U.S. China Trade Tensions Have Impact on Emerging Markets

The August Forecast Flash from Global Insight by IHS Markit contains its fair share of good news and bad news, say economists.

It notes that the Federal Reserve (Fed) cut interest rates as expected. The United States also enacted additional fiscal stimulus. Earlier, China initiated modest fiscal and monetary stimulus, and more is likely given weak growth and an escalating trade war.

Meanwhile, the European Central Bank (ECB) has promised additional monetary easing. Many other central banks around the world have followed suit by lowering interest rates. Unfortunately, and at the same time, the trade war between China and the United States has taken a turn for the worse.

“The Trump administration has threatened to impose 10% tariffs on an additional $300 billion of Chinese imports, and China has retaliated by banning U.S. agricultural imports and devaluing its currency by a small amount,” observes Chief Economist Nariman Behravesh. “If hostilities do not escalate further, then the impact of these new actions will be adverse but small.”

He adds that if this is just the opening round of a much bigger conflict, “then all bets are off,” and the risks of a recession will have risen sharply.

China's growth was already slowing before the latest round of trade hostilities, notes Sara Johnson, Executive Director, Global Economics.

“Anticipating that China would partially offset the adverse impact of new tariffs with additional policy stimulus, our August forecast of real GDP growth is revised down 0.1 percentage point in the next two years, to 5.8% in 2020 and 5.7% in 2021,” she says.

She added that the recent currency devaluation was relatively small and meant as a “warning shot,” as the Chinese government quickly assured global markets it was not the beginning of “competitive devaluation.” Nevertheless, further devaluation could trigger massive capital flight and financial instability.

Even in the best of circumstances, emerging markets are sensitive to developments in the world's two largest economies, concludes the report.

The so-called “truce” between the United States and China (in the wake of the G20 meeting in late June in Osaka, Japan) was short-lived. The new salvo by the White House and retaliation by China increase the dangers of a much bigger conflict and a recession in the near future.

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