Markets dropped Tuesday after trade war talk escalated.
US markets somewhat recovered yesterday.
Last week, US President Donald Trump passed a 25% tariff on US$ 50 billion worth of Chinese goods. He has threatened to impose more tariffs if China retaliates…
…So China retaliated.
China imposes tariffs on US products
China published their own list of tariffs. They will be imposing 25% duties on US$50 billion of US products.
China said it would target tariffs in two waves.
The first would take effect by this coming July, and will include items like soy, cars, pork and aircrafts, among others.
As reported by Reuters, US soybean futures dropped 1.5% after the announcement.
The US is the world’s largest producer and exporter of soybeans.
While China is a big soybean producer, it is also US’s largest importer of soybeans.
Soybeans are a big-ticket item. Not only because the US is a large exporter, but because states producing soybeans make up some of Trump’s large voter base.
The second wave of tariffs from China could include natural gas and oil.
Last year, China became the world’s largest oil importer…and they buy a lot of US crude oil.
As Reuters reports, this is also a tactical move.
‘The Chinese have become a major buyer of U.S. crude, importing about 319,000 barrels per day (bpd) in the first five months of the year, according to vessel-tracking and port data compiled by Thomson Reuters Oil Research and Forecasts.
‘This makes China the biggest net buyer of U.S. crude (Canada imports more but also exports to the U.S.), and therefore an important customer for the booming shale industry.
‘With U.S. crude exports running at about 2 million bpd [barrels per day], China’s purchases represent about 16 percent of the total.
‘However, U.S. crude supplies to China account for only about 3.5 percent of the country’s total daily imports.’
The announcement comes at a perfect time, just before the Organization of Petroleum Exporting Countries (OPEC) meets this weekend to decide if they should increase production.
China is one of the biggest export markets for US shale oil drillers. US oil is cheap when compared to Brent oil, but tariffs would make US oil less competitive against Brent.
And, if OPEC decided to increase production, it would make it easier for China to replace their current US oil imports with other producers.
But it didn’t end there. After China retaliated, the US hit back.
Tit for tat
The US is now threatening to impose 10% tariffs on an extra US$200 billion of Chinese goods.
As you can see, the tit for tat strategy can make things escalate quickly.
And this comes after the US ended exemptions on tariffs on steel (25%) and aluminium (10%) for Mexico, Canada, and the European Union (EU) this month.
Mexico and Canada have retaliated by placing duties on US goods.
The EU is also looking to impose retaliatory tariffs on US imports by this Friday. As you can see in the map below, the tariffs affect some states more than others.
Source: Business Insider
[Click to enlarge]
EU tariffs are also quite tactical.
They are mainly targeting US swing states like Iowa, Michigan, Minnesota, Ohio, North Carolina and Wisconsin. That is, the states that can swing an election towards either a republican or democratic candidate.
Who will blink first?
We have no idea. A trade war is a lose-lose situation for all involved. It decreases competition and makes goods more expensive.
But investors are starting to get concerned.
Investors flock to small caps
That’s why they are flocking to small-cap companies in the Russell 2000 index. The Russell 2000 index measures the performance of 2,000 small caps. Small caps, as the name refers to, have small market capitalisations, up to about US$2 billion, and usually trade domestically in the US.
You see, a full-blown trade war will affect exporters and large companies with exposure to international markets.
As Bloomberg reports: ‘About 43 percent of S&P 500 sales came from abroad in 2016, according to S&P Dow Jones Indices data, compared with roughly 20 percent for the small-cap Russell 2000 Index.’
Since the beginning of the year, the Russell 2000 has risen by over 12%, while the S&P 500 has only seen a 2% gain.
And the spread of gains between the two indices has been increasing as tariff talk escalated, as you can see in the graph below:
[Click to enlarge]
If talks were to keep on escalating, we could see more investors rushing into small caps.
Editor, Markets & Money