By Diana Mousina

There was plenty of volatility this week as equities initially got hit following more detail from the US around additional tariffs on Chinese imports. The announcement actually contained nothing new as Trump said in late June that the US would look to impose an additional 10% tariff on $200bn of Chinese imports if China was to retaliate against US trade tariffs (which China did last week).

After investors looked through the noise and decided that fundamentally, nothing had changed, stocks had a good rebound. There were also encouraging comments from China’s Vice Minister of Commerce calling for more talks with the US, with the White House indicating it was open to this. US equities were 1.5% higher over the week, Japanese shares surged by +3.7% (thanks to a weaker yen), China also rebounded significantly from recent lows, up by +3.8%, Eurozone equities +0.2% while Australian stocks fell by 0.1%.

The Australian share market has been surging over recent weeks, so some pullback was anticipated. The US dollar rose a little further this week, but is probably close to reaching a peak for now. US 10yr treasury yields were slightly lower this week and commodities generally weakened against the higher US dollar.

The latest on the US-China trade war

The additional $200bn of Chinese goods imports that may be subject to a 10% tariff are mainly final-use consumer products (which is bad news for consumer inflation), in contrast to the first $34bn of tariffs which were applied on specific machinery, some electronics and optimal/medical equipment.

This week’s announcement does not mean that tariffs will start immediately on more than $200bn of Chinese goods import. There will be a “consultation process” (as there was on initial tariffs announced in March) that will continue until 30 August which means that these tariffs may not be implemented until late September/early October (right before the mid-term elections). So, there is still time for the US and China to negotiate a solution.

What will be the economic impact? 

So far, the value of total global tariffs imposed (solar panels and washing machines, steel and aluminium, $34bn of Chinese imports) amounts to a small 3-4% of total US imports. But, including the additional $16bn of Chinese imports (which are likely to be implemented), the $200bn investigation which started this week, another potential $200bn (that Trump said could be done if China retaliates further) plus potential tariffs on car & car parts imports, this is worth around 30% of US imports and this would have a larger negative economic impact via hitting growth and lifting inflation. But we are not there yet. And so far, there has been no sign that trade worries have hit business or consumer confidence. 

How will China retaliate? 

China imports much less from the US (around $130bn annually vs the US at $520bn), so its proportional retaliation to US tariffs will move to other qualitative areas like increasing regulation of US companies operating in China, lifting inspections of US goods imports at customs. Or China could impose higher tariffs on US goods imports. China could also sell its holdings of US Treasury bonds or weaken its currency. But, given recent market unease around future Chinese/emerging market growth and a big drop in Chinese equities, this is not likely in the near-term. 

The bottom line around trade is that any potential negotiations around trade will be long and drawn out, so investors need to be aware that trade tensions are here to stay for now, particularly before the mid-term elections in November. Recent polling for Trump has been more positive lately, which should be watched if consumer inflation rises quickly from tariffs.

Brexit issues continued

Three cabinet members resigned including Foreign Secretary Boris Johnson and Brexit Secretary David Davis who were two prominent figures for the Leave campaign. These resignations followed PM Theresa May’s latest proposal around the future EU-UK trade relationship which looks like a free market with the UK in goods (but not in services and people). 

The risk of a softer Brexit is more likely for now. May’s proposal still needs to be approved by the European Union which may not be willing to accept free movement of goods, without the inclusion of services/people.

APRA stress testing

Australian Prudential Regulation Authority (APRA) Chairman Wayne Byrnes spoke this week about the broad sweep of macroprudential measure imposed by the regulator over recent years. Byres noted that macroprudentual tools introduced (to slow investor loan growth and reduce high risk lending across investors and owner-occupiers) have improved lending practices, but that the heavy lifting is “largely done” now. So don’t expect any more significant macroprudential settings to be imposed.

Further tightening could be done at the margin, like more focus on borrower’s expenses and monitoring total debt (not just housing) commitments by households. Byres also noted that recent APRA stress testing around bank’s capital requirements saw major lenders maintain their capital ratios above minimum requirements. 

It was also mentioned that APRA views the changes in lending practices to not have had an obvious impact on housing credit flows overall as investor credit has slowed, but owner-occupied credit is still running at a solid pace (see chart below).

In our view, the APRA measures have had a larger impact on slowing credit growth in the economy than APRA is indicating, particularly in the absence of higher interest rates. Credit growth should slow further, because lending standards have been tightened again, along with a natural slowing in demand for new housing loans.