Global Economy Still Strong, But China Trade Is Troubling Global Economy Still Strong

Trade risk is real, but that is mostly going to be felt in China. For
now, global growth trumps Trump’s trade war rhetoric, Barclays Capital
believes. They are not alone. Most of Wall Street increasingly thinks
this is a trade war the U.S. can win and is winning. At least in the
near term.

It seems that even the mainstream financial press—long a proponent
for tariff-free trade—has since discovered the distortions China brings
to the market. China is known for questionable competition practices and
subsidizing industries already grappling with oversupply issues, like
steel and solar panels, to name a few.

China strategists are trying to convince Europe to side with them on a
number of issues related to trade. In the best-case scenario, China
ultimately relents andturns away from its decades-old mercantilism and
opens its market more to competitors.

Despite the headlines of the first shots being fired in the
China-U.S. Trade War, there is only one market taking this on the chin,
and it isn’t the S&P 500.

Incoming data show a soaring U.S. economy, a healthy labor market
with near full employment thanks to stricter border controls shrinking
(illegal) lower skilled-labor pools, and some rebound in Europe and
Japan. A full-blown trade war would bring stagflationary impulses
globally, but for now overall fiscal and monetary policies, plus
financial conditions led by regulatory rollback, support growth and
investment.

Next week’s data out of Europe should confirm improving activity there as well.

For the U.S., June inflation numbers will be the market’s focus for
the week while emerging-market fund managers will be waiting to see
China data on new loans.

“In the near term, a sharper-than-expected China slowdown from a
domestic credit crunch and external trade tensions could be the main
risk to global growth,” says Christian Keller, head of economics
research at Barclays Capital in London.

Last week, the U.S. slapped a 25% tariff on $34 billion worth of
Chinese imports, effective immediately. China retaliated with the exact
amount, hitting American agribusiness. Another $16 billion in Made in
China tariffs will come online later this month. China will retaliate in
kind, with energy and petrochemical products in the crosshairs. Sadly
for China, this is like shooting itself in the foot as it already
charges high tariffs on those items and needs soybeans, fuels and other
chemicals. They will have to look for cheaper markets, if they can find
them.

The biggest threat for U.S. companies in the different sectors being
targeted is the loss of market share. This will take a good year to iron
out. No one knows for sure which end is up, says Johan Gott, a
principal with A.T. Kearney in Washington.

“Companies are in a holding pattern. No one knows how long these tariffs will last,” he says.

President Trump also pointed to possible plans for another $200
billion “in abeyance,” and he threatened to ultimately put tariffs on
all Chinese imports. The next things to watch for will be who sides with
China. If Europe sides with China, it could be harder for the U.S. to
avoid a deeper riff with the Union over their own respective trade
differences.

Then there is the North American Free Trade Agreement. The recent
election of pragmatic, left-of-center leader Andrés Manuel López Obrador
in Mexico signals that the U.S. and Mexico are now led by NAFTA
skeptics. Obrador sent a fig leaf to Trump and invited him to his
inauguration. If Obrador can help Trump on Trump’s pet-peeve, illegal
immigration, both sides may come to a deal sooner than anyone imagined.
Like Obrador, Trump would also like to see Mexicans making more money,
making it harder for corporations to relocate based on labor rates. If
Trump shuns Obrador, NAFTA will start looking weak again. Had Obrador
given Trump the virtual finger, which some expected (and others hoped
for), NAFTA would be in worse shape, as would the outlook for global
trade.

Investors seem willing to bet that the near-term winner of the trade
war is Trump. However, the detrimental effects of an escalating trade
war are being considered by central bankers here and in Europe. The
negative impact mainly comes from a worsening in business sentiment and
corporate investment.

Fed members have said in reports that “plans for capital spending had
been scaled back or postponed as a result of uncertainty over trade
policy.”

Despite months of Trump tearing up trade orthodoxy, economic data
remains strong here as well as in Germany, where after a batch of weak
datapoints, factory orders and May industrial production numbers came in
stronger than expected. Germany also faces Trump’s ire over trade.

Moreover, solid industrial production stats out of France and Italy,
expected this week, could convince the market that the nationalist
politics taking hold in Italy and Germany (France’s president Macron’s
approval now worse than Trump’s) have not pulled the rug out from the
economies. On the contrary. New leaders are less austere, more
pro-growth. The nationalist push in Europe is largely a reaction to the
EU’s unpopular migrant policy.

Similarly, Japan’s Tankan survey showed elevated business sentiment
thanks to strong corporate earnings and better than expected capital
expenditures.

In Brexit land, service and composite PMI posted a strong rebound in
June, which could be further corroborated by next week’s new monthly GDP
estimate.

China is the only one major economy that’s in somewhat of a pickle.
The MSCI China is in bear territory, down over 20% from its high on
January 26. Softer manufacturing PMI figures in China could offset a
U.S.-driven global rebound.

“China’s economy now faces the parallel challenge of negative
domestic credit … and uncertainties around trade,” says BarCap’s Keller.
“Given China’s impact on the global economy, (this) could pose the main
risk to the optimistic global growth outlook,” he says.