President Donald Trump's ambitious effort to reroute global trade flows in an America First direction is racing toward a conclusion. In the next couple of months, Trump will escalate his China trade war or declare a truce. He'll decide whether to unleash global auto tariffs, and he'll push Congress to accept his deal to replace Nafta. How those Trump trade issues are resolved will have a major impact on the global economy as well as the Dow Jones and broader stock market.
On Wednesday, just a report that Trump's top negotiator thinks more Trump tariffs are needed to pressure Beijing helped trigger a sharp Dow Jones sell-off at the stock market's open. But stocks soon erased losses to close modestly higher.
The good news is that fallout from Trump trade war threats will likely be fairly benign. Yet that assumes Trump settles for limited trade gains to avoid a more serious hit to the Dow Jones and U.S. economy. The more that Trump demands, the more likely it is that the China trade war could spiral up or auto tariffs could provoke a trade war with Europe.
Trump Wants China Trade Deal
Trump is anxious to strike a China trade deal to avert an escalation of tariffs set for March. He appears to have the leverage to get a China trade deal so that he can declare a win. But don't expect a deal that sharply shrinks the massive U.S. trade deficit with China that's been rising under Trump. If Trump holds out for a deal that resolves U.S. complaints about China trade policies, the China trade war could still escalate.
Auto Tariffs Decision
The Trump administration faces a mid-February deadline for wrapping its national-security investigation into auto imports. Trump has threatened global auto tariffs of up to 25%. This is a risk that can't be ignored, especially after General Motors in December announced plant closures in Ohio, Michigan and Maryland, amid slack demand for its sedans.
Still, the outcome is more likely to resemble Trump's rewrite of Nafta, the U.S.-Canada-Mexico Agreement. Those key North American free-trade partners agreed to limit their auto imports to the U.S., with any imports in excess of the annual quota of 2.6 million passenger vehicles apiece subject to tariffs.
The USCMA deal announced on Oct. 1 removed any real possibility of a blowup of Nafta. Trump still needs Congress to sign off on the deal. The incoming Democrat-controlled House wants additional changes, while Trump has said he might start a Nafta withdrawal countdown to force Democrats to back his deal. There may be sparks, but the real risk has passed.
Weak Dow Jones, Stock Market To Tame Trump Trade Demands
The stock market tumble to bear market territory likely has provided a wake-up call to Trump.
Back in September, JPMorgan analysts wrote that the strong economy and stock market could "embolden the president on all geopolitical fronts" and create risk of "a major miscalculation."
But Trump's final trade tweet of the year offered another indication that the president may be feeling somewhat less bold when it comes to trade conflict heading into 2019.
"Just had a long and very good call with President Xi of China. Deal is moving along very well. If made, it will be very comprehensive, covering all subjects, areas and points of dispute. Big progress being made!"
Yet the tweet likely presents too optimistic a front. A China trade deal may well be in reach, but it's very unlikely to resolve "all subjects, areas and points of dispute."
Robert Lighthizer, Trump's top trade negotiator, is reportedly underwhelmed by Beijing's commitments to seal a China trade deal. He reportedly thinks that more Trump tariffs are needed to get China to do more than buy more soybeans and make empty promises to stop requiring U.S. companies to hand over intellectual property to access the Chinese market.
But Lighthizer is narrowly focused on extracting the best deal. Trump has to worry about the impact for the Dow Jones, broader economy and his 2020 re-election bid.
China Trade War Cease-Fire
Trump tariffs of 10% on $200 billion worth of Chinese imports took effect Sept. 24. But the U.S. delayed the planned escalation to 25% on Jan. 1 by roughly two months after a dinner between Trump and Chinese President Xi Jinping at the G20 meeting in Buenos Aires.
Trump tariffs, though potentially damaging for both economies, have become a sideshow in the U.S.-China trade war. The real fight is over global leadership in advanced technology industries. For now, the dependence of Huawei and the Chinese high-tech sector on American technology has left China highly vulnerable and in desperate need of a trade deal.
