Months of heated rhetoric and threats of hundreds of billions of dollars in tariffs have given way to constructive dialogue between the U.S. and two of its major trading partners, the EU and Mexico.
Meanwhile, trade relations between the U.S. and China are closer to reaching a boiling point, and more give-and-take is required to achieve a NAFTA reboot.
Our economists believe the global and U.S. economies are strong enough to withstand trade challenges, especially given the worst-case scenario of a full-on global trade war seems unlikely.
But financial markets may be confronted with tougher and more provocative rhetoric and perhaps additional tariffs before the bulk of trade issues are resolved.
A bull in a China shop?
The U.S.-China trade relationship is the most complicated and has the highest stakes, in our view.
This conflict could crystallize in coming weeks as the U.S. determines whether to make good on its threat to slap tariffs on another $200B in Chinese imports. The Trump administration turned the heat up recently by raising the possibility this could be a 25 percent tariff, rather than 10 percent as it had previously signaled. A formal review of this policy is ongoing and a decision is possible after September 5.
U.S. trade scenarios, from worst to best case
- Most trade models say protectionism damage would be fairly small.
- In the meantime, trade uncertainty is likely to drag on the economy.
- Integrated supply chains increase potential damage for multinationals.
Source - RBC Global Asset Management
China’s response to any U.S. actions—whether it decides to counter or negotiate—may be even more important in determining the near-term direction of this trade dispute. After learning Washington may up its tariff to 25 percent, the foreign ministry spokesman said, “… pressure and blackmail from the U.S. won’t work.” China has repeatedly warned it will retaliate if additional tariffs are imposed.
Select industries in both countries are showing signs of strain from the modest tariffs already in place, but neither economy is showing lasting scars. Should the tariffs keep mounting, we view the Chinese economy as more vulnerable due to its already well-entrenched path toward a slower growth rate.
For more about the root causes of the U.S.-China trade dispute, read In the trenches of the China and U.S. trade dispute.
The U.S. and EU are moving in the right direction—even if their initial “deal” to negotiate a formal trade agreement was skinny on details and, in some respects, seemed like a solution in search of a problem. We never viewed an all-out trade war between the U.S. and EU as a credible risk. Consider the “deal” low-hanging fruit.
The U.S.-EU framework lays the groundwork for broad, constructive trade talks with the goal of reaching zero tariffs on most industrial goods, and tackles some thorny issues that have concerned markets.
It unwound the Trump administration’s auto tariff threat, which was highly unpopular with manufacturers and parts companies on both sides of the Atlantic, many market participants, and even some U.S. administration trade officials. The two sides will refrain from levying tariffs against each other on autos and other goods, as long as formal trade negotiations are ongoing. But U.S. tariffs on non-EU automakers and auto parts companies, such as in Mexico, Canada, and Asia, are still a risk.
Trade tariffs worry U.S. consumers
% of respondents who made negative references to potential impact of tariffs
Tariff concerns have risen among all consumers, and especially the top third of households.
Source - RBC Global Asset Management, University of Michigan Surveys of Consumers
The U.S. and EU also committed to “resolve” the steel and aluminum tariffs and counter-tariffs that came into effect recently. This would be positive for the industrial sector as high raw materials prices have squeezed profits. But once again, it doesn’t address the existing steel and aluminum tariffs on non-EU countries, including on Canada, the biggest steel importer into the U.S.
It’s difficult for us to reconcile this U.S.-EU goal on steel tariffs with President Trump’s enthusiastic appearance at a U.S. Steel plant in Illinois shortly after the EU deal. He told the crowd of steel workers, “After years of shutdowns and cutbacks, today the blast furnace here in Granite City is blazing bright, workers are back on the job and we are once again pouring new American steel into the spine of our country … Thanks to our tariffs, idle factories throughout our nation are roaring back to life.” To us, this doesn’t seem like a president who is ready to fully “resolve” the steel issue—with the EU maybe, but perhaps not with all countries.
This is the reality check when it comes to tariffs. Once they are put in place, they are difficult to unwind because real people and political constituencies benefit from them.
NAFTA: Reaching for a reboot
Patience still seems warranted when it comes to NAFTA.
We’re encouraged the U.S. and Mexico are apparently making progress on auto and auto parts negotiations, as has been reported by multiple news agencies. These issues have been key sticking points.
