DBS: Market selloff on Trump trade war fears ‘justified’

U.S. two-dollar billsPhoto by Leslie Shaffer

The markets were justified in selling off after the Trump administration announced fresh initiatives to impose tariffs on imports, this time from China, DBS said in a note on Friday.

“Going beyond the semantics of ‘trade war,’ these are substantial measures with far-reaching implications, and we find the negative response of markets justified,” DBS economists Taimur Baig and Irvin Seah said in the note.

“Repeated measures could inflict lasting harm on economies and markets, with Fed policy decision, trajectory of economic growth, the path of the U.S. dollar and the direction of long-term rates, and China’s holding of U.S. Treasurys all becoming uncertain and politically sensitive,” the note said.

Models ‘underestimate impact’

While macroeconomic models indicate no more than 0.1-0.2 percent downside to Chinese growth on the measures, the models are underestimating the impact, the economists said. They estimated the 25 percent tariff on US$50 billion worth of Chinese goods implied a 2.5 percent across-the-board tariff on all of the mainland’s exports to the U.S.

“This may not seem very large at first glance, but we think considerable worry is warranted as many firms work with razor-thin margins, and, as the U.S. president has indicated, this is by no means the last salvo in this saga,” DBS said. “Without any ambiguity, higher tariffs will raise the cost of exporting to the U.S., which will hurt margins and/or cause prices to rise.”

DBS expected China to adopt a two-pronged approach: diplomacy alongside promises to import more U.S. goods, while simultaneously imposing tariffs on soybeans from farm states that voted for Trump.

Will it be enough to defuse the situation?

DBS expected the Trump administration won’t be placated with efforts to reduce the U.S. trade deficit with China and will instead seek broader measures against trade imbalances.

The economists said the problems with the approach were “manifold.”

For one, the OECD estimated that the foreign content share of China’s exports was at 30 percent, well above the levels in other large economies and second only to South Korea in the G-20, DBS noted.

Additionally, many U.S. multi-national companies have export-oriented production in China and they’ll get caught up in the dragnet, DBS said.

Is this yesterday’s battle?

DBS added that the Trump administration’s focus on the goods trade deficit was outdated.

It noted that China’s current account surplus has been narrowing and its intellectual property protection has “strengthened substantially” recently.

The goods trade focus is also a bit dated as well, DBS noted.

“The world is moving to an irreversible direction of greater service orientation, and many manufactured goods are approximating commodities in their increasingly undifferentiated nature of production,” DBS said. “Fixating on goods trade deficit is, therefore, akin to
fighting yesterday’s battles.”

DBS added that hopes the Trump administration would reduce trade tensions after November’s mid-term elections may be “wishful thinking.”