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Since March 2018, the US and China have been locked in a battle of words over trade that has resulted in announcements of new tariffs on products from both countries.² While the tit-for-tat tariffs have not turned into a full scale trade war just yet, it has shaken investors, causing markets to swing in the days following the announcements.¹

So why are we in this perilous state of a possible trade war between the world’s two largest economies¹?

US President Donald Trump has given several reasons for the US to act against China. The key reason is trade imbalance and the large trade deficit the US has with China that has continued to widen in recent years.² In 2017, the US imported USD504 billion worth of goods from China, while China imported USD130 billion from the US.² President Trump argues that the growing deficit shows how China is unfairly restricting US exports while boosting its domestic producers.²

The US administration has also alleged that China has sought to misappropriate US intellectual property through joint-venture requirements, unfair technology licensing rules, purchases of US technology firms with state funding and outright theft.³

The imposing of new tariffs on Chinese imports is meant to crack down on Chinese intellectual property theft and address unfair trade practices.⁴

While the US has announced new tariffs on USD50 billion worth of imports from China covering over 1,300 products at a 25% tariff rate, and China has retaliated by announcing its own set of tariffs on USD50 billion worth of US imports at an identical 25% rate on 106 products, neither country has actually implemented the new measures.⁵

The Chinese government has not specified when the tariffs will be implemented, saying the rollout would depend on when the US introduces its own tariffs. And for the time being, China has signalled their willingness to negotiate.⁵ On the other side of the Pacific, the US has said it will consult with businesses over a 30-day period before making its final decision.⁵

It would seem neither side really wants a trade war. A full-fledged trade war between the US and China would have a severe impact on the global economy and there is a risk global growth could fall quickly, according to the director-general of the World Trade Organisation, Roberto Azevedo.⁶ The hope is that it will not get to that stage. While China has said it is not afraid of a trade war, it maintains that negotiations should remain open.⁶ The US has also said that it was cautiously hopeful that the two countries could come to an agreement on trade issues.⁶ HSBC views China’s somewhat tougher than expected response – including suggested tariffs on some commercially-important and politically-sensitive goods such as soybeans – as a strategy of forcing the US to the negotiating table.⁵ HSBC believes there is a good chance that China may make some concessions in the coming weeks, which may help to calm tensions.⁵

For the time being, assuming the Chinese tariffs are imposed, the impact on the US economy is likely to be minimal.⁵ The tariffs affect roughly 38% of US exports to China, but it represents only 3% of total US exports in 2017.⁵ Also, for some products such as aircraft or soybeans, Chinese buyers may accept higher prices given the limited availability of substitutes in the global market.⁵

For China, the tariffs may push inflation slightly higher, but affected goods only represent a fraction of total Chinese imports, so the overall impact is likely to be muted.⁵ The Chinese government may also counter adverse economic impacts by some policy support measures.⁵

However, if a full-blown trade war were to eventuate, the consequences could be dire not just for the US and China, but for other countries as well.⁷ Countries that sell intermediate goods to China that are used to make products exported to the US like Taiwan and Malaysia could end up on the losing end.⁷ South Korea, which counts both the US and China among its largest trading partners, could also be a major casualty if a trade war breaks out.⁷

Overall, Asian economies would likely to be significantly impacted by a full-blown trade war, being export-oriented countries and key suppliers of components to China.⁷ Big financial centres like Hong Kong and Singapore, which rely greatly on the Chinese manufacturing sector, would also suffer if trade tensions escalate.⁷

A full-blown trade war would also impact the West.⁷ Fears of a trade war between the US and China are already driving up borrowing costs and pushing stock prices down.⁷ Companies with global operations like BMW have also warned that a US-China trade war would ripple around the world.⁷ BMW said in a statement that barrier-free access to markets is a key factor for growth, welfare and employment throughout the global economy, and a further escalation of the trade conflict between the US and China would be harmful for all stakeholders.⁷

However, there could be winners as well in this US-China trade war saga.⁷ Some regions could benefit from a drop in exports of US goods such as soybeans.⁷ China was the largest buyer of soybeans from the US in 2017, and given that China’s agricultural import needs are generally inelastic, there would likely be a redistribution in trade flow which could see China substitute US soybeans with those from Latin America.⁷

China’s proposed tariffs on fossil fuel imports from the US could also see the Middle East gaining a greater share of Chinese trade.⁷ China already sources most of its polyethylene imports from the Middle East and could further increase its reliance on the region if it decides to tax American imports.⁷ While the US currently accounts for less than 5% of China’s imports of the commonly used plastic, bank analysts expect that number to triple over the next two years if tariffs aren’t imposed.⁷

There may be a natural fear that the proposed tariffs on both sides may hurt investment portfolios but it is important to react slowly.⁸ While the stakes seem high, getting rid of portfolios containing Chinese investments before careful analysis may not be the way to go.⁸

For the time being, HSBC has not altered our asset class views, which includes an overweight stance on global equities.⁵ The tariffs have yet to be implemented and remain dependent on the outcome of the 30-day consultation period, providing room for the US and China to negotiate.⁵ There are major incentives for both sides of the table to reach an agreement.⁵

World economic activity remains very strong and global trade growth is above trend, providing a supportive backdrop for global equities.¹⁰ As such, HSBC’s current valuations remain consistent with an overweight stance on the global equities asset class.¹⁰

In a sign that level heads may prevail, President Trump decided to send a large delegation to China at the end of April 2018 to negotiate a tariff deal, and has somewhat allayed fears that a full-blown trade war would materialise.⁹

While the situation continues to play out, it may be useful to discuss with your Relationship Manager or independent financial advisor about strategies to help your investment portfolio survive a changing trade environment, if indeed the worst case scenario happens.⁸ In particular, it would be beneficial to review investments that are within and affected by the Pacific Rim.⁸

In the meantime, a good course of action would be to continue to monitor the situation closely and weigh the potential implications of any further escalation.⁵ Key risks to investments include a potential breakdown of talks and the implementation of further measures with more economically damaging quotas and investment restrictions.⁵ Your Relationship Manager will be able to provide you with updates and how any change in the situation may affect your investments.