Market Memo: Trade headlines may be scary; the impact on trade finance is not

08-21-2018

Despite ominous headlines, the scope of tariffs enacted to date affect a tiny proportion of the global trade bucket—just 0.8% of world trade. The risk is if these tit-for-tat skirmishes between the U.S., China and Europe turn into full-scale trade war. The U.S. is weighing tariffs on imported autos and parts, and on up to $250 billion of Chinese imports. China and Europe say they stand ready to retaliate. All of this has made for volatile global markets and understandably has investors with trade-finance exposure wondering: what is the impact on the availability of this asset class and its future returns?

First, some perspective. This year, global GDP is expected to grow 3.1%, with highly correlated world trade expanding by between 3.1% and 5.5%, according to the World Trade Organization. But what if all sides fail to reach a compromise and an actual trade war ensues—an outcome the markets haven’t priced in? Bloomberg Economics estimates a 10% rise in global tariffs—more expansive than what is being discussed today—would still only shave about 0.5% off global GDP by 2020, with global trade down roughly 4% relative to a baseline of no change in tariff policy. In a worst-case scenario, tariffs in the 30-60% range, global GDP may be trimmed 2-3%, economist Paul Krugman recently estimated in the New York Times. Put simply: a trade war undoubtedly would create disruptions and inefficiencies, but it shouldn’t represent a substantial hit to global trade or GDP.

Global trade isn’t going away

The reality is global trade should march on regardless of what the U.S., China and the European Union do. An estimated 80% of world trade is financed, with bank capital incapable of meeting that demand; the Asian Development Bank estimates there’s a $1.5 trillion funding gap between the demand for trade financing and available risk capital among banks. This is why banks have turned, and likely will continue turning, to funds as an alternative source of capital for financing trade transactions. Moreover, “south-to-south” trade (trade between emerging economies) represents an increasing part of the global trade pie and is largely separated from the current trade tiff. Indeed, as more regional trade pacts such as the Comprehensive Progressive Agreement for the Trans-Pacific Partnership (CPTPP) and China’s Belt and Road Initiative (BRI) are adopted, south-to-south trade should keep growing regardless of what occurs between the U.S., China and Europe.

The bottom line: the need for collateralized trade finance that can seek to mitigate risks involved in trade is rising, not falling, as a result of the current trade frenzy. And this favorable supply-demand dynamic should only serve to support underwriting credit margins and trade-finance investments going forward. So worry about a trade war? Sure. The market hates uncertainty and messiness. But just note that, when it comes to trade finance, positive fundamentals remain very much in play.