U.S.-China mini-deal: trade policy volatility is here to stay

• The so-called “mini-deal” between the U.S. and China is not a game-changer for the global economy. The U.S. average tariff could reach around 8.5% by year-end (taking into account a 10% tariff on EU car imports and the 15 December round of tariffs on Chinese goods). We remain in our intermediate “Trade Feud” scenario; policy volatility is the new norm in trade negotiations, and it goes beyond tariffs (ban lists of companies).
• We are far from a comprehensive agreement. The hardest part of negotiations still lies ahead: the two parties are switching to “Phase two”, which should deal with market access, IP protection, China’s industrial subsidies, U.S. sanctions on Huawei and Chinese surveillance firms. We are unlikely to see a comprehensive deal before the 2020 U.S. election.
  
• We give 55% probability to the scenario of the U.S.  turning its trade policy focus to Europe on 17 November. In the case of a 10% tariff on car imports, aggregate export losses for the EU would be EUR4bn per year, and GDP growth would be hit by an annual -0.1pp.

Hence, we are far from a comprehensive agreement, and the hardest part of the negotiations still lies ahead. The two parties are now switching to “Phase two”, which  should deal with market access, IP protection, China’s industrial subsidies, U.S. sanctions on Huawei and Chinese surveillance firms. We are unlikely to see a comprehensive deal in 2020. We reiterate our belief that a softening in China’s stance on such core issues is unlikely. China would rather play the long game as it is not bound by elections. That being said, China has started to import more from the U.S. (+1.6% y/y in August 2019, see Figure 2).

The mini trade deal between the U.S. and China is yet another illustration of the continued volatility over policy announcements on both the U.S. and China’s sides, with indications of a temporary Trade Détente following this summer’s escalation. This is something we pointed out in our September Global Macroeconomic Update. We continue to believe this policy volatility is the new norm in trade negotiations.
 
The Trade Détente is not a game-changer for the global economy: As of 15 October, the U.S. average tariff dropped -0.7pp compared to our previous estimate since USD250bn of Chinese imports remains taxed at 25%, not 30%. Hence, by year-end, the U.S. average tariff should reach 8.3% (instead of 9%), from around 7.5% today,  taking to account the 15 December tariff implementation. The 50% tariffs on steel imports from Turkey (likely on 21 October) would have a negligible effect on the U.S. average tariff.

The tariff volatility is here to stay, notably during the impeachment inquiry. Although the mini trade deal provided relief to financial markets, it will not improve global economic growth, which would continue to slow down to +2.4% in 2020, the lowest level since 2009. We remain in our “Trade Feud” scenario and we believe the impeachment inquiry in the U.S. will create further noise and switch President Trump’s attention to other regions (similar to the recent conflict with Turkey). The U.S. economy is likely to continue in its slowdown phase before a negative quarter of growth in Q1 2020. The Fed should pursue its monetary policy easing cycle: We expect one more rate cut by year-end and three more in 2020. As a reminder, in our monitoring framework, the switch from “Trade Feud” to a full-fledged “Trade War” happens at the 12% U.S. average tariff threshold. To switch to a full-fledged trade war (not our baseline scenario) we would need two out of the three following events: (i) Mexico tariffs hiked to 25% on all imports (USD370bn); (ii) 25% tariffs on all cars imported into the U.S. (USD200bn) and (iii) a tariff hike from 15% to 25% on list 4 (A and B) of U.S. imports from China (USD300bn). We expect a correction in the European equity markets, which will comfort the ECB in cutting the deposit rate in Q1 2020 and increasing the QE size (from the current EUR20bn per month to EUR30bn).

Trade policy volatility is not limited to tariffs. The U.S. recently added eight new Chinese electronics companies to its business-ban list. However, should the U.S. expand this list in a new round of trade restrictions, the impact will be felt by big companies (e.g., Lenovo). As China remains the U.S.’s first market, this could in turn affect U.S. companies. In that case, the impact on semiconductor supply chains will also be disruptive beyond China (Taiwan, South Korea and Germany will also be hit).

We give 55% probability to the U.S. turning its trade policy focus to Europe on 17 November

The decision of imposing U.S. tariffs on car imports (currently taxed at 3% from the EU) is expected to come on 17 November. President Trump has criticized ECB policy on several occasions and put Germany on the list of “currency manipulators”. There is also a delicate balance with France, which has recently imposed a GAFA tax. Hence, we expect President Trump to announce on 17 November that the U.S. aims to implement a 10% tariff (from a range of 10%-25%) on imported European cars (EUR48bn from the EU out of the EUR260bn of total imported cars by the U.S.) in the absence of noticeable progress on the U.S.-Europe trade deal.

What could be the impact?

EU growth would be hit by -0.1pp (for 10% U.S. import tariffs). Germany would be hit the hardest in terms of export losses and given the weakness of its automotive sector, we expect the recession in the industrial sector to continue in early 2020. Hence, a technical recession could easily materialize even if it is not our central scenario. In terms of GDP growth, Finland, Germany and Sweden would be the most exposed.

If the U.S. were to impose 10% tariffs on its EU car imports in November:

• Aggregate export losses for the EU would be EUR4bn per year.
• The increase in the U.S. average tariff will be very limited (+0.2pp), which is still far from a “Trade War” situation (average US import tariff above 12%. )

If tariffs are further hiked to 25%:

• The total export loss for the EU would be EUR12.5bn per year.
• Germany would be hit by more than -0.3pp of real GDP growth per year, pushing it closer to a full-blown recession.
• The U.S. average tariff would go up by +0.5pp.  
  

We expect a correction in the European equity markets, which will comfort the ECB in cutting further the deposit rate (-10bps in March and -10bps in September) and increasing the QE size in April (from the current EUR20bn per months to EUR30bn).