ETFs are an accident waiting to happen in EMs and US-China standoff raises the risk: Michael Every, Rabobank

ETFs are an accident waiting to happen in EMs and US-China standoff raises the risk: Michael Every, Rabobank

Michael Every, Head of Financial Markets Research Asia-Pacific, Rabobank International, says if 90% of China’s export of around $500 billion to the US gets affected, that is going to be an additional headwind against them.

Edited excerpts:

President Trump has directed the US Trade Representative to list out $200 billion worth of Chinese goods for imposing tariff. That’s not good news.

Michael Every: Good or bad news is in the eyes of the beholder. It is certainly not going to be well received by the financial markets. What we effectively see here is Trump taking the nuclear option on trade. Initially, we only had $50 billion in tariffs. The widespread suspicion was after China responded proportionately with exactly the same tariff back on the US, Trump would escalate it by imposing tariff on $100 billion worth goods. But he is going to impose tariff on $200 billion worth goods and has said that if there is any further retaliation from China, it will go up by another $200 billion, taking this to $450 billion which is 90% of China’s export to the US.

Clearly the US is going all in and either we are going to see China blink and this gets resolved peacefully or this is going to get very messy.

China’s GDP slowdown in its transition to a more domestic-led economy is becoming the talk of the town and that draws a lot of EM strategies. How much of this trade tension can impact and further impact China’s growth?

China’s growth is already slowing as we saw from the recent numbers. Not that you can really trust many Chinese data today to be accurate representation of what is going on but we know that it is slowing. Trump move would be a severe headwind. If 90% of China’s export of around $500 billion to the US gets walloped and I certainly see a much lower market share in the US, that is going to be an additional headwind against them.

It, however, is not going to blow the economy over largely because the domestic side of the Chinese economy is much bigger than it used to be. One thing I have to clarify; this constant message we hear about China rotation from construct to consumption is simply not true. It is still an investment-led economy. It is still government-led economy and this is not an economy where Chinese consumers will step up and say do not worry about the lack of exports, we will just go out and buy more as will be the case say in US or other developed economies.

Instead the Chinese government will turn around and say let us do another highway, another railway, another bridge to nowhere and that will keep the economy going instead, which is all very fine in the short run but it ends in a huge problem in the long run.

We talked to Tata Steel management yesterday and he was very worried about a tariff war. He made a very interesting point and mentioned that because of the tariff war, steel prices in US have gone up and that takes care of the additional tariff which US is imposing on a country which is exporting to US. Do you think rise in inflation because of US tariff war would slowdown US faster than anticipated? Bond yields are also now seeing some correction at 2.88.

Well on the first point, it is extremely complex because it is a very fast-moving situation but I do think that was an interesting comment because it points to the fact that this is a very dynamic process rather than a static one. When economists do their number crunching, it is usually over static models and presuming x, y, therefore z. But the irony could well be that yes, if steel prices in the US are pushed up by high tariffs, suddenly everyone else looks cheaper despite the fact there is a 25% or 10% tariff — whether steel or aluminium. At which point, the question becomes do you get further tariffs until they squeeze prices higher again? It is an interesting tail chasing exercise that they are undertaking.

In terms of the 10-year bond yield, yes. When they were breaking through 3%, almost at about 3.5% or 4, % I said let us hold 3% first.

We have not managed to hold 3% and while on one hand inflation is going up due to these tariffs, that is genuinely going to turn into a demand pullup which would keep bond yields higher and I very much question that assumption.

Because of the dependence emerging market flows have on passive instruments like ETFs, they also get impacted by volatility. There have been emerging market ETF outflows of close to $3 billion over a year and that accentuates a fall in the markets across the region?

We have already established this year something that many people have been saying for a long time but nobody wanted to listen to it. ETFs are an accident waiting to happen and they are happening. The only question is who do they happen to and when? If we are going to see an escalating US-China trade standoff, it is exactly the kind of headwind that is likely to increase the risk of one of those accidents happening with ETFs in emerging markets.