After briefest of respites, global trade war fears return with a vengeance

THE trade war is far from over, and neither is the associated rout in the stock market.

The broad S&P 500 had turned positive for the year to date, clawing back from bear-market territory on signs that US President Donald Trump had been bluffing with his “Liberation Day” tariff assault on the rest of the world.

On Friday (May 23), the index of multinational US companies fell back into the red after Trump returned with a fresh volley of trade threats.

First, he vowed to impose 50 per cent tariffs on all European Union (EU) imports, starting on June 1. Two days later, he extended that deadline to July 9 to give both sides more time to iron out a trade deal. Stock futures rose after the unexpected reprieve, but there’s no guarantee Trump will not shift the goal posts again.

Over the weekend, he also lashed out at Apple, vowing to slap a 25 per cent duty on iPhones unless production is brought back to the US from China.

The US-focused Russell 2000 has now given back roughly half the gains registered since May 12, when China and the US unveiled a short trade-war truce.

The truce had brought to an end a dizzying period for stock, bond and currency markets characterised by the Wall Street catchphrase “Sell America”.

In the feverish aftermath of Trump’s Liberation Day on April 2, a tit-for-tat battle had driven duties up to roughly 145 per cent on Chinese imports. At those levels, all freight traffic between the world’s two largest economies had slowed to a crawl. Effectively, it was an embargo that threatened to put countless small US businesses into bankruptcy and leave the shelves of retailers empty.

Stock and bond markets initially surged in mid-May as the tariffs were reduced to roughly 30 per cent on both sides for 90 days, with a plan to continue negotiations during that period.

Fallout from trade war

Even the 30 per cent level of tariffs was unthinkable just a few months ago, before Trump began to bang the tariff drum. If the threat against EU tariffs is followed through, retailers will struggle to fill their shelves for the holiday season. Consumers may struggle to find new generation iPhones, Gucci bags and Star Wars figurines.

Walmart, the empire built on price “rollbacks”, is now warning of tariff-related price increases, and its lead is bound to be followed by smaller rivals.

Trump has pressured corporations to back his tariff plans by “eating” the extra costs. Even those who have agreed to eat their tariff pie, such as Home Depot, will face repercussions and could start laying off workers.

“Tariffs force corporations to pass along higher costs, thus propelling inflation or eating costs and hurting profit margins, or some combination of the two. None of these are good outcomes,” said JD Joyce, the president of Texas-based financial advisory Joyce Wealth Management.

The other casualty of even a relatively contained trade war will be monetary policy. The US Federal Reserve considers risks to the jobs market and inflation to be hanging in the balance at the moment.

The tipping factor is likely to be the trade war. Fed officials say it’s too early to tell if the new tariffs will be a major cause of inflation or job losses, or both. Fed chairman Jerome Powell has cited the need to wait for the final trade policy to become clear, and to observe its impact on the global economy as the main reason the Fed has suspended plans for further rate cuts.

Some brokerages expect that wait to last through the end of this year.

Three potential outcomes

There’s a distinct chance, with Trump at the helm, that things will once more spiral out of control. As the threats to EU reveal, Trump does not have the patience to negotiate myriad trade deals with every nation that imposes tariffs on US goods. The only official deal struck so far, that with the UK, still included substantial duties on imports from the UK.  

Two weeks after the US-China truce, the only smoke signals from the negotiators on both sides were assurances that they remained open to further talks.

The buzzword on executive calls during the latest earnings season was “uncertainty”.

“Increased economic uncertainty due to tariff variability seems to have brought further moderation into May,” warned analysts at Bank of America Global Research, in a note entitled “Are May flowers wilting?”

There are three potential outcomes, according to strategists at Morgan Stanley.

One would be a de-escalation of trade tensions that would allow the US to avert a recession. A second would be a resumption of trade frictions through a return of reciprocal tariffs, which would result in a “mild recession”, they said.

In the third and potentially worst-case scenario, the US could cut back significantly on fiscal spending, which, in combination with the trade war, would result in an “adverse” recession. 

Should Trump carry on with his recent negotiating pattern of having all bark and little bite, the US markets could continue on an upward path. But any escalation in the trade war with China, the EU or other major economies will likely cause another painful rout in US stocks, Treasuries and the greenback.