02 June 2019

The current geopolitical disruptions that corporate and indeed money managers have to grapple with leave little room for short-term optimism. Indeed, looking at Japanese firms in isolation, especially from the bottom up is currently of little use as these path driven markets take their cue from bigger picture stuff which we are following closely. Moreover, given the size of Japan's trade with China last year is nearly 60% bigger than that with the US, Japanese firms remain highly exposed to these developing trade disruptions. 

This week it has been difficult to know where to start given the strings of geopolitical and trade developments, all painting a grim picture of escalating trade war between the US, not only with China, but indeed with the rest of the world. President's Trump's latest tweets on early hours of last Friday that Mexico will be subject to 5% import tariffs (which could be raised to 25%) until it is able to stem the flow of illegal immigration to the US has taken trade disputes beyond the realm and rules of fair trade and can only hurt confidence and raise the scope for more market uncertainties. 

Many corporate executives were said to be planning of relocating some of their Chinese production capacity being exporting to the US, to Mexico. This is especially after the NAFTA (USMCA) renegotiations were agreed upon by the three nations and had been put forth to the US Congress for its passage. Needless to add, many of these plans will be shelved now with on-shoring production bases in the US increasingly looking to be the only safest choice despite the entailing higher production costs. 

Moreover, it is now difficult to see how USMCA will be passed by the US Congress as Democrats are unlikely to support Trump's latest tariffs on Mexico as they have done in the case of China, especially if immigration is the primary issue. Indeed, China itself will see these tariff hikes on Mexican exports as more reasons for caution in trusting the US in abiding by any future agreements. 

Having mostly heard one side of the story on the US/China trade negotiations, China seems to have finally changed its stance by engaging with the media and clarifying its own position and its version of how trade talks of the past year have unfolded. In a white paper released today, China accuses the US of also back-tracking, by unwilling to remove any existing tariffs as a show of good faith, calling once again for a more balanced approach to trade negotiations and to preserve the dignity of both sides in its conclusion. While China says it is still open to more talks, it once again reiterates that it will not negotiate with a gun to its head. 

China's version seems supported by President Trump's past tactics and his comments for much of this year on the state of trade talks which he had previously described as hugely productive, over-promising dramatic concessions from China which the US trade representatives themselves were far more cautious in reaffirming. With China now coming into open and explaining its own stance, it wants to regain some control of the trade-related narrative as gloves come off. 

Indeed, China's retaliation plans to the US Huawei ban and other hawkish moves last month seems to be gathering shape. Not only the Chinese policy makers are said to be pondering limiting exports of rare earth metals to countries and companies that they deem as unfriendly, but they are drawing a list of global companies of what they regard to be "Unreliable Entities, that harm the interests of Chinese companies by breaking trade rules and supply contracts". 

This is clearly targeting all global firms that have decided to limit their supply of component and services to Huawei or indeed limiting purchasing its equipment. The recently reported discovery of two Huawei packages containing documents being shipped by Fedex to the company in China from Japan, which were diverted to the US without authorisation has made matters even more complicated. 

Although China seems to have decided against targeting Apple, we hear that Chinese consumers are increasingly staying away from the brand for patriotic reasons. Some Apple analysts are now pondering double-digit drops in China sales of iPhones in the second half of this year if the situation escalates. Indeed, Chinese consumer spending patterns on overseas goods and services must also be watched closely in a case of such back-lash engulfing other segments, say cosmetics. 

With the first wave of tariff hikes announced in early May by both the US and China coming into effect, it is already apparent that much of the price increases are likely to be passed on to the US consumer. How the Fed will interprets these coming price increases when the US economy is at full employment levels is crucial to markets which are clearly discounting at least 50bps cut to the Federal Fund Rate. With the US central bank now under huge pressure to adopt a looser monetary policy stance to help limit the damage of this trade-related wrecking ball, any hesitation could add further gloom by triggering concerns of policy mistakes once again.