After the escalation in the US/China trade war last month, investors might be losing faith in the prospect of a negotiated solution.
Trade risks have no doubt increased, and could hurt share markets in the short term, but we still believe that Trump is likely to eventually strike a deal with the Chinese at some stage.
Investors had been hoping that China and the US would reach a settlement in their trade dispute after they halted new tariffs in December and entered talks.
But those talks broke down in early May. That saw the US ramp up tariffs on China. China has responded, though not to the same degree.
There’s now also increasing talk the trade war will spread beyond tariffs to other things, such as Chinese students studying in the US and tech companies.
More recently, President Trump threatened to ramp up tariffs on Mexico to 25 per cent if the Mexican government didn’t do more to stop the flow of immigrants across the US-Mexico border.
Trump has since suspended the threat after Mexico agreed to a deal that will see it tighten border security, but it shows Trump’s willingness to use trade as geopolitical weapon.
Some might argue that the trade war and tariffs are not a big deal as they are not being imposed on all US imports, but the trade war is threatening global business confidence.
Businesses have set up their supply chains so that inputs into their products come from all around the world. When they see the barriers and tariffs go up, it threatens their supply chain.
That hurts business confidence, which in turn, makes it very hard for them to decide where to invest. The trade war is dampening US business investment, and it could affect business investment globally.
That threat to the global economic outlook is causing renewed volatility in share markets.
After reaching lows in December, share markets rebounded to highs in April and early May. Hopes that the trade issue would be resolved drove the recovery, along with the US Federal Reserve taking a more benign approach to monetary policy.
Since then global share markets have fallen back. The risk is they have more downside because the trade issue affects confidence, economic growth and profits.
Waking up to the threat
The problem we face is that President Trump and others may be underestimating the threat to global growth.
They may not understand that threat until they see share markets come down a bit more aggressively.
This is a bit unnerving for investors, and we could see a bit more short-term volatility in share markets as a result.
The major hope now is that if President Trump wants to get re-elected in 2020, he can’t risk rising US unemployment and the threat of a recession, which could be a consequence if he continues to pursue these trade wars.
I think he is conscious of that and, ultimately, I think China and the US will come to some sort of negotiated solution.
But investors should brace for more volatility in the short term, before things start to stabilise. Which I think they will before too long, but it may also require more monetary easing by central banks along the way.
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