How badly would a US-China ‘no deal’ on trade hit Asia markets? Daiwa says it could get ‘nasty’

World currencies

Conventional expectations might be that the Trump administration will strike a trade deal with China before the mid-term elections in November to claim a “win,” but there’s a solid chance of a “no-deal” scenario which could hit Asia markets badly, Daiwa said.

There are two main reasons a trade deal between the U.S. and China could get the kibosh, Daiwa said in its Animal Spirits strategy note last week.

“First, an ongoing (no time limit) trade war may play well with the Trump base, and Trump (counter to conventional wisdom) may not be
pragmatic about concessions with China, holding out for better terms of trade,” Daiwa said.

“The other is that the cost-benefit analysis in China may dictate that the political cost of looking too weak on trade in the eyes of the Chinese
population may outweigh the economic benefit of avoiding a trade war,” it added.

It called the scenario a “fat-tail”event, with a 25 percent probability. A fat-tail risk is a statistical phenomenon which suggests ‘extreme” events, such as a financial crisis, are more likely to occur.

Based on reports last week, the Trump administration reportedly could impose its proposed tariffs of as much as 25 percent on US$200 billion of Chinese imports in the coming days. Since then, Trump has threatened to impose tariffs on all imports from China, with the mainland set to swiftly retaliate.

That comes as Bob Woodward, of the famed Woodward and Bernstein pair who broke the Watergate scandal and unseated President Nixon, published a book about the Trump administration, titled, “Fear.” One anecdote in the book is that Trump, while editing a then-upcoming speech after the G20 summit, scribbled his thoughts, writing “TRADE IS BAD.” The note was reportedly reproduced in the book, which noted that while Trump never spoke the words, they appeared to be the “truest expression” of his protectionism and isolationism.

‘Not priced in’

Daiwa said a no-deal scenario hasn’t been priced in to Asian equities.

“Things could get nasty pretty quickly,” Daiwa said, adding equities could face 15 percent to 21 percent downside from end-August valuations. The Global Financial Crisis low was 28 percent below end-August levels, it noted.

But overall, Daiwa said it hasn’t changed its market strategy since July.

It said it was staying overweight Japan in Asia Pacific and underweight Asia ex-Japan.

“This is a hedge against an outsized U.S. dolalr rally, as it would hurt emerging markets but be positive for Japanese earnings,” it said. “Within Asia ex-Japan, our largest overweight remains India, as Indian growth is less correlated with the global trade cycle than other Asian countries.”

Daiwa added that it was “slightly overweight” on China, but neutral on China A-shares.

“We see China as being central to a post trade-deal rally in emerging markets, under our baseline scenario,” of a U.S.-China trade deal being struck before the mid-term elections.

It added that it upgraded consumer staples and discretionary in early July, saying it expected it to provide sustainable growth drivers.

Daiwa said it was underweight on Indonesia, Malaysia and the Philippines.


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