“Last week trade tensions between the United States and China significantly escalated. President Trump asked US Trade Representative Robert Lighthizer to come up with a list of $200 billion worth of goods to be tariffed at a 10% rate, with the potential for another $200 billion more if China retaliates. The first list of $200 billion could be announced in two to three months’ time.

“So far this news is just threats, however if that changes, up to $450 billion worth of Chinese goods could be taxed (including the $50 billion already announced). That’s compared to $505 billion total U.S. imports from China last year. For context, that total $505 billion is about equal to 2.5% of nominal GDP.”

… may stall steaming US economy

“Elevated trade tensions may start to weigh on business sentiment. If businesses aren’t confident, they aren’t going to invest. Business confidence measures like the National Federation of Independent Businesses’ (NFIB) Small Business Optimism Index are near record highs, as the US economy steams ahead. But, there is anecdotal evidence that trade worries have already started to weigh down sentiment. According to MarketWatch, Raphael Bostic, the President of the Atlanta Fed stated, ‘optimism has almost completely faded among my contacts, replaced by concerns about trade policy and tariffs. Projects under way are continuing, but I get the sense that the bar of new investment is currently quite high.’ Investment spending is a key input into our GDP forecast for this year. We will be watching business sentiment carefully in the coming weeks and months.”

Tariff threats impacting NAFTA negotiations

“Aside from trade action with China, there are other tensions simmering. NAFTA is being renegotiated. The United States exports much more to Canada and Mexico than to China. There is also the looming threat of US auto tariffs. If tariffs on autos become a reality, that will be just as impactful, if not more so, than tariffs on Chinese goods. Autos make up 14% of total imports versus China’s 15%. The auto supply chain is highly integrated with 35% of the value of US auto exports containing imported parts. The more integrated the supply chain, the more risk there is of broader disruptions from any trade restrictions. The threats of auto tariffs plus steel and aluminum tariffs have likely made NAFTA negotiations more difficult to boot.”

Will this matter for the Fed?

“The Federal Reserve (Fed) will be focused on tangible economic impacts from any trade action. Right now, the only tariffs enacted are very small in scope and will likely have negligible effects on the U.S. economy. If broader tariffs do come to pass, the Fed may look beyond the transitory inflationary impacts and be focused on any drags on U.S. economic growth. We suspect the Fed may be less concerned about impacts on global financial markets today as compared to the past.”

How are trade tensions affecting investment?

“The downside risk scenarios of a protracted trade war with China or another country have increased. With more trade announcements in the pipeline, this will likely lead to more down days in the market. Pop ups of risk-off days will keep downward pressure on the U.S. 10-year. In turn, the yield curve, or the difference between long-dated and short-dated government bonds, may flatten further. Upward pressure on the dollar may stay around, and that means that domestically-oriented smaller cap U.S. stocks may continue to outperform larger cap U.S. stocks with more foreign exposure. Trade is a smaller share of overall GDP for the United States as compared to many other developed countries, so U.S. stocks may beat developed market stocks. “

By Robin Anderson, Senior Global Economist

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