International trade tensions are mounting, the agreement between France and Germany contains the institutional risk in the eurozone

Macro Highlights - 6/26/2018

In short
  • Trade tensions have continued to escalate, with the US threatening to apply trade tariffs of 10% on USD200 million in US imports from China…
  • … preventing Beijing from retaliating on the same scale, as Chinese imports of US goods total just USD130 billion
  • The European Union’s retaliation to US trade measures was contained, in accordance with the rules of the WTO...
  • ... and the 20 June Franco-German agreement seeks to maintain cohesion ahead of the upcoming European summit, limiting a further rise in the institutional risk

Trade tensions are mounting between the US, China and the European Union

Au cours des dernières semaines, les tensions commerciales entre les Etats-Unis, la Chine et l’Union Européenne se sont accrues. Après la mise en place de tarifs douaniers sur l’aluminium et l’acier le 8 mars 2018, l’administration Trump a annoncé de nouvelles mesures vis-à-vis de la Chine. La Chine et l’Union Européenne ont quant à elles répliqué, conduisant les autorités américaines à reformuler de nouvelles menaces. Il y a donc indéniablement une escalade des tensions commerciales qui pourrait accroitre l’incertitude économique et affecter la confiance des investisseurs. Cette semaine, nous vous présentons une revue chronologique de ces annonces, qui permet de mieux appréhender ce renforcement des tensions :

22/01/2018 : Announcement by the US administration of import tariffs of 30% on solar panels and 20% on washing machines.

08/03/2018 : Announcement by the US that it would impose trade tariffs on steel (25%) and aluminium (10%) imports.  The exemptions initially granted to Canada, Mexico and the European Union ended on 1 June 2018. South Korea, Australia, Argentina and Brazil will be exempt from these tariffs but will have to limit their export volumes. According to data published by the Peterson Institute1, USD40.9 billion worth of goods would be affected by the tariffs (measures effective since 23 March), i.e. 1.7% of total US imports in 2017.

15/06/2018 : Announcement by the US of additional trade tariffs of 25% on USD50 billion worth of goods coming from China. The tariffs will enter into force on 6 July 2018 for USD34 billion worth of goods. The list of remaining goods (USD16 billion) have been submitted for a more in-depth review before being defined. Based on the accusation of unfair practices by Beijing with respect to intellectual property, technological transfers and innovation, the Trump administration announced it was imposing trade tariffs on 1,102 technology products c oming from China. The US Trade Representative specified that the list of goods specifically targets products related to the Chinese industrial policy, “Made in China 2025”. The Americans thus targeted the aerospace, IT and communications, robotics, industrial equipment, new metals and automobile sectors. The tariffs will enter into force on 6 July for USD34 billion worth of goods, and at a later date for the remaining USD16 billion. The USD50 billion in goods represent 2.1% of total goods imported to the US, 9.9% of Chinese exports to the US and 2.2% of total Chinese exports.

15/06/2018 : In response to the trade measures imposed by the US, China also announced tariffs on goods imported from the US for a total of USD50 billion. This measure will be applied as from 6 July for an initial amount of USD34 billion - most of which agricultural products, such as soya or seafood products, and the automotive segment - while the remaining USD16 billion will be announced and applied at a later date. For the latter, mainly Chinese imports of US products linked to energy such as oil are set to be targeted. These Chinese retaliation measures could discomfit the Republicans ahead of the mid-term elections in November, due to the concentration of agricultural production in the Midwestern states, several of which are ‘swing states’.

18/06/2018 : Following the announcements by Beijing, President Trump threatened to apply 10% tariffs on a further USD200 billion in US imports from China. If it were to be applied, this measure would raise the question of how China would retaliate. In fact, Chinese goods imports coming from the US, of around 130 billion, are lower than this amount, preventing an identical retaliation by China. China would thus have to take other types of measures in order to respond to such a measure by the US.

20/06/2018 : In reaction to the application of US tariffs on steel and aluminium, of 10% and 25%, respectively, representing EUR6.4 billion in European exports, the European Commission voted in favour of a 25% increase in customs duties on imports worth EUR2.8 billion coming from the US. The list of products targeted breaks down into steel products for one-third, agricultural products for one-third (corn, rice, peanut butter, bourbons) and industrial products for one-third (boats, leather shoes, cosmetics, jeans), all exported from states that are politically strategic for Donald Trump. The amount targeted would reach EUR2.8 billion, in line with the rules of the World Trade Organisation (WTO), and represent less than half of the EUR6.4 billion in European exports concerned by the new US duties.

24/06/2018 : The US president threatened to implement additional measures if the countries concerned retaliate, and notably asked the US Treasury to draw up a series of restrictions to limit direct Chinese investment in the US, primarily in the technology sectors. According to the US Bureau of Economic Analysis, while net direct investment flows from China in US companies had reached USD25.4 billion2 in 2016, in 2017 they were negative at -USD504 million.