China Relies On U.S. Technology
Huawei relies on chip technology from Qualcomm (QCOM) and the Android operating system from Google parent Alphabet (GOOGL). "If Huawei cannot license Android from Google, or Qualcomm's patents in 4G and 5G radio access technology, it will not be able to build smartphones or 4G/5G base stations," Jefferies analysts Edison Lee and Timothy Chau wrote.
China also depends on advanced chipmaking equipment from Applied Materials (AMAT), Lam Research (LCRX) and KLA-Tencor (KLAC).
Despite anger over the arrest of Huawei CFO Meng Wanzhou, Chinese President Xi appears intent on meeting commitments made in his Argentina dinner with Trump. Beijing may be able to weather Trump tariffs, despite fresh data signaling China manufacturing is contracting. But the risk of a U.S. technology freeze-out provides every reason to expect that a China trade deal will happen.
China Has Leverage Too
But Xi will only go so far. China is hardly without leverage, having the ability to complicate technology supply chains and dent market prospects for companies like Apple (AAPL) and Boeing (BA). An escalating China trade war would send financial markets reeling at a time when the global economy is looking vulnerable.
It would take an extreme amount of boldness for Trump to pull the trigger now. Trump almost settled for a modest China trade war win in May that would have had Beijing buy an extra $70 billion in U.S. goods over several years.
Yet even with a China trade deal, the risk is rising that the global economy — especially high-tech sectors — will become divided between spheres of influence in a technological U.S.-China cold war. The U.S. wants to keep China's Huawei out of 5G next-generation mobile networks, citing security risks. U.S. allies are imposing bans or severely restricting the use of Huawei gear. China, through funding Belt and Road infrastructure projects in Asia, the Middle East and Africa, is working to expand its sphere of influence.
Given the ever-growing geopolitical rivalry, a China trade deal would amount to a cease-fire, but probably not a lasting truce. That would avert a near-term blow to a shaky global economy, but it would leave a cloud hanging over U.S. companies that depend on China as a manufacturing base and key global market.
Trump Wants Wall Around U.S. Auto Market
Trump's Nafta revision will require 75% of auto components to come from within the trade bloc, up from 62.5%. In addition, 40% of value added to vehicles will have to come from workers earning at least $16 an hour.
Currently, the U.S. has a 2.5% tariff on imports of autos built outside of the Nafta pact. Yet if USCMA raises costs, as expected, it makes that 2.5% tariff even less of an advantage for domestic production.
Trump tariffs of 10% on aluminum imports and 25% on steel imports also hike costs for U.S. automakers.
The only way to reconcile Trump's claims that USCMA "will be a new dawn for the American auto industry" and that "we will be manufacturing many more cars" is to assume that Trump auto tariffs are on the way.
The General Motors (GM) restructuring also leads to the same conclusion. Last month, Trump downplayed shifting consumer preferences for GM's decision and stressed the importance of auto tariffs. He highlighted the 25% tariffs on light trucks and SUVs, known as the 'chicken tax,' as key to making that sector a "go-to favorite" among manufacturers in the U.S.
"If we did that with cars coming in, many more cars would be built here," Trump tweeted, and GM wouldn't be closing factories.
China Trade War First On Trump Agenda
The U.S. can't afford multiple trade wars at once. UBS economists estimate that a full-fledged China trade war plus imposing global auto tariffs would grind U.S. economic growth to a halt in 2019. That helps explain why Trump has put auto tariffs on the back burner while prosecuting his China trade war. But if a China trade deal is coming, that will lift a big impediment to imposing global auto tariffs.
The real question about auto tariffs isn't whether Trump will give the go-ahead, but how they'll be structured. Trump rails about cars assembled in Mexico for the U.S. market. But he agreed to a quota of 2.6 million vehicles, above current levels. That's a big concession, considering that the U.S. auto market has peaked.
Some combination of tariffs and quotas looks likely in any deal with the European Union. German automakers might have to accept a quota that is somewhat below current levels to satisfy Trump. However, there may be other ways to give Trump a win. For example, Volkswagen (VWAGY) CEO Herbert Diess recently announced that VW is forming an alliance with Ford (F) and may use the American carmaker's facilities to expand its own U.S. capacity. Volkswagen also has been considering an expansion in Tennessee.
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