There has been a flurry of activity regarding our trade policy with China and China’s reaction to it. Jeff Herzog, Ph.D. and Portfolio Manager at Lord Abbett, published this analysis on May 17, 2019. I thought it was very insightful and hope you do as well!
The title of his article is “Tariffs, Tweets, Trade and Trump: An Update.”
The U.S. administration is clearly weighing market reaction to its current actions, but at the same time investors are trying to absorb how far the White House will press China. While the economic impact depends on the ebb and flow of negotiations, beyond the tweets that batter markets we think the main issues are as follows:
- We believe an increase in the tariff rate to 25% on $200 billion in Chinese imports will increase inflation and slow growth in the United States by slight amounts. But imposing tariffs on the remaining roughly $300 billion in imports – something indicated as a potential follow-on move by the U.S. government – potentially will notably increase inflation and decrease growth, in our view.
- Spillover effects could make all of these developments more pernicious than simple accounting exercises. For example, non-Chinese producers could raise prices as they are shielded from Chinese competition. Alternatively, Chinese exporters are more dominant in certain products, and this will make it difficult for the firms that depend on these inputs to find cheaper alternatives.
- Much like his instinctual grasp of market timing, the U.S. president is attuned to the economic cycle. And in this respect, the timing is relatively favorable for a small trade war as U.S. employment is strong and inflation is subdued. But pressing China further may risk a more adverse reaction in markets.
Running the Numbers
The recent decision to boost the tariff rate on $200 billion of Chinese imports to 25% represents a 15% incremental increase. If the entire cost is passed through to U.S. consumers, this would represent only 0.2% of the $14 trillion in aggregate consumer spending (based on data from the U.S. Bureau of Economic Analysis). Limiting the impact to the pass-through only is a very stringent assumption for three reasons: trade diversion to countries not subject to tariffs is possible in some cases; tariff costs may not be fully passed on to consumers; and depreciation in China’s currency, the yuan, could offset some of the tariff impact. This last item is particularly vexing for the Trump White House as it has in the past accused other countries, such as Turkey, of circumventing tariffs through currency depreciation. We believe Trump is likely counting on a muted impact on inflation: Estimates of the impact of the tariff increase on the Personal Consumption Expenditure (PCE) index, an inflation benchmark monitored by the U.S. Federal Reserve (Fed), range from 0.1% to 0.3%, and are thus fairly moderate.
The latest twist in the trade policy saga likely will weigh on so-called “soft” data, but it comes at an opportune time as the economy is well-prepared to absorb a moderate shock. With regard to confidence, we think businesses’ outlook for future investment may see a negative impact from a more erratic policy environment and a further erosion of the rules-based trading system enshrined in the World Trade Organization. Manufacturing sentiment surveys are already somewhat depressed and thus incremental negative news may not be perceived as overly disappointing, in our view.