  • At present, the trade barriers in place are set to have a limited impact, notably on the US and Chinese economies. In the US, while some sectors could suffer from the measures implemented, the impact on the economy as a whole should remain limited, as the share of goods concerned by the hike in tariffs represents less than 4% of total imports.
  • However, this trade conflict creates economic uncertainty that could weigh on the confidence of investors. Moreover, if the escalation were to continue, the macroeconomic impact could be greater.


The Franco-German agreement seeks cohesion ahead of the upcoming European summit

Following the changes in the Spanish and Italian governments, the agreement between Angela Merkel and Emmanuel Macron on a set of reforms that aim to improve the economic and monetary union (EMU) prevented a further rise in the institutional risk and confirmed that Angela Merkel still has room for manoeuvre despite the internal tensions within her government. These agreements nevertheless must be submitted for validation during the European summit on 28 and 29 June, and notably obtain the adherence of the Nordic countries, which have recently denounced the lack of inclusiveness of discussions on the future of the EMU.

The importance of the Franco-German agreement is thus reinforced due to the lack of political support of the other large European nations:

  • In Spain, the new government led by Pedro Sanchez has a minority in Parliament, already fragmented by the different political currents. While the new ministers remain pro-European, domestic issues (possible revising of the constitution) appear to be a priority compared to the reform of the European institutions.
  • In Italy, the new eurosceptic government is putting pressure on all European partners to improve the management of migrant flows, relegating the issue of the financial and institutional stability of the eurozone to secondary importance. Furthermore, the announced fiscal expansion (introduction of a universal income and tax cuts for households and businesses) would call into question Italy’s budget commitments to its European partners.

However, tensions within the German government could limit Angela Merkel’s room for manoeuvre. The Chancellor, who is the leader of the Christian Democratic Union (CDU), has to contend with the demands of her interior minister and leader of the Christian Social Union (CSU), Horst Seehofer, to find a solution to the migrant issue during the European summit of 28 and 29 June.

  • These internal tensions stem from a German political environment that saw the Alternative for Germany (AfD) party, which is highly critical of the 2015 policy for accepting refugees, obtain 94 seats in Parliament in the elections of 24 September 2017, notably at the expense of the CSU electoral base.
  • As we near the Bavarian legislative elections to be held on 14 October, Horst Seehofer - formerly the prime minister of Bavaria - would thus want to reclaim part of his electorate in order to stand out from Angela Merkel’s stance, implying tougher positions on the migrant issue.

This position would call into question the CSU-CDU government coalition and would thus weaken Chancellor Merkel’s room for manoeuvre, particularly for implementing new European and structural reforms.

Thus, the Franco-German summit of 20 June 2018 confirms the good intentions for cooperation between Angela Merkel and Emmanuel Macron to demonstrate European cohesion and obtain an agreement on the second pillar of the Economic and monetary union:

  • The setting of a European budget for the period 2021-2027. This would be the first mechanism offering funding capacity specific to the eurozone that would aim to (1) improve the competitiveness of the euro zone through new investments in human capital and innovation, and (2) play the role of stabiliser in the event of an economic shock in one of the Member States. This second objective would require one of the two following proposals to be put in place: the temporary suspension of the contribution to the budget of the euro zone for the State in question, or the set-up of a European employment-insurance stabilisation fund with no rule of transfer among States. This last solution will be subject to proposals during the European Council meeting of December 2018.
  • The reinforcement of the European Stability Mechanism (ESM), which could change name (European Monetary Fund?), via the set-up of new financial support instruments.
  • The reinforcement of the banking union with notably a target gross NPL ratio (excluding provisions) of 5% and a target net NPL ratio of 2.5% (including provisions).
  • The reinforcement of the capital markets union, notably by putting in place a pan-European personal pension product and via the harmonisation of insolvency rules among the countries.

However, no mention was made regarding the migrant policy, which will be discussed during the European summit this coming 28 and 29 June.

The adherence of all European partners to these proposals for a strengthening of the economic and monetary union would contribute to lowering the institutional risk of the eurozone following the agreement reached on Greece’s exit from its bailout plan. Eurogroup has thus reached a deal to allow Greece to exit from its 2012 bailout plan on 20 August 2018. This agreement will also enable the country to alleviate its debt. The average maturity of the debt was thus increased by 10 years to 42.5 years, while the grace period for paying back the capital and interest was extended by 10 years, implying an initial repayment in 2033. Lastly, Greece received the last tranche of the 15-billion-euro bailout, providing it with a cash buffer in the event of new shocks in the short term.

We nevertheless maintain our scenario that includes a deceleration in economic growth in the eurozone. Despite the improvement in lead indicators for overall activity (PMI) in the eurozone, the sub-indicators still point to downward trends. While there is an improvement in services, the industrial sector is decelerating as a result of the rise in input pri ces and production growth that is higher than growth in new orders, which implies that purchasing managers have revised down their business expectations.