In our view, an escalatory trade war could prove beneficial for South American exposures, while Mexico and South East Asia look more vulnerable.
The Trump administration is giving its protectionist, ‘America First’ instincts freer rein. Import tariffs of 25% on steel and 10% on aluminium were announced on 8 March, following narrower sanctions on solar panels and washing machine parts in January, and the clock is ticking on possible measures under Section 301 of the Trade Expansion Act to counter China’s abuse of intellectual property. America’s trade partners are seeking exemptions and preparing retaliatory measures.
It would be rash to claim perfect foresight into how these trade tensions will play out. Since the US, to the chagrin of nationalists, runs deficits in goods trade with most partners, it can ‘win’ by restricting access to its domestic markets. But even here trade partners can respond smartly by targeting politically sensitive sectors, as the EU might do by restricting access to its market for iconic US brands and agricultural products from Trump-supporting states. The US also typically runs a surplus in services with most partners, and is a net exporter of capital, providing additional scope for retaliation through, for example, restrictions on market access for US financial and professional services companies, or push-back for US foreign direct investment.
The immediate flow consequences of tit-for-tat protectionism can therefore cancel out. We suspect the secondary consequences of concerns over the US policy mix are probably negative for the US dollar. Certainly if an emerging market government introduced protective tariffs that pushed up prices for domestic consumers and undermined competitiveness in dependent industries, we would be inclined to sell its currency. And the US dollar has indeed typically weakened during previous serious trade disputes. In our portfolios, however, rather than positioning outright short the dollar, we prefer to try to identify the contributors and detractors within emerging markets from any escalation of international trade tensions.
Our view is that global trade flows will not be significantly affected overall, and certainly not enough to materially slow global growth, which is an important support for emerging market assets. The US economy is relatively closed, with imports of goods and services accounting for only 11.4% of GDP in 2017, and so trade restrictions on small subsets of those imports are unlikely for us to move the dial in terms of headline growth even in the US itself, let alone in the global economy more broadly. Certain categories of goods are more likely than others to be subject to protective measures, however, and so we aim to identify those countries whose exports, or whose place in global supply chains, put them at risk.
Manufacturing will be the target sector for protection. Figure 1 shows the rough breakdown of US merchandise goods imports, according to UN Conference on Trade and Development (UNCTAD). Machinery and transport equipment accounts for around 40% of all US imports. As well as being the largest category, this is also the category where imports compete most directly with the output of US workers, and therefore is a tempting choice for protectionists looking to shore up political support in the challenged manufacturing heartland of America.
Figure 1: US imports by broad category
Source: UNCTAD, 2016
Producers of machinery and electrical equipment therefore seem to be most at risk of seeing their US market access restricted. To gauge where the main vulnerabilities lie, we used statistics on trade flows from the UNCTAD as a standardised data set. We can see from Figure 2 that for a number of countries, such exports account for more than 30% of their total exports to the US. It is striking that those countries are mostly in South East Asia, and unsurprisingly include Mexico, which specialises as a manufacturing hub for the US market in the same global supply chains, validated by geographical proximity and the advantages of the North American Free Trade Area.
Figure 2: Country exports of machinery to the US, as a share of their total exports to the US
Source: UNCTAD, 2016
Commodity exporters should be less exposed. Producers of goods that are not available in the US will be relatively protected from the impact of any trade war. Commodities in particular either have open access, because they are needed as inputs to US manufacturing processes, or already face restrictions because they compete with US producers. Those countries whose exports are dominated by commodities (and therefore have a low share of machinery and similar manufactured goods), are on the right hand side of Figure 2. They are concentrated in South America, but also include South Africa, India and Russia.
As we watch for the measures and counter-measures that could add up to an escalatory trade war, we therefore plan to be mindful of the beneficiaries and those that could be hard hit. There are lots of other drivers of currency moves, including carry, positioning and idiosyncratic trade and investment flows. When looking through the prism of disruption to trade flows to and from the US, however, we expect to prefer exposure to South America and other countries with similar profiles, while steering clear of Mexico and South East Asia.