JPMorgan: Markets aren’t pricing in risk premia for a real trade war

U.S. two-dollar billsPhoto by Leslie Shaffer

Trade conflict has become an “ever-greater wildcard,” but most markets are only pricing in a “trivial” risk premia for a trade war, JPMorgan said in a note on Friday.

That’s a particular concern if the U.S. metals tariffs were batting practice for a country-specific swing toward China, the bank said.

To be sure, JPMorgan noted that the U.S. so far put sanctions on five products — lumber, solar panels, washing machines, aluminium and steel — which total about 3 percent of U.S. imports and only 0.3 percent of U.S. gross domestic product (GDP).

Trade fears haven’t changed market calls

The bank added, that’s why it hasn’t changed its economic forecasts on those measures, or its asset allocation call for this year to go “near-maximum” overweight on equities versus bonds.

JPMorgan said it always assumed the Trump administration would double or triple enforcement actions against trading partners.

“But doubling or tripling from a low base (the U.S. has sanctioned several products a year for the past 50 years) doesn’t have to imply a material economic development or a broad and sustained financial event,” it said.

But it added a strong word of caution.

Caution on China

”A legitimate suspicion is that recent events represent batting practice for a proper, country-specific swing,” it said, pointing to the investigation of China for intellectual property violations.

Any details of the tariff rates and products included would determine the economic impact, which could be significant as China makes 20 percent of U.S. imports, equivalent to 2.5 percent of U.S. GDP, it said.

But JPMorgan doesn’t appear to believe markets are pricing in much of this risk.

‘Poor U.S. policies’

It noted that while the U.S. dollar is several percent cheap, despite interest-rate differentials, amid the trade conflict and twin deficits, but outside of currencies, risk premia look small, if not non-existent.

”The absence of much risk premium is a reminder that China sanctions will likely prove a market event, though one we are still biased to frame as an intra-month one,” it said.

“This hopeful view reflects two key assumptions, however: that trade policy always involves showmanship, and that domestic and international pushback will eventually constrain poor U.S. policies,” JPMorgan said.