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First shots fired in trade war. Limited damage.


July 6, 2018

This morning, the United States and China exchanged their first "blows" in the well-publicized trade "war." The United States enacted tariffs on $34 billion of China exports to the United States and China retaliated with an equal amount on exports to the United States. Both these moves were well telegraphed, with financial markets generally shrugging off the event, U.S. stocks strengthening and the U.S. dollar weakening during this holiday-shortened trading week. The key question now is likely to be “what happens next?”

The next move appears to be in the United States’ "court," with the U.S. administration studying and perhaps readying additional tariffs to bring U.S./China trade into balance, although indications are the next move will not be ready until this fall.

Economic impacts likely small this year

We expect the initial impacts on the U.S. economy to be modest at the aggregate level, although some of the possible near-term losers, such as soybean farmers, are already seeing significant impacts. The absolute size of current tariffs are small when compared to the stimulus generated. According to calculations by Strategas Research Partners, the recent tariffs will cost the U.S. economy about $12.5 billion in 2018 while tax cuts are generating expected benefits of $200 billion. Additionally, the total size of the U.S. economy is $19.96 trillion annually, according to the first quarter report on nominal gross domestic product (GDP). U.S. economic growth continued to accelerate through the second quarter as evidenced by a rebound in manufacturing confidence (based on the Institute of Supply Management Purchasing Manager survey for June) and still-strong growth in U.S. payrolls (which have gained an average of 214,000 jobs per month so far in 2018). Specific industries are likely to experience headwinds from the specific tariffs. China is the largest buyer of U.S. soybean exports and prices fell as much as 15 percent in the second quarter of 2018 in anticipation of tariffs, likely impacting the expected earnings for farmers at fall harvest time.

Asset price headwinds unlikely until next year

For now, we expect positive U.S. economic momentum to continue to support stock prices and earnings growth. Further expansion of tariffs later this year (especially if the tariff scope moves beyond China) could temper this momentum, but this is likely a 2019 or later event. Yesterday, President Trump cited up to $550 billion as an outer boundary for duties and tariffs on Chinese goods, so a risk to the market’s current assessment of this situation could be accelerated back and forth on tariff amounts and implementation timelines. That said, we anticipate that global stock markets will price in tariff impacts as implemented, rather than as expected, given the fluid and changing nature of trade discussions. We believe risks in markets are more balanced between stocks and bonds, for now. Earnings growth is unlikely to repeat the first quarter surge from tax cuts, but growth trends remain positive domestically, although more challenged abroad. Bond yields have risen, making fixed income investments somewhat more attractive, but yields remain historically low.

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