China Markets trade

Here Are The Macro And Market Implications Of Three Main Trade War Scenarios

"Risk of global recession".

Rhetoric around the trade war appears set to deteriorate into recriminatory mudslinging following Donald Trump’s ill-advised decision to claim Beijing was “beaten so badly” in what were previously described as amicable negotiations between representatives from the world’s two largest economies.

Trump, it would appear, can’t resist the urge to couch everything in terms of competition and zero-sum games.

Meanwhile, China is accusing the US of “guarding trade in the name of IP protection.” Beijing’s state newspaper is blaming the US for the setback in the trade talks.

As detailed on Saturday evening, a move by the Trump administration to slap tariffs on all Chinese imports would have serious ramifications for US inflation, and the situation would be complicated further if the US were to impose auto tariffs predicated on the Section 232 probe.

Read more: As Trump Threatens China Again, Here’s What Happens To Inflation In A Worst-Case Tariff Scenario

It’s not entirely clear what all of this would mean for Fed policy. Obviously, a worst-case scenario that sees inflation pressures build materially as Trump goes “all-in” on the protectionist push would also see growth take a serious hit, leaving monetary policymakers to ponder the proper response to tariff-related price pressures and a deteriorating economic outlook.

In the near-term, any dollar strength that accompanies further escalations risks bringing the dollar liquidity shortage/squeeze story back to the fore. That narrative was already starting to work its way back into the financial news cycle (see here and here).

One worry being voiced by analysts is that Trump now believes his own story when it comes to the notion that the Fed, not the trade war, was the proximate cause of last year’s risk asset malaise. Consider this, from BofA:

There is also the possibility that the Trump administration does not believe that the trade war negatively affected markets. The issue is that when the markets were weak last fall, the trade war was escalating and the Fed was hawkish. During the recovery this year, trade tensions have cooled and the Fed has turned dovish. So the cause of the market moves is not entirely clear and it is possible that the President believes that the Fed, and not trade, was the real problem. This is what economists call an “identification problem.”

This is a question that continues to haunt market participants. Although it’s pretty clear that Jerome Powell’s “long way from neutral” communications misstep was the straw that broke the camel’s back, don’t forget that just 9 days previous (so, on September 24), tariffs on $200 billion in Chinese goods went into effect. Here’s a visual:

BofA goes on to note that according to their event study, both the trade war and the Fed “contributed similarly to both last fall’s selloff and the subsequent rally, until the latest trade shock.”


In Goldman’s analysis of the worst-case scenario for US inflation (highlighted in the first linked post above) the bank assumes 25% tariffs on all Chinese imports and the imposition of auto tariffs. In that scenario, Goldman sees a peak 0.9pp impact on core PCE and a potential 0.8% downside for US GDP (that takes into account a 10% slide in equities).

Using the same worst-case assumptions, BofA assesses the cross-asset implications. To wit:

Of course the most worrying scenario is a full-blown trade war. In this case we assume that the US and China end up imposing 25% tariffs on nearly all bilaterally-traded goods. There is no trade deal in the near term. We also assume escalation on the auto tariff front after talks with China break down. We even see a risk of a 20% tariff on all auto and parts imports with partial retaliation by impacted countries. We continue to view this scenario as very unlikely. There will be plenty of warning signs in the markets and the forward-looking data on the path to a trade war: we fail to see how the Trump administration would not be persuaded to back down at some stage, especially with the Presidential elections coming up next year.

With all due respect, saying something like “we fail to see how the Trump administration would not be persuaded to back down” assumes that the US president is a rational actor. That is not a safe assumption.

In any event, here is table from BofA which attempts to summarize what the bank believes the cross-asset implications would be for various outcomes. We’ll present it without further comment other than to draw your attention to the “risk of global recession” warning in the “Growth” column corresponding to the “Trade war” scenario.



8 comments on “Here Are The Macro And Market Implications Of Three Main Trade War Scenarios

  1. Why otherwise bright people would assume, at this point in his Presidency, that Trump is a rational actor is beyond me. He’s not playing 9 dimensional chess in preparation for 2020. He’s miffed about various things, including China’s apparent effort to renegotiate some portions of the trade talks, and is taking it all out on the Chinese.

    There are trades to be made with Trump in office if you can figure out how to get into the mindset of an upset 8 year old who didn’t get ice cream for dessert.

    • I would like to send him ice creams !

    • Anonymous

      “(Trump) is taking it all out on the Chinese.”
      Unfortunately he’s taking it out on American business and the consumer too. We end up paying for his personal battles.
      On the positive side, if there is one, maybe the Chinese will stop forced technology transfer. LOL

      • Anonymous

        Who makes companies enter the Chinese market? Only the greed of the BODs/shareholders. If you know China will steal your IP, don’t go there. If you want to protect your IP and hence your long-term strategic advantages, stay home. But, don’t try to have your cake and then whine when they copy it and run to the government for help like your some passive victim! It’s reflective of our society as a whole and it’s SAD!
        The SA

  2. monkfelonious

    It’s pretty amazing that an actual dildo has such sway. I’m hoping that in the future we are all merely amused by this passing fancy. How is it possible that we are led by someone that can’t even form a proper sentence? Jeezus, even Adolf and Benito could write.

    • Anonymous

      I’m afraid I have to disagree with you there. An actual dildo would be far more useful and would be much more likely to bring someone happiness.

  3. jamaican

    @DoubleB: probably because many people still hope against hope that there is a shred of rationality left in the president of the USA.
    It IS kinda hard to accept that that’s not the case.
    What really keeps boggling my mind is the fact that he has no tolerance for ambiguity whatsoever.
    Everything is black/white, winner/loser, or, in this case ONLY the Feds fault/nothing to do with China…
    Just like you’d expect from a 9 year old.
    The world needs to understand that the US president is a child (and a spoiled one at that)

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