After taking the backseat to investors’ concerns lately, U.S.-China trade tensions are back in the spotlight. Indeed, tensions never really went away after the signing of the phase one deal, and COVID has brought forward longstanding issues with China’s conduct of policy. Noncompliance of phase one purchases, which in any case are subject to market forces in the agreement, is not the issue at hand. We think the recent escalation underscores broadening bi-partisan sentiment against China within the U.S. and souring relations with other countries (Source: Politico)[i].
Moreover, COVID has emboldened U.S. priorities for protectionism and economic security and accelerated pre-corona trends toward decoupling and reshoring. The U.S. is acting with Huawei restrictions while proposing legislation to delist Chinese companies from U.S. exchanges and sanctions over human rights abuses. In its latest bravado, the U.S. administration issued a broad critique of China’s economic and military policies, from IP theft and protectionism to human rights.
Exposed are risk-correlated commodity countries such as Canada and Asian assets, limiting the scope for USD weakness and putting our EM overweight at risk. However, we are less concerned about U.S.-China trade tensions this time around. We think markets will continue shrugging harsh language as long as tariffs aren’t imposed again. Asian equities (Chart 2) may be less exposed thanks to rebounding Chinese growth, supported by infrastructure spending. The Presidential election and the economy’s feeble state will also motivate Trump to avoid risk-off measures like tariffs and stick to a toughening stance instead. That said, we firmly believe that tensions are here to stay with scope for more non-tariff barriers. Finally, protectionism and reshoring are among the pre-corona trends (such as info tech disruption and retail apocalypse) that the pandemic has accelerated.