Coronavirus analysis: how will rising US-China trade tensions play out?

May 21 2020

Brian DaingerfieldHead of G10 FX Strategy, Americas

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5 minute read

As the US and China tackle the impact of the coronavirus crisis, trade tensions begin to rise again. We outline two scenarios for how relations might escalate. 

It seems hard to remember a time when anyone was talking about anything other than coronavirus. But not so long ago, one of the biggest issues in global economics was the bitter trade conflict between the world’s two biggest economies, the US and China. That battle is still rumbling on, even though it’s no longer headlines news – for now. - How might the coronavirus outbreak affect trade relations between the two countries?

Coronavirus analysis: What’s the current state of play?

In January, the US and China signed their much-heralded Phase One trade deal, which saw the US cut some tariffs it had previously imposed on Chinese imports. In return, China agreed to buy more US goods and address some complaints about intellectual property practices. After years of disagreement, the deal was widely welcomed by the markets.

Fast-forward a few months, and coronavirus has opened up a whole new front in the US-China trade debate. President Trump has called for a review of China’s handling of the outbreak and the global economic lockdown is making it nigh on impossible for the two countries to meet their obligations under the deal.

Phase One: the progress so far

President Trump has made it clear that it’s critical that China meets its trade commitments if the deal is to survive, but we think the picture is more nuanced. China has taken some encouraging steps to facilitate trade in agricultural goods, and there are also some positive signs in terms of China’s intellectual property concessions.

Politics matters

But it’s not just about trade figures – in a US election year, it’s politics that counts. We’ve long been sceptical about the overwhelming market consensus that President Trump would go easy on China in 2020 to avoid hurting the US economy in an election year, and the coronavirus outbreak has only served to increase the risk of another trade-war escalation.

That’s because President Trump can no longer campaign on a platform of unparalleled economic success under his leadership. With the US facing a historically deep recession, the President looks likely to deflect attention by running on a “Tough on China” platform, in particular by highlighting China’s role in the coronavirus outbreak. Polling showing worsening sentiment toward China suggests that this could be popular among the US electorate.

Escalation would be risky

President Trump may see political benefits to going on the offensive against China, but an escalation of the trade war in the form of new tariffs would be risky.

First and foremost, the move would throw the door wide open to retaliatory action by China at a time when the US is heavily reliant on Chinese imports of protective healthcare equipment that’s vital in the fight against coronavirus. China has previously taken targeted retaliatory steps against US agricultural products, so such a move would not be without precedent.

These and other retaliatory measures could impact the US’s ability to control the virus and delay the long-awaited reopening and recovery of its economy. So our base-case scenario – just – is that the US will not impose new tariffs in the short term. But that’s by no means certain, so we need to consider how things might look if it does.

Scenario one: Tariffs the likeliest option in the event of escalation

President Trump has shown his inclination towards tariffs on many occasions during his administration – as well as implementing them on China, he’s also threatened them on countries including Mexico, Turkey and Saudi Arabia. So they’re likely to be his tool of choice in any escalation.

If he does go down the tariff route, the obvious question is what basket of goods should be targeted and at what rate. We think the US would consider an approach of calculating damage from COVID19 and then applying tariffs proportionate to that economic damage. We currently anticipate that the US economy will shrink by around USD1,300bn (USD2,600bn annualised) in the first half of 2020. We have little insight upon which to base how the US would assess China’s responsibility for lost growth, but we believe the US government may impose tariffs in the range of USD300–500bn.

Scenario two: Non-tariff escalation options

While tariffs are a tried-and-trusted tool in President Trump’s armoury, he does have other options available:

  • The President has reportedly considered removing China’s sovereign immunity within the US judicial system, opening up the Chinese state to legal action over coronavirus in US courts. Such a move would be purely symbolic as enforcement of any ruling in a US court against China may prove a challenge in reality.
  • Having removed China’s status as a foreign exchange manipulator alongside the completion of the Phase One trade deal, the US could reintroduce it. But again, such a move would have few practical implications.
  • The President could impose wide-reaching sanctions on virtually all forms of commerce between the US and China. We believe a draconian step of this nature is both unwarranted and unlikely.
  • The final option is to cancel the US’s debt payments to China, which is a major holder of US Treasuries. This is highly unlikely as US debt repayments are seen as sacrosanct, and even an attempt at selective non-payment could trigger devastating divestment from Treasuries at a time when the US is running a historic deficit to fight the coronavirus.

Coronavirus analysis: What does all this mean for investors?

Any form of retaliation by the US would be likely to put pressure on Chinese assets and also have repercussions for China’s neighbours in emerging Asia. A resumption of the trade war would threaten China’s economic recovery, with clear negative implications for countries reliant on commodity exports to China and also for risk assets in general. Safe-haven assets, by contrast, could benefit.

President Trump’s current threats may just be political bluster, but the risk of future escalation has nevertheless dramatically increased. Even before the pandemic, we felt that if Trump wins re-election this year it would give him a mandate to pursue a more aggressive stance on US-China trade policy. The coronavirus crisis has only amplified that risk going forward, even if the President holds his position in the near term.

Stay tuned for more updates.


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