U.S.-China trade war threatens global credit conditions, says S&P

A potential trade war between world economic giants, the United States and China, would threaten global credit ratings, according to global credit rating agency, Standard & Poor’s.

In its quarterly updates on credit conditions in North America, Europe, the Asia-Pacific region, and Latin America, published recently, the foremost rating agency says an escalating trade battle between the U.S. and its trading partners, notably China, in the form of billions of dollars in retaliatory tariffs are dragging down global investor confidence, spending, and economic growth.

It noted that while global credit conditions remain broadly favourable, it’s still unclear whether all involved parties will negotiate new trade terms or retaliate into an all-out trade war.

“Whatever the case, the actions thus far have infused broad uncertainty around the world.”

Its regional and global outlook is tempered by what it identifies as top global risks, including trade interruption and geopolitical tensions, the potential for asset-price volatility, Chinese debt overhang, and investor concerns about a turn in the U.S. credit cycle, which could lead to a liquidity pullback from emerging markets.

Specifically for Europe, the Middle East and Africa (EMEA), it said credit conditions would remain favourable as the economy in the region has navigated recent shocks quite well, adding that nationalistic policies in the region over time has threatened to undermine confidence that global institutions can cushion against unexpected systemic shocks as they arise.

S&P noted that trade and Brexit are two such policies with potential for widespread systemic impact.

“Financing conditions still remain favourable, supported by the European Central Bank’s accommodative monetary policy, particularly in the bank market, where lenders have the capital to deploy. Even so, credit spreads have started to widen and investors are becoming more selective at the lower end of the rating spectrum. In the U.K., funding conditions appear tighter, mainly reflecting a modest appetite for new borrowing by business and households.”

In the U.S. and Canada, S&P noted, “credit conditions remain broadly favourable as the U.S. economic expansion continues, with interest rates increasing at a measured pace, and upcoming maturities appear manageable,” adding that the biggest threats to what’s been a historic stretch of benign conditions are increasing primarily the escalating U.S.-China trade dispute, along with rising corporate debt, upward pressure on borrowing costs, and imbalances in Canada’s housing market.

S&P maintained that finance conditions remain favourable, with debt issuance holding up fairly well, they said corporate distress ratio is at the lowest in more than three years, upcoming maturities seem manageable, and interest rates rising at a measured pace.

For Asia-pacific region, it said credit conditions also continue to be favourable but risks emanating from the U.S. are increasing.

“Trade interruption risk is on the rise as the U.S. and China impose 25 percent tariffs on each other,” it highlighted.

Meanwhile, there appears to be upward pressure on interest rates and spreads, and investor sentiment points to a potential turn in the U.S. credit cycle. After improving for the past three quarters, financing conditions in emerging Asia, while still favourable, may start to face headwinds later in the year.

According to S&P, broadly favourable credit conditions exist in Latin America amidst increasing downside risks.

“On the bright side, credit conditions in the region still benefit from GDP growth, which we expect to be higher this year than in 2017, although a bit lower than we previously forecasted,” says S&P.

The global rating firm explained that a combination of external and domestic factors has resulted in falling currencies and tighter financing conditions, and pressure on the region’s currencies could begin weighing on inflation levels and result in monetary tightening over the next few months.

“Financing conditions remain neutral to slightly favourable in Latin America, but will likely face headwinds in the second half of 2018, especially among nonperforming loans. As interest rates rise, countries with higher exposure to international funding may face additional capital flow constraints, as investors may allocate capital to higher yielding securities in developed markets instead of emerging markets.