Trump's trade war becomes reality today as China tariffs kick in

US President Donald Trump is firing the biggest shot yet in the global trade war by imposing tariffs on $US34 billion ($46 billion) of Chinese imports, delivering on a promise to his political supporters that risks provoking retaliation and harming the world economy.

The tariffs on Chinese goods will go forward just after midnight, Trump told reporters on Air Force One on Thursday.

The key question for financial markets is: will it trigger fresh volatility, or is the trade war escalation already priced in?

Trump's biggest gamble

As of 12:01 am Friday in Washington (2:01 pm in Sydney) , US customs officials are set to begin collecting 25 per cent tariffs on Chinese imports of goods ranging from to farming plows to semiconductors and airplane parts. It's the first time the US has imposed tariffs directly aimed at Chinese goods following months in which Trump accused Beijing of stealing American intellectual property and unfairly swelling America's trade deficit.

The biggest economic gamble of Trump's presidency could spread as it enters a new and dangerous phase by imposing direct costs on companies and consumers globally. China has vowed to hit back in kind on goods ranging from American soybeans to pork, which may in turn prompt Trump to raise trade barriers even higher.

"Once these tariffs start going into effect, it's pretty clear the conflict is real," said Robert Holleyman, former deputy US trade representative under President Barack Obama. "If we don't find an exit ramp, this will accelerate like a snowball going down a hill."

Trump's administration is already reviewing duties on an additional $US16 billion of Chinese goods and eyeing an additional at least $US200 billion if China strikes back. Recent US tariffs on steel and aluminium antagonised fellow rich nations and drew return fire from the European Union and Canada.

Trump is doubling down on his promise to put "America First" in the nation's foreign and economic policies. He blames China for a bilateral trade deficit of $US336 billion and for costing US manufacturing jobs.

Iconic American companies such as Harley-Davidson are among those set to suffer now. The motorcycle maker said this month it may move production out of the US to avoid EU tariffs on its bikes. American businesses from Apple to General Motors all operate in China and are keen to expand. That hands Chinese President Xi Jinping room to impose penalties such as customs delays, tax audits and increased regulatory scrutiny .

Priced in?

But a rally of as much as 4.5 per cent in European carmakers on Thursday, fueled by discussions on lowering tariffs with the US, suggests markets had already been primed for adverse news on global trade. Yet Chinese shares remained under pressure as officials wouldn't say whether talks that could deliver a last-minute reprieve were ongoing.

"We can no longer talk about whether a trade war will develop, only the scale of the conflict," Steve Barrow and Jeremy Stevens at Standard Bank wrote in a note this week. "A promising global economic and financial market picture has been thrown into turmoil."

This new era of protectionism could hardly have come at a more sensitive time for markets. While the backdrop for growth is indeed strong -- particularly in the US -- financial assets were already girding for so-called quantitative tightening as the world's major central banks step back from stimulus.

That's siphoning liquidity from the system, and volatility is on the way back as a result. The Cboe's Volatility Index, known as the VIX and a gauge of investor jitterniness, has averaged 16.3 this year, compared with 11.1 in 2017. After recovering from a spike in February's market blow-up, currency swings have risen for six of the past seven weeks, according to JPMorgan Chase & Co. indexes.

"Investors should expect volatility to continue," says Mark Haefele, chief investment officer at UBS Global Wealth Management. "We recommend investors stay invested, but consider five actions: looking to alternatives, hedging equity exposure, improving credit quality, diversifying sector and country risks, and taking a longer-term view."

The worst-case scenario is that the trade war, in concert with monetary tightening, upends the global business cycle.

German Chancellor Angela Merkel raised the spectre of the financial crisis as she warned of potential fallout on Wednesday. Shares of European carmakers had fallen more than 11 per cent since mid-June through Wednesday.

Still, the sector's rebound today suggests that a lot of negative news on tariffs is already priced in, Michael Bell, a global market strategist at JPMorgan Asset Management, said in an interview. If trade concerns die down, stock markets may see a "pretty big bounce," he said.

Ticking clock

US stocks are already outperforming amid a global slide, the greenback hit the highest in almost a year last week and US Treasuries are well supported even as rates rise.

Contrast that with Chinese assets -- Shanghai's benchmark share gauge tumbled into a bear market last week and have extended the drop since, while the country's central bank has verbally intervened to slow the yuan's descent. Only Chinese bonds are on the up, catching a bid as domestic investors flee riskier assets.

"So far the trade war dynamic has made significant headlines," said James McAlevey, head of rates at Aviva Investors. "Fifty billion dollars writes headlines but it doesn't move the needle on US growth. If it doesn't escalate, we don't think it has material knock-on implications for the US economy."

All the same, a US factory survey on Monday showed executives "overwhelmingly concerned" about tariffs, and some companies are already sounding warnings. While investors are turning to American assets, they are opting for defensive strategies -- pouring cash into exchange-traded funds that track producers of consumer staples and energy, for example.

Meanwhile, both countries seem in no mood to back down -- the US this week moved to block China Mobile from entering the American market, and a Chinese court temporarily banned Micron Technology chip sales.

"The clock is ticking until Friday's trade war threats become a reality," Jasper Lawler, head of research at London Capital Group said in a note. "Relations between the US and China remain hostile, rattling investors. Further blocks and red tape this time on the likes of Micron Technology and China Mobile highlighted the likelihood of increased friction."

Bloomberg