A $200bn Game of Chicken

The U.S. and China rev up the trade rhetoric, but still have big incentives to swerve.

When U.S.-China trade rhetoric turned sour back in March, we acknowledged that this was likely to dominate the news headlines throughout 2018, but unlikely to be the big driver of market sentiment. We urged investors to focus on the clear signals coming from the major central banks and try to filter out the noise.

Well, the noise has gotten harder to ignore this past couple of weeks and it certainly has dented market confidence. Risks are rising from this game of chicken, as well as renewed frictions between the U.S. and other trading partners such as Canada, Mexico, and the European Union.

As we suggested in our earlier Perspectives, markets are not yet ready to trust this administration on trade negotiations. The next few months will be a vital proving period for that trust, during which the noise and anxiety are likely to increase. The time is right, therefore, to clarify why we still believe the two biggest players are likely to swerve from their collision course and avoid a truly damaging outcome.

Tit-for-Tat

On June 15, the U.S. confirmed tariffs of up to 25% on $50 billion worth of Chinese goods, beginning on July 6. This had been in the pipeline since March, and in itself was not very material. Most economists reckoned it would knock one-tenth of a percentage point off both U.S. and Chinese GDP, at worst.

More worrying was that, in confirming the tariffs, the U.S. spurned China’s reported offer to purchase an extra $70 billion of its products over the next year. China responded to the tariffs almost immediately with its own, on $50 billion worth of U.S. goods. The U.S., in turn, met that with talk of a new set of measures covering as much as $200 billion worth of products.

That could take the economic hit up from one-tenth to three-tenths of a percent of GDP. And it sounds an awful lot like tit-for-tat.

Broadening the Theatre of Battle

How far could this go? On the face of it, quite a long way.

Peter Navarro, trade advisor to the White House, says that “China has much more to lose than we do” and “may have underestimated the strong resolve of President Trump.” He seems to be suggesting that, because China exports $500 billion of goods to the U.S. and only $130 billion of goods goes the other way, China will run out of things to slap tariffs on before the U.S. does.

While this is true, China could easily broaden the theatre of battle. Subsidiaries of U.S. companies operating in China, and the joint ventures U.S. companies have established there, do very good business—north of $250 billion worth, according to most estimates. China’s biggest weapon in a trade war probably isn’t tariffs, but finding ways to close down Apple stores, for example, or otherwise making life difficult for those U.S. businesses. That’s before we even consider consumer boycotts, or more dramatic actions regarding China’s currency peg or its reserve holdings of U.S. securities.

Moreover, while China arguably has “more to lose” in a trade tussle, it may have a higher pain threshold. Yi Gang, governor of the People’s Bank of China, says that “all kinds of monetary tools” are at the ready to support domestic markets, and that China “has room to face all sorts of trade friction.”

The U.S. has its fiscal stimulus buffer, for sure, and it has to be said that U.S. market reaction has so far been muted. But in the event of continued escalation would the White House be prepared to see 10% or more come off U.S. equity markets running into mid-term elections, or agricultural commodity prices continue to weaken into harvest season?

Swerving to Save Face

Both sides have an incentive to back down in a way that saves face, then. That incentive is particularly acute for President Trump, looking for strong headlines leading into the November polls. Some argue that China’s initial offer to ramp up its purchases of U.S. goods was not only a little too vague, but also that it simply came too early and too easily for the White House to accept. It would have lacked the drama of taking the game of chicken to the brink. When the timing is more propitious, the argument goes, a similar offer with more detail and clearer enforcement mechanisms will break the deadlock.

Finally, the markets have not really discounted the possibility that we end up with lower global tariffs once the dust settles. For example, last week saw some of Germany’s biggest auto manufacturers back the idea of eliminating the 10% tariff on U.S. autos going to Europe and the 2.5% tariff on European cars going to the U.S.

For these reasons, we still believe we are experiencing short-term volatility right now, rather than the start of something much more damaging. There is a real risk that Trump’s White House is prepared to inflict self-harm to make a point about China’s economic model. There is also a risk that the four months until the U.S. mid-terms simply leaves a lot of time for things to get out of hand. But for now, for all the drama, we still expect the swerve to come.


