After a one-month truce, the U.S.-China trade dispute has flared up again with another round of tit-for-tat trade restrictions, impacting financial markets worldwide.
The latest trade barriers do not warrant making abrupt adjustments to equity portfolios, because the U.S. and global economies do not seem in danger of an imminent recession.
The new 10% U.S. tariff on $300B in Chinese goods is a firm nudge, not a body blow. This tariff is largely as an attempt to exert psychological pressure on China. It does however, raise the risk that the White House could ultimately go all-in by hiking the tariff from 10% to 25% or more in the coming months, as President Trump has already threatened.
On a practical basis, assuming the 10% tariff is implemented on September 1, China’s economy could lose more steam, mainly due to uncertainties that even higher tariffs could be forthcoming. For the U.S., this new tariff is barely a blip on the radar screen. While prices of some consumer goods could rise modestly, the total impact would be equivalent to a mere 0.1%—that’s one-tenth of one percent—of the $21T U.S. economy.
China is also applying psychological pressure. It countered the 10% tariff in two areas near and dear to Trump, by suspending agriculture purchases from the U.S. and allowing its currency to weaken. There is no path to Trump’s re-election without the farm states; Chinese leaders understand this. But here again, this move is unlikely to have a noticeable impact on the U.S. economy. Agriculture exports to China plunged by 54% from 2017 to 2018 due to previous tariffs, and yet the U.S. economy kept growing. For all of 2018, U.S. agriculture exports to China were less than a fraction of one percent of GDP. So, the broader economy can absorb further declines.
For the first time in 25 years, the U.S. Treasury Department has designated a major trading partner as a “currency manipulator.” This has sparked “currency war” rhetoric, but it is unlikely to have much practical impact in the near term. This designation will prompt the U.S. to negotiate currency issues with China or pursue its case with the International Monetary Fund.
As the 10-year Treasury yield plunged 35 basis points over four trading sessions to 1.71% on Monday, part of the Treasury yield curve became more inverted, with short-term yields creeping higher than long-term yields by a greater magnitude. Recession risks have risen by this measure. However, other major U.S. recession indicators have yet to flash red or even yellow. Employment data, leading economic indicators, and the level of manufacturing new orders versus inventories are still signaling that GDP growth should persist for at least the next 12 months. In addition, consumer spending is elevated, confidence is high, and wages have been rising at a healthy clip for more than a year. This is notable because consumer spending drives almost 70% of U.S. economic activity.
As long as trade tensions don’t heat up to the degree that a global or U.S. recession becomes a credible threat, the equity market can work through this volatile period.
Tim