Volatility has emerged again, but this time fear of a trade war is the latest source of worry. On Thursday, the Trump administration announced plans to levy tariffs on as much as $60 billion worth of Chinese imports. This announcement was not a surprise, but added to a list of other concerns including privacy issues at a leading technology company and the Fed’s latest growth and rate-hike forecasts.

While U.S. equities started to decline on Wednesday prior to Fed Chair Powell’s statement, news of tariffs on Chinese goods put global markets on edge as investors feared escalating trade tensions could undermine the global recovery. The sell-off was broad-based, with stocks in the U.S. declining by 2.5% to 3.5% on Thursday, followed by similar losses globally. As risk appetite faded, investors sought the safety of government bonds with the yield on the U.S. 10-year Treasury note declining to around 2.82%. U.S. stocks extended losses on Friday to deliver their worst week in more than two years, as investors weighed whether these growing trade tensions could escalate into a trade war. 

Trump’s China Tariffs and Potential Retaliation

The announcement to take action against China is in response to the findings of the Section 301 Investigation that the U.S. Trade Representative undertook in August of 2017. The investigation concluded that unfair Chinese trade policies resulted in an estimated $50 billion in annual losses related to intellectual property, technology transfers and licensing agreements. The U.S. will impose a 25% tariff on targeted Chinese products to compensate for the harm caused to the American economy. The yet-to-be finalized product list will include items in aerospace and high technology, but is not intended to have a negative impact on U.S. businesses and consumers.

China has already responded, with its Commerce Ministry stating that China is planning retaliatory tariffs on approximately $3 billion worth of U.S. goods such as steel, aluminum, pork, wine, fruit and other products. As we have seen with Trump’s executive order on steel and aluminum tariffs, there will likely be a series of negotiations before details are finalized. To date, we have seen exclusions for Canada, Mexico and the European Union on the steel and aluminum tariffs. If this serves as a template, the negotiations between the U.S. and China are probably just beginning.

Investment Implications

Equity markets will likely remain volatile as trade negotiations transpire, but we tend to believe that the world’s two biggest economies will be able to agree on a mutually-beneficial resolution. For now, we are in a period of broad-based global growth and believe that the proposed trade tariffs should only have a minimal impact on economic growth and inflation. Investors should continue to benefit from pro-growth positioning that favors equities over bonds within a well-diversified portfolio.

What We’re Watching

It will take time for trade policies to have an impact on the economy. With that in mind, we will be watching the following as negotiations play out over the coming weeks and months:

  • Will the list of products and goods ultimately result in a tariff or is this just a negotiating tactic?

  • Will the Republican Party influence Trump’s stance given it’s an election year?

  • Will the U.S. respond to Chinese retaliation?

The outcome of these variables will shed more light on the impact of tariffs on economic growth and the markets. While there is a somewhat higher chance of a long-tailed risk of a severe outcome, this is not our base case. For now, we continue to believe that China and the U.S. will be able to manage their differences in a measured way and avoid a major trade war.

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