Escalating risks of a trade war following the U.S. administration’s recent threat of imposing steep tariffs on Chinese goods and repeated warnings of abolishing NAFTA have rattled market sentiment. Risk assets have responded poorly to the uptick in trade tensions, which should hardly come as a surprise given the potential negative implications for the global economy and, by extension, the corporate earnings outlook.

 

The bad news is that trade frictions are unlikely to abate heading into November’s U.S. midterm elections, as we expect Trump to continue to pull on the protectionist policy “lever” in a bid to galvanize populist voters. The good news is that there are promising signs that the latest bout of trade scuffles are unlikely to deteriorate into a full-scale trade war.

 

The onerous U.S. tariffs on imported steel and aluminum are a case in point, as several nations eventually secured exemptions before those duties took effect. China’s relatively measured retaliatory response to Trump’s proposal of imposing tariffs on a to-be-determined list of Chinese products signals an obvious desire for de-escalation. “Feedback” from U.S. businesses and financial markets should serve as additional constraints on the degree of severity on Trump’s “America First” trade agenda.

 

We expect equities to remain vulnerable to further trade-related headlines in the near term, but the bottom line is that we view the risk of a full-blown trade war as fairly low. A more likely scenario, in our view, would entail the U.S. administration following its recent negotiating pattern of abrasive headline announcements packed with combative rhetoric, followed by a “cooling off” period and more targeted, less adverse implementation. As long as Trump’s protectionist stance continues to feature far louder bark than bite, we do not expect the latest trade strife to derail the constructive macro landscape for risk assets.