May 31, 2019 Patrick Oliver-Kelley

Two huge uncertainties for the world economies: Will there be a deal or will America raise tariffs; is there a point at which China might lash out against America?

  • An IMF study says tariff revenue collected from levies on Chinese goods “has been borne almost entirely” by U.S. importers.
  • China and the U.S. have been engaged in a trade war for more than a year. In that time, they have targeted billions of dollars-worth of goods with high import tariffs.
  • President Donald Trump claimed on May 8 that the higher levies on Chinese goods are “filling U.S. coffers” to the tune of $100 billion per year.
  • But the IMF says the bilateral trade deficit between China and the U.S. remains “broadly unchanged” even with the tariffs.

The latest tit-for-tat tariffs on Chinese imports have already taken a wrecking ball to stocks’ gains. Now, some analysts are bracing for the impact to trickle out to the broader economy.

One prominent analysist said, that the potential cost headwinds of 25% tariffs on all Chinese exports to the U.S. could be in the range of 1.0-1.5% of the index’s net income, But demand destruction and ailing confidence increase the potential impacts well beyond just higher costs and would likely lead to an economic recession.

Late last week, the Trump administration raised the rate of tariffs on $200 billion worth of Chinese imports to 25%, and announced that further levies on another $300 billion in imports would be forthcoming. Trump has claimed repeatedly that China broke the deal the two sides had been working toward over the past several months, leading to the use of tariffs to try and extract further concessions.

Beijing retaliated by announcing plans to set a tariff rate as high as 25% on a portion of $60 billion worth of U.S.-made goods, effective June 1. The news sent contracts on the Dow down more than 500 points in pre-market trading.

We have highlighted the likelihood of an earnings recession or S&P contraction of bottom-line growth, the near level of the S&P 500 of 3000 approached earlier this year, was probably overvalued. Last week, the S&P 500 posted a weekly loss of 2.18% as concerns about trade tensions simmered. However, the index was still up about 15% for the year-to-date.

But earnings recession aside, an increase in the prospect of increased trade tensions has also pulled up the probability

There are many signs that the risk of a recession in the next 12 months is rising, While an economic recession doesn’t always ensue after the indicator signals downturn, on average equities tend to underperform treasuries over the next twelve months by about 6%, indicating we have little upside until either prices fall back to more reasonable levels or this indicator reverses.

While the prospects of a near-term trade deal appear off the table for now amid a trade talk deadlock, a breakthrough would be unlikely to immediately reverse the choppiness in trading seen over the past several sessions. Negative surprises like the re-escalation of U.S.-China trade tensions can have greater negative price impacts than fundamentals might suggest, as such unexpected occurrences can leave a lasting impact on sentiment and outlooks.

Volatility may not subside as quickly as some might think even if there is a proper de-escalation of these trade deal risks.

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