It’s also a positive sign that relations between President Trump and Mexico President-elect Andrés Manuel López Obrador are off to an amicable start.
But while López Obrador is broadly supportive of improving NAFTA, RBC Capital Markets notes that some of his goals and strategies differ from the current Nieto administration and that could take time to sort out. López Obrador doesn’t take office until December 1.
At this stage it’s also unclear whether the U.S. prefers bilateral trade agreements with Canada and Mexico or if it’s committed to the traditional three-country NAFTA framework.
Regardless of the structure, there are a number of other thorny issues to sort out between the U.S., Mexico, and Canada aside from autos.
It would be difficult for a complete NAFTA reboot to take place this year, according to RBC Capital Markets’ currency strategists, unless the U.S. abandons some of its key demands. They doubt this will occur in coming months. Therefore, NAFTA uncertainty could linger into next year.
RBC Global Asset Management’s Chief Economist Eric Lascelles believes there is a 50 percent likelihood a new NAFTA deal will be struck at some point, a 25 percent likelihood the trade agreement will be terminated, and a 25 percent chance the current framework will stay in place.
A key risk that is often missed in the wider trade debate is duration—the length of time tariffs and trade uncertainties remain in place.
Even if the trade disputes never reach a boiling point or a full-on global trade war, the longer they simmer, the greater likelihood they will become a headwind for the global and U.S. economies.
This can manifest in a variety of ways. At the most basic level, the longer tariffs linger, the more likely they will try business executives’ patience.
U.S. CEO confidence has pulled back slightly as trade challenges have mounted, but remains elevated. We believe it will retreat further if additional tariffs are implemented. And if corporate sentiment sours, capital spending decisions could be postponed or curtailed.
While long-duration trade disputes could put U.S. economic momentum moderately at risk, they could potentially impact trading partners more. We are already seeing anecdotal evidence that mid-size Canadian firms are becoming hesitant to spend, for example.
The heat map illustrates that relatively small tariffs that last for just months or quarters can be absorbed, as shown with the green boxes. But tariffs that last for years or are permanent, especially those that are larger in size, are more problematic, as shown by the orange and red boxes.
A second dimension to tariff math: Duration
Heat map of cumulative tariff pain
Source - RBC Global Asset Management
How this could end
We don’t think the tariff risks have to become acute before meaningful trade deals can take place. Corporate pressure should go a long way toward bringing an end to the trade disputes.
A non-trivial share of major trade relationships—whether between the U.S. and China, the U.S. and the EU, or NAFTA members—is business-to-business and involves complex global supply chains with interdependencies that are often misunderstood or underappreciated by government officials. Some tariffs could tie global supply chains in knots. We don’t doubt businesses of all sizes in all countries involved will continue to warn governments about this, which could encourage positive movement toward eventual deals.
Corporate lobbying has already changed the trajectory. We believe the U.S. and German auto industries played a major role in the tariff ceasefire that transpired between the U.S. and EU.
Furthermore, multiple challenges have already been filed against U.S. tariffs in the World Trade Organization (WTO) by major trading partners. Forthcoming rulings by the body or efforts to reform trade rules within the WTO by member countries could create pathways toward resolutions despite the institution’s imperfections.
Navigating the trade winds
Some of the hot trade rhetoric and tariff moves seem like they are already priced into equity markets. After all, countries have been grappling with trade challenges for months, and markets are forward looking.
But we’re cognizant that if stalemates between trading partners persist or tit-for-tat tariffs mount, the U.S. and other markets would be vulnerable to additional headwinds and volatility, at the least, and downside in more acute instances.
The renewed U.S. sanctions on Iran also complicate matters, as President Trump wrote in a tweet, “Anyone doing business with Iran will NOT be doing business with the United States.”
When there are uncertainties like these, which entail scenarios that could produce wide outcomes, we stay focused on the U.S. and global economies.
As long as trade rhetoric and tariffs don’t put economic and earnings growth seriously at risk, equity markets should be able to navigate through this period. So far, the trade actions have not dampened conditions in the U.S., nor have they impacted other countries much, if at all.
While the dispute between the U.S. and China could get worse before it gets better and NAFTA may take more time to reboot, our economists believe the collective tariff tiffs should be manageable for major economies and could ultimately result in lower trade barriers overall. Getting to that point, however, may involve more fireworks.