Trade Tensions Back in the Headlines
Tariffs increased and trade deal delayed
The US-China trade war has returned to media headlines. The White House, frustrated by mired trade negotiations, increased existing tariffs on $200 billion of goods imported from China from 10% to 25%, and proposed a 25% tariff on roughly $325 billion of additional goods. China subsequently retaliated by increasing tariffs on $60 billion worth of US goods. The S&P 500 was down nearly 5% from its high on the news.1
Our base case remains that a worst-case scenario will be avoided, and that a trade deal will be reached before the incremental tariffs have a strong impact on the economy. However, until a deal is reached, we expect related headlines to contribute to market volatility.
Why does it matter?
The latest increase in tariffs is disruptive to the US and global economies. The additional tariffs likely lead to slower economic growth, disrupted supply chains, currency volatility, and high levels of business uncertainty.
Sources: Multi Asset Solutions (MAS), Bureau of Economic Analysis (BEA), 5/14/19. US GDP estimates from 2018 at $20.5 trillion.
Most of the goods targeted by US Tariffs on Chinese imports have been on intermediate inputs. Intermediate inputs are goods and services used to produce other goods. They include raw materials and semi-finished goods sent from China (i.e. fabric to make a shirt). The increase in tariffs on these goods is likely to be disruptive if they are sustained. Manufacturers who use intermediate goods have already been shifting production, diversifying supply chains, or in some cases shutting down. While a year’s worth of tariff threats has likely made some businesses more resilient, increasing costs could force additional manufacturers to raise prices or go out of business.
The biggest economic threat would come from imposing tariffs on the incremental $325 billion in imports from China that currently don’t face tariffs at all. The goods at risk in this scenario are concentrated in capital equipment and final goods. These goods are ultimately consumed rather than used in production of another good. This means they could have a more direct impact on consumer prices. While we view this circumstance as unlikely, higher inflation over several months could push the Federal Reserve out of its “patient” stance and into another interest rate hike.
Potential paths forward
The precise path to trade resolution is highly uncertain. “Tough on China” is a bipartisan issue in the US, and so the Trump Administration would like to see some movement on structural reforms. On the other hand, China insists that all current tariffs must be removed and is unlikely to change its laws for structural agreements.
We think that cooler heads will ultimately prevail. Neither Xi nor Trump want to hurt their countries’ economies or financial markets. For President Trump, 2020 elections are right around the corner. Historically, voters view the economy as a top issue for elections. Xi’s job of managing China’s economic transition from producer to consumer is made increasingly difficult by a trade war. What’s more, the countries’ massive economies are deeply intertwined in consumption, production, and investment. We believe that Trump and Xi are aware of this risk and will likely settle on some sort of trade deal this year.
In the meantime, the scale and impact of threatened tariffs are likely to impact investor sentiment and could weigh on risk assets and business investment as we await a resolution.
Indicators to watch
What investors may want to do
|Trade deal reached in 2019||
|“All out trade war” scenario is sustained for 6+ months||
We believe a trade deal will be reached between the US and China. As we wait, it will be important to monitor the dollar/yuan (top right), corporate credit spreads (top left), and US business (bottom right) and consumer confidence (bottom left). Today, these indicators remain relatively strong. A deterioration in these indicators, however, could lead to trouble for financial markets and the US economy, with or without changes in trade policy.
Sources: Bloomberg, Multi Asset Solutions (MAS), NFIB: Small Business Association, Conference Board, 5/14/19.
1. As of 5/13/2019
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