Joseph V. Amato is President of Neuberger Berman Group LLC and Chief Investment Officer—Equities at Neuberger Berman. He is also a member of the firm’s Board of Directors and its Audit Committee. To learn more, see Mr. Amato's bio or visit www.nb.com.


Brad Tank is a Managing Director, Chief Investment Officer, and Global Head of Fixed Income at Neuberger Berman. He is a member of Neuberger Berman's Operating, Investment Risk and Asset Allocation Committees. To learn more, see Mr. Tank’s bio or visit www.nb.com.

In Case You Missed It

  • NAHB Housing Market Index: -2 to 68 in June
  • U.S. Housing Starts: +5.0% to SAAR of 1.35 million units in May
  • U.S. Building Permits: -4.6% to SAAR of 1.30 million units in May
  • U.S. Existing Home Sales: -0.4% to SAAR of 5.43 million units in May
  • Japan Consumer Price Index: +0.7% year-over-year

What to Watch For

  • Monday, 6/25:
    • U.S. New Home Sales
  • Tuesday, 6/26:
    • U.S. Consumer Confidence
  • Wednesday, 6/27:
    • U.S. Durable Goods Orders
  • Thursday, 6/28:
    • U.S. 1Q18 GDP (Final)
  • Friday, 6/29:
    • U.S. Personal Income & Outlays
    • Case-Shiller Home Price Index

– Andrew White, Investment Strategy Group

Statistics on the Current State of the Market – as of June 22, 2018

Market Index WTD MTD YTD
Equity      
S&P 500 Index -0.9% 1.9% 4.0%
Russell 1000 Index -0.8% 2.0% 4.3%
Russell 1000 Growth Index -1.1% 2.7% 9.1%
Russell 1000 Value Index -0.6% 1.3% -0.7%
Russell 2000 Index 0.1% 3.3% 10.4%
MSCI World Index -0.9% 1.2% 1.9%
MSCI EAFE Index -1.0% -0.2% -1.3%
MSCI Emerging Markets Index -2.3% -2.7% -5.2%
STOXX Europe 600 -0.8% 0.4% -2.2%
FTSE 100 Index 0.7% 0.3% 2.2%
TOPIX -2.5% -0.1% -3.0%
CSI 300 Index -3.7% -4.5% -9.7%
Fixed Income & Currency      
Citigroup 2-Year Treasury Index 0.1% -0.1% -0.1%
Citigroup 10-Year Treasury Index 0.2% -0.5% -3.2%
Bloomberg Barclays Municipal Bond Index 0.1% 0.0% -0.4%
Bloomberg Barclays US Aggregate Bond Index 0.0% -0.5% -2.0%
Bloomberg Barclays Global Aggregate Index 0.1% -0.6% -1.6%
S&P/LSTA U.S. Leveraged Loan 100 Index -0.1% 0.2% 2.0%
ICE BofA Merrill Lynch U.S. High Yield Index -0.1% 0.9% 0.6%
ICE BofA Merrill Lynch Global High Yield Index -0.1% 0.4% -1.0%
JP Morgan EMBI Global Diversified Index 0.3% -0.8% -4.9%
JP Morgan GBI-EM Global Diversified Index 0.4% -2.4% -6.0%
U.S. Dollar per British Pounds -0.1% -0.3% -1.9%
U.S. Dollar per Euro 0.2% -0.3% -3.1%
U.S. Dollar per Japanese Yen 0.5% -1.1% 2.5%
Real & Alternative Assets      
Alerian MLP Index 1.7% -0.2% 0.8%
FTSE EPRA/NAREIT North America Index 2.2% 3.3% 1.0%
FTSE EPRA/NAREIT Global Index 0.6% 1.2% 0.6%
Bloomberg Commodity Index -0.4% -3.6% -0.1%
Gold (NYM $/ozt) Continuous Future -0.6% -2.6% -2.9%
Crude Oil (NYM $/bbl) Continuous Future 5.4% 2.3% 13.5%

Source: FactSet, Neuberger Berman.

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