manager, which describes the material terms and various considerations and risks relating to such security, investment product or fund.
Alternative investments, such as private equity and hedge funds, contain risks that are amplified when compared with other asset classes, such as illiquidity, stock or sector concentration, financial leverage, difficulties in valuation, and short selling. Alternative investment vehicles have minimal regulatory oversight and alternative managers have the latitude to employ numerous investment strategies with varying degrees of risk.
We are not licensed or registered with any financial services regulatory authority outside of the United States. Non-U.S. residents who maintain U.S.-based financial services accounts with us may not be afforded certain protections conferred by legislation and regulations in their country of residence with respect to any investments, investment solicitations, investment transactions or communications made with us.
You may not copy this report or distribute or disclose the information contained in the report to any third party, except with our express written consent or as required by law or any regulatory authority.
BMO Wealth Management is a brand name that refers to BMO Harris Bank N.A. and certain of its affiliates that provide certain investment, investment advisory, trust, banking, securities, insurance and brokerage products and services. Not all products and services are offered in every state and/or location. Capital Advisory Services are offered by a division of BMO Harris Bank, N.A. Member FDIC.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
Securities, investment advisory services and insurance products are offered through BMO Harris Financial Advisors, Inc. Member FINRA/SIPC. SEC-registered investment adviser. BMO Harris Financial Advisors, Inc. and BMO Harris Bank N.A. are affiliated companies. Securities and insurance products offered are: NOT FDIC INSURED – NOT BANK GUARANTEED – NOT A DEPOSIT – MAY LOSE VALUE.
Not all products and services are available in every state or location or through all entities within BMO Wealth Management or CTC | myCFO. Securities, investment, and insurance products offered are: NOT A DEPOSIT – NOT INSURED BY THE FDIC OR ANY FEDERAL GOVERNMENT AGENCY – NOT GUARANTEED BY ANY BANK – MAY LOSE VALUE.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.