From US-China trade ceasefire to US-EU trade war?

• We expect the US administration's trade policy to shift focus to Europe in 2020, but do not expect a wider EU-US trade war.

•  We see 30-40% probability of US tariffs on European car imports hitting in H1 20, in light of both political and legal complexities. In the event of car tariffs, we see downside risks to euro area and German GDP growth of 0.1-0.2%.

•  We still see a tangible risk of further US tariff measures for EU products under the ongoing Airbus-Boeing dispute in the coming months, while progress on an EU-US deal on industrial goods is set to remain sluggish.

•  Fixed income markets do not currently embed an EU-US tariff premium, in our view. Should the US impose tariffs, we would expect European yields to take a leg lower towards levels seen in H2 19 and European equities to suffer.

As the US and China have sealed the phase-one trade deal and the USMCA agreement finally passed Congress, fear has built that President Trump's trade ire will soon shift to another region: Europe. In December, US Trade Representative (USTR) Lighthizer already warned that ‘dealing with Europe is something that's very important and the president has focused on'. At the World Economic Forum (WEF) in Davos President Trump just repeated his tariff threat if an EU trade deal cannot be reached before the US election. So will 2020 turn out to be the year when the trade war shifts from China to Europe, unravelling the nascent cyclical rebound of recent weeks?

Tensions between the US and EU regarding trade policies are not a new feature and have simmered since 2018. The start was marked by the decision by the US to slap import tariffs on European steel and aluminium in June 2018. As a consequence the EU introduced counter tariffs on a range of US food and consumer products worth EUR2.8bn, with the option of another EUR3.6bn by June 2021 (or earlier in case of a positive finding in the WTO dispute settlement). While the steel and aluminium dispute remains unresolved, three additional areas of contention have since opened up.

US auto tariffs: easier said than done

The most important one from an economic perspective remains the question about car tariffs. A key focus of the Trump administration is to improve the US trade deficit with the EU, which has widened since the financial crisis. At the same time, the share of European cars and car parts in total US imports from the EU has steadily increased. Hence, it is not so surprising that US trade tactics have singled out this important sector. In February 2019 the US Department of Commerce concluded that imports of automobiles and certain automotive parts pose a threat to national security as they affect US producers' global competitiveness and R&D needed to maintain US military supremacy. The move relied on the infamous Section 232 of the 1962 Trade Expansion Act, which originally was intended to protect America's Cold War-era defence industrial base and which the Trump administration has previously used to justify the steel and aluminium tariffs. Although the President concurred with the findings of the report, he 26 January 2020 Senior Analyst Aila Mihr +45 45 12 85 35 [email protected] Senior ECB Rates Strategist Piet P. H. Christiansen +45 45 13 20 21 [email protected] Senior Equity Strategist Bjarne Breinholdt Thomsen +45 45 12 80 57 [email protected] Other reading  US-China trade - A cautious note on the phase-one deal - and what's next  10 key questions about the global economy in 2020 Current tariff measures affect only a small part of total US-EU goods trade Source: BEA, Macrobond, Financial, Danske Bank Autos play an important part in shrinking the US-EU trade deficit Source: BEA, Macrobond Financial, Danske Bank Euro Area Research From US-China trade ceasefire to US-EU trade war? 2 | 26 January 2020 https://research.danskebank.com Euro Area Research refrained from imposing tariffs right away and instead directed USTR Lighthizer in May 2019 to enter into negotiations with the EU, Japan and other major car exporters to address the issue at hand within 180 days.

While Japan was able to strike a mini deal with the US on the contentious car issue on the side-lines of the UN meeting in September and Mexico, Canada and South Korea will be shielded from tariffs through the USMCA and KORUS deals, progress on the US-EU trade deal on industrial goods has been slight. Former EU Commission President Juncker originally initiated the talks in July 2018. Since then agreements in part have been reached on issues such as increased EU purchases of LNG and soybeans and regulatory cooperation, however disagreements still abound about the actual scope of the deal (see EU's Progress Report). While US negotiators are keen to include agricultural products, the EU wants to limit the deal strictly to industrial goods and proposals by Europeans to include automobiles in the agreement have repeatedly been turned down from the US side, in fear that it would further boost EU car exports to the US. We have a hard time seeing this issue being resolved in the near future, even if the stalled talks could be reinvigorated with new momentum after EU Commission President Ursula von der Leyen's visit to Washington in February.

With an EU-US trade deal still not on the horizon anytime soon, the risk of a unilateral move by the US on European car imports remains tangible. Especially the political temptation to boost his approval rating ahead of the election in the auto states of Michigan and Ohio might feature prominently in President Trump's deliberations for tariffs (see chart).

On the other hand, the political argument is not straightforward, as the EU's retaliatory response - which we expect to come relatively swiftly in the event - could well see Trump's move backfire. In a sign of goodwill and as part of the negotiations on a deal on industrial goods, the EU has already increased imports of US LNG and soybeans significantly since July 2018 (see chart). These purchases would likely be redirected to other countries as part of the retaliation strategy and we also expect other US agricultural and energy products to feature high on the EU's list of rebalancing measures.

Further, higher car prices for US consumers are also unlikely to win votes. The US imported cars and car parts in the volume of USD63bn from the EU in 2018 and the Michigan-based Center for Automotive Research has estimated that new car prices in the US would rise by USD2750 on average in response to a 25% import tariff.

Furthermore, when Trump again chose to dither and the 180 days' deadline for action under Section 232 slipped on 14 November 2019, the question of car tariffs took on an additional legal dimension. While some trade law scholars argue the Section 232 provision explicitly requires action within a certain time period, others argue that the expiration of the 180 days does not preclude future action in response to a national security risk (see discussion here). All this does not rule out a move from the US administration nevertheless - it has surprised the market many times before in 2019 - but it increases the risk of costly lawsuits from car manufacturers in the wake of a tariff hike.

In sum, we think the political arguments for the Trump administration to move ahead with the tariffs are mixed. While it could boost Trump's re-election chances in important swing states, the US would also forfeit an important pressure point to push for European concessions in the trade negotiations or exert leverage on European foreign policy (as recently illustrated with the triggering of the Iran nuclear deal dispute settlement mechanism, see story). Additional legal complexities and a seeming preference to avoid fighting a trade war with Europe on too many fronts (see more below) in sum leave us to see only a 30-40% risk of car tariffs being introduced in H1 20.

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