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Blog Posts — May 9, 2019

Putting a dent in auto imports: Stress-testing the impact of US tariffs on EU cars

by Christoph Schon, CFA, CIPM

Much attention has recently been paid to the trade conflict between China and the US. Yet, there is also the impending threat of special tariffs of up to 20% on car imports to the US from the European Union. Such a move would, obviously, have a particularly strong adverse effect on Germany, which is already plagued by recession fears. Our stress tests, combined with historical precedents, indicate that losses in the critical automobile sector of Europe’s largest economy could be up to 9-12%.

President Trump first threatened to impose duties of 20% on automobile imports from the European Union in June 2018. Since then, both sides have repeatedly signalled their willingness to seek a trade agreement in order to avoid the damaging tariffs, but little progress has been made so far. In the meantime, the US Commerce Department provided a report to the White House on whether motor vehicles and parts posed a national security threat for the United States. The president now has until May 18 to decide whether this is the case and whether special tariffs on those imports are justified.

The German economy—already plagued by recession fears—is likely to be hit disproportionally by such a move. Between June 14 and June 29, 2018—when the tariffs were first proposed—the German stock market lost 6%, with the auto sector being hit twice as hard. This compared with a decline of just 3% for the overall European market.

The table below shows the simulated performance of selected sectors and countries within Axioma’s European multi-asset class model portfolio. The numbers in the second column are based on the actual market movements from mid- to end-June 2018, while the returns in the third and fourth column are derived using a so-called transitive stress test in Axioma Risk™. In the latter two cases, we applied a downward shock of -6% to the German DAX® index and used correlations from the second quarter of 2018 and the 3 months to April 6, 2019, respectively, in order to estimate the pricing factor movements for the remainder of the portfolio.

The results below confirm the notion that Germany will be among the hardest-hit countries in Europe under such a scenario. Using current correlations, we also note a bigger effect on France, which has had a flurry of negative (economic) news in recent weeks. The German automobiles and components sector shows an even larger negative performance of -9%, although it is less severe than the actual -12% observed in June 2018.

At the Eurozone level, consumer discretionary companies, which include automobile manufacturers, were among the worst performers in all three scenarios, alongside other cyclical sectors, such as information technology—another crucial part of the German economy. Defensive industries, such as utilities, real estate and consumer staples, on the other hand, tended to be hit less hard. Safe sovereign bonds from Germany, France and the Netherlands can be expected to benefit from flight-to-quality flows, while peripheral issuers are likely to suffer from increased risk premia. Italy exhibited a particularly bad performance when using correlations from Q2 2018, as that was the onset of the budget conflict between its populist government and the European Commission. But even under more recent conditions, Italian BTPs still carry substantial spread risk.

Simulated returns for selected countries and sectors