As Trump rolls the dice with further tariffs on China, we wonder what the end game is for global growth and US monetary policy.
US President Donald Trump has fired the latest shot in his trade war, keeping a promise to impose 10% taxes on $200 billion worth of Chinese imports, effective from 24 September.
From 1 January, this figure could rise to 25% — a delay intended to give US companies time to establish new supply chains. In reaction, China has suggested it will respond in kind, covering a previously identified $60 billion of imports, with variable tariff rates of up to 10 percent.
True to form, Trump has already threatened to respond to any Chinese retaliation, with restrictions on a further $267 billion of additional goods, covering nearly all of China’s imports to the US.
We have already incorporated this round of tariffs into our forecasts: they take a couple of tenths off US economic growth, all else being equal. But we also identified any further escalation in trade tensions as the main downside risk to global growth. This danger appears to be increasing.
What began as a multilateral melee has become a bilateral bust-up
Interestingly, the market reaction has been relatively muted. This may be because what began as a multilateral melee, with the US facing off against Mexico, Europe, Canada and China, has become a bilateral bust-up between Washington and Beijing.
Market participants, moreover, may expect the recent US fiscal stimulus and Chinese currency weakness to mitigate any short-term negative impact of the fracas on the world’s two largest economies.
Yet this does not mean we can be at all certain as to how the situation might unfold. At a recent meeting, a former senior US official who was involved in economic policy said it is unclear whether the White House has a strategy – and if it does, what that strategy actually is.
Beijing, as a result, does not know whether the Trump administration’s objective is to reduce a trade imbalance, strike a deal to lower tariffs or merely to disrupt supply chains to reduce US reliance on China.
The former official also said China would probably not wish to engage in a full-scale financial war, by devaluing its currency and dumping US Treasury holdings, although some of the depreciation in the renminbi this summer was probably in anticipation of the tariffs. Beijing also might avoid interfering too much with US companies operating in China, according to the official, so as not to commit too much economic self-harm.
For the Fed, the trade war constitutes a negative supply shock
The reaction of the US Federal Reserve will clearly be key to the market outlook. The central bank appears to be taking the view that it will respond once tariffs have been implemented, but will not forecast an escalation.
From the central bank’s perspective, the trade war constitutes a negative supply shock – raising inflation, lowering growth – so it will be inclined to stick to its current guidance for interest-rate increases. But if the conflict triggers a significant tightening of financial conditions, this could derail the once a quarter hiking cycle we currently expect.