The Re-escalation of Trade war & its implications

The U.S stocks managed to close up last Friday after overcoming a deficit of more than 350 points with the Dow Jones rising 114.01 points, or 0.4%, to end at 25,942.37. This claw back from earlier lows still did not help S&P 500 and Nasdaq close the worst week for the year losing 2.2% and 3% respectively. The stock’s rally this year is at a turning point as the impetus provided by the dovish FOMC is at a danger of being offset by the renewed trade tensions between U.S and China. The downturn in the stocks was triggered earlier this week when President Trump sent out a tweet threatening to increase tariffs on $200 billion of Chinese imports from the current 10% to 25% on Friday – which eventually he did.

This sent jitters through the global stock markets as investors had put this issue on the back burner expecting some kind of trade deal to happen soon. But Trump’s frustration over the prolonged negotiation between the two largest economies is evident from this action. Not only this, but he threatened to increase the tariffs to 25% on the remaining $325 billion of Chinese imports as well. The Chinese Commerce ministry immediately announced that it would take retaliatory measure to counter this move although they were thin on details. Fearing a rout in the Chinese stocks, the state funds went on a massive buying spree in the market pushing the Shanghai Composite Index up more than 3%.

While The U.S President continues to defend the tariffs saying that these measures would strengthen the U.S economy, I believe this is a classic Arm twisting technique that Trump is used to in his business dealings, which might or might not work on a macro scale. Analysts differ on the opinion as well – one industry group thinks that higher tariffs could cost U.S 400,000 manufacturing jobs while putting further pressure on the American farmer. Others are still cautiously optimistic that a deal would be worked out. Data-wise, The U.S CPI numbers came out lower than expected which supports that dovish tone of the Feds. While the imposition of tariffs could cause a slip in consumer spending warranting rate cuts as observed by Atlanta Fed President Raphael Bostic in a meeting with business leaders – something that Trump so desperately wants the Feds to do anyways.

China, on the other hand, is in no less of a conundrum either. With the economic growth slowing to the lowest level in years & the issues of forced technology transfer and intellectual property is badly damaging the reputation of the second largest economy at the time when it is trying to revive the old silk route through the “Belt & Road initiative,” involving more than 60 countries. Having said that China still has some options to explore as retaliatory measures in case of a break down in trade talks & escalation of the trade war to the next level.

Putting tariffs on U.S imports by the same amount, but they might not be that effective since China imports much less from the U.S as the latter does from China.
The second one could be halting of U.S soybeans which it had started to buy more of as a gesture of good faith after the trade talks started. This could hurt the U.S farming sector, which is already reeling from the ongoing tariff war.
Depreciation of Yuan (Chinese currency) has been a tool that China has unjustly used over the years to gain a competitive edge for its exports over the years & can be effective as well.
The final option which could be the most destructive & least desired one is of Dumping U.S treasuries which China owns $1.1 trillion of, more than any other foreign nation. This has the potential of causing the most destruction to the global economic system as we saw the bond markets jolted severely last year after a report that Chinese officials recommended slowing or halting Treasury purchases. Also, if China were to do so, it had no better alternative to park its World’s biggest foreign currency reserves worth $3.1 trillion.

The only other headliner last week that competed with the echoes of trade war worries was the most anticipated high-profile IPO of the global ride-hailing service Uber. The company priced its IPO at $45/share – the low-end of its targeted range – for a valuation of $82.4B. It took the conservative approach fearing what happened to its contemporary LYFT – which lost 7.4% of the value on Friday alone, accumulating the total losses to 29% since it launched in March. This move for the third largest U.S IPO ever, however, did not help the plunging fortunes for the investors on the debut day as the stock for Uber closed down 7.6% to $41.57 posting a cumulative loss of $655 million.

On the trade front, financial pundits are hoping that things will get worked out amicably in the end, as it is not in the best interest of either of the two countries or the global economy as a whole to continue on this path a full blown trade war. Ending things on a lighter note with this…