Analysts are throwing in the towel on the prospects for a trade truce between Donald Trump and Beijing.
After 14 months of headline hockey and policymaking-by-tweet, markets are suffering from an acute case of whiplash. The August 1 escalation, which found Trump breaking the Osaka truce just a month after it was agreed, left many observers exasperated.
China has clearly seen enough. The yuan devaluation was a warning shot and, frankly, the fact that Beijing didn’t let the currency fall further after Steve Mnuchin branded the country a currency manipulator was a feat of stoic fortitude on Xi’s part.
At this point, Wall Street has effectively been forced to give up on a deal before the 2020 election. It’s a “fool me once” type of thing.
It doesn’t help that Trump continues to say things that suggest he might be willing take the dispute beyond what most thought was the “all-in” scenario (i.e., 25% duties on the remaining $300 billion of Chinese goods, which are set to be taxed at 10% starting on September 1). Recently, the president went so far as to say he’d be fine with not trading with China at all.
None of this is good news for a late-cycle economy in the US or for the rest of the world, which is mired in a manufacturing slump.
“Fears that the trade war will trigger a recession are growing [and] we expect tariffs targeting the remaining $300bn of US imports from China to go into effect and no longer expect a trade deal before the 2020 election”, Goldman wrote Sunday, adding that “the risks of further escalation have also risen, with President Trump threatening tariffs of ‘well beyond 25%'”.
If Trump were to make good on threats to tax all Chinese imports at 25% and move ahead with auto tariffs, the US effective tariff rate would spike to the highest in ~70 years.
“Tariff man” indeed.
When it comes to the impact on the US economy, the main problem is that it’s impossible to quantify four of the main channels through which economic activity will be affected: the financial conditions channel, the policy uncertainty channel, the business sentiment effect and the effect of supply chain disruptions.
On the FCI impact, Goldman pegs the cumulative tightening impulse thus far at around 60bp. You should note that the plunge in long-end yields has helped to cushion the blow to the tune of ~25bps.
Indeed, the bank writes that “the trade war would have tightened our FCI by nearly 120bp, up from the actual 60bp, if the Fed had ‘promised’ to look through the trade war”. Translated into GDP, the trade-related tightening in the FCI (as broken down in the chart) will result in a peak 0.4% drag on economic output.
On policy uncertainty and business sentiment, Goldman uses a number of methods to estimate the likely impact of the trade war. Ultimately, the bank estimates “a roughly 0.1pp cumulative hit to GDP”.
When it comes to the supply chain effects, Goldman again warns that import substitution will be substantially more difficult in the next round. That said, the bank finds scant evidence to support the conclusion that supply chain disruptions are affecting capex or hiring, so that’s good news.
“The upshot is that we have revised our estimate of the growth impact of the trade war in our baseline scenario, with a peak cumulative drag on the level of GDP of 0.6%, and a 0.2% contribution from the 10% tariffs on $300bn”, Goldman writes, summing up a pretty trenchant analytical exercise when read in its entirety.
On the bright side, the bank reminds you that the biggest drag is still likely to come from the FCI impulse. That suggests (from Goldman’s perspective anyway) that “many investors are overly pessimistic about the effects of trade restrictions on near-term US growth”.
The problem – and we’re reasonably sure Goldman would agree with this – is that estimating how the FCI impulse will evolve in the event things escalate is an extremely difficult, if not wholly impossible, exercise. That is, who knows how far stocks might fall (or how much credit spreads might widen) if the White House were to announce 25% tariffs on all Chinese goods after the 10% duties go into effect. And what about the possibility that Trump ultimately moves forward with auto tariffs on Europe? And that’s to say nothing of how the market might react if China resorts to an even steeper devaluation or indicates it might sell Treasurys or cuts off rare earths exports or cracks down on US corporates operating in the country.
Also consider that if the bank is correct to say that investors are “overly pessimistic”, it likely means that those same investors will be inclined to sell faster upon getting bad news. That behavior itself determines the size of the FCI impulse. (As ever, there are self-referential dynamics at play.)
In any event, Goldman thinks the impact is probably manageable, which is nice because, again, the bank’s base case is now that there will be no trade deal before the 2020 election.
On Sunday evening, Trump opened his Twitter app to reassure his subjects.
“Many incredible things are happening right now for our Country. After years of being ripped off by other nations on Trade Deals, things are changing fast”, the president said. “Big progress is being made. KEEP AMERICA GREAT!”