ALBERT EDWARDS: US-China tensions are distracting from a far more catastrophic trade war that's threatening to break out

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Trump in March 2018

• As President Donald Trump has continued to escalate a trade conflict with China, Societe Generale strategist Albert Edwards argues that a far more damaging trade war may be brewing out of the spotlight.
• Of particular concern to Edwards is the large discrepancy in global auto tariffs, which favors both the European Union and China at the moment.

As President Donald Trump's trade conflict with China dominates headlines, a far more sinister situation is brewing - at least according to outspoken Societe Generale strategist Albert Edwards.

His concern is instead focused largely on the European Union, and the role its accommodative monetary policy and weak currency have played in creating an unsustainable trade surplus.

Edwards points out that as the Federal Reserve has recently adopted a hawkish approach to monetary tightening, the European Central Bank has been more dovish in its efforts to taper asset purchases. The resulting divergence has led to a weak euro and a strong dollar, which has, in turn, allowed the euro zone's trade surplus to grow. For context, note that a depressed currency is positive for exports.

This dynamic can be seen in the charts below:

Societe Generale

As a result, Edwards says a trade war is primed to break out - and that it could dwarf the escalating trade conflict with China.

"The key is that the ECB has, with its divergent monetary policy, pushed down the euro and is indirectly responsible for greatly exacerbating current trade tensions," he wrote in a client note. "The ECB's QE might have papered over the cracks in the eurozone for now, but it has also raised the likelihood of a full blown US/EU trade war."

So how might a US-EU trade war look? Edwards says the focus will be squarely on European automakers. As he points out, Trump has long expressed disdain towards the dominance of German brands in the luxury auto market.

And as of right now, the US charges just 2.5% on car imports, compared to 10% for the EU and 25% for China. Edwards says expect that to change as Trump looks to implement "considerably higher" tariffs.

Also complicating matters is the presence of Germany, which could be a far more difficult opponent than any Trump has faced so far in his global dealings. Edwards also notes the expedited nature in which the EU can process new regulations, leading to increased risk of immediate retaliation.

"Germany, in my years of observation, will not 'play the game' and make concessions, as well as conciliatory noises," he said. "It will push back robustly and the legalistic bent of the European Commission will see tit-for-tat tariffs being implemented far faster than anything seen in the current US-China trade spat."