Global trade disputes are the subject of nearly daily headlines.

Tit-for-tat tariffs between the U.S. and China risk breaking into an all-out trade war between the world’s two largest economies. The U.S. tariffs on steel and aluminum imports from the European Union (EU), Canada and Mexico have also exacerbated trade tensions beyond the U.S.-China relationship.

Investors are taking note. The new global trade tensions component of our BlackRock geopolitical risk dashboard shows concern over trade risk is more than three standard deviations higher than its average over the last 12 years.

The tool measures market attention to global trade tensions by tracking the frequency of related words in analyst reports, financial news stories and tweets, taking into account positive and negative sentiment in the text. The higher the BlackRock Geopolitical Risk Indicator (BGRI) score for global trade tensions, the more markets are focusing on this risk.

What does it mean?

It’s clear market attention to global trade risks has spiked. We think this helps explain the large disconnect we have seen since late January between robust corporate earnings and muted or outright negative stock returns.

We see this geopolitical risk here to stay, with trade tensions getting worse before they get better. The U.S. administration is shaking up the post-war system of global trade and international alliances with the aim of reducing its trade deficit. U.S. President Donald Trump has moved from long-held protectionist views and pronouncements to taking multiple, simultaneous trade actions in every key region of the world, citing unfair trade practices or national security concerns.

The U.S. focus on bilateral trade deficits is not just about China (see our U.S.-China relations BGRI). Increasingly, the U.S. finds itself at odds with traditional allies such as Canada, the EU and Japan. The U.S. has implemented tariffs on a small volume of trade, and announced a bigger program targeting an additional $200 billion in goods imported from China. The outcome of a U.S. investigation into auto imports—which represent another $300+ billion in potential tariff—also looms large. Meanwhile, tensions between the U.S., Canada and Mexico have increased after the U.S. proposal for bilateral trade deals in lieu of a renegotiated North American Free Trade Agreement (NAFTA). Nevertheless, we see NAFTA talks continuing.

No easy fix

With no easy fix to reducing the U.S. trade deficit, we see trade disputes as a major source of macro uncertainty and volatility. Yet we do not see them derailing the global expansion–for now. Prolonged trade tensions could threaten to affect the global economy through the confidence channel if companies start to delay investment. Market sentiment could also deteriorate amid fears of a global trade war if we see a scenario where the U.S. escalates trade disputes and U.S. allies impose retaliatory tariffs, followed by the overhaul of key multilateral trade agreements and the further undermining of the global trade web.

How might markets respond to such a scenario?

Measuring how trade–or any geopolitical risk–may impact markets and portfolios can be a challenge. We apply market-driven scenarios to arrive at some estimations. We could see a global equity market selloff, with Chinese and emerging market (EM) equities under-performing; EM currencies weakening versus the U.S. dollar; and U.S Treasuries and gold rallying in a bid for perceived safe-haven assets.

Potential triggers of worsening trade tensions?

We see three:

1. Tit-for-tat tariffs with China escalate further with material actions implemented by both sides.
2. The U.S. announces its intent to withdraw from NAFTA and negotiate bilaterally with Mexico and Canada.
3. The U.S. imposes duties on autos, sparking retaliation from the EU and other countries.

The risk of escalating trade tensions is one reason we see building portfolio resilience as crucial now (read more on that in our Global Investment Outlook Midyear 2018). Global trade tensions is just one of the 10 key geopolitical risks we have BGRIs for in our geopolitical risk dashboard. There, we also share our analysis of each risk’s likelihood of occurrence over a six-month horizon, escalation triggers and potential market impacts.

To be sure, tracking geopolitical risks is not an exact science, and we are continuously fine-tuning our risk scenarios and methodologies. The global trade tensions indicator, for instance, replaces a more narrow tracker of the risk of a U.S. withdrawal from NAFTA. Check out the full BlackRock geopolitical risk dashboard to read more, including a deep dive into the risk of European fragmentation in the wake of a populist government forming in Italy.

Isabelle Mateos y Lago is BlackRock’s Chief Multi-Asset Strategist. She is a regular contributor to The Blog.

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