THE trade war rhetoric between the US and China has been heating up and last week cotton was brought into the mix as China included the fibre in a list of 106 products on which it would impose a 25 per cent tariff.
The announcement saw an immediate two to three per cent decline across the Intercontinental Exchange number two futures curve.
While the market regained its losses in the following day of trade as the announcement was digested, it is nonetheless yet another factor bringing uncertainty to an already fluctuating market.
There are a number of critical questions that remain – from the most fundamental of “will this actually come into force?” (a factor reliant on the US taking action on the 1300 products it announced tariffs on earlier in April) – to “when it would be implemented?’” And indeed the timing also has major implications for the outcomes.
Current arrangements for the import of cotton into China include a World Trade Organisation tariff rate quota of 894,000 tonnes which attract a one per cent tariff.
Out-of-quota imports are subject to a 40 per cent tariff, making it quite difficult for imported cotton under these requirements to be competitive in the domestic market.
At its discretion, China offers additional quota which sees variability in annual import volumes.
In recent years however, volumes required by the textile giant declined significantly as reserve sales began to clear the record domestic stocks.
A strong trading relationship with high-quality cotton exporters, such as the US and Australia, has remained however and although total volumes imported were just higher their WTO TRQ commitments in 2016-17 at about five million bales, US cotton represented 43 per cent of those cotton imports.
Demand for imports in China has been poised to lift as stocks become less able to buffer the gap between Chinese production, restricted imports and total consumption of cotton.
One of the key unknowns regarding this proposed tariff is whether China sources from the US (with the duty applied) or from alternative locations, such as Australia or Brazil (where it would be expected local premiums would rise).
A 25 per cent tariff would make sourcing that cotton more expensive at a time when the quality of imports will become even more important.
Rabobank maintains a bearish view for the ICE#2 into the second half of 2018, currently forecast to decline towards the low-mid US70 cents a pound range.
The forecast increased acres planted in 2018-19 is set to again lift stocks outside of China in 2018-19. While demand remains strong in the short term, underpinning the outlook for cotton prices in Q2 2018, this tariff and the uncertainty it brings does raise some risk factors to keep a close eye on.
In particular the timing of any implementation, any cancellations of Chinese export sales or falls in demand for US cotton.