Trade War Odds Rise as Tensions Escalate: Economists

The EU has said it will retaliate with tariffs on several billion dollars worth of U.S. imports, a plan reaffirmed by German Chancellor Angela Merkel in a German TV interview Sunday. “We don’t let ourselves be taken advantage of again and again.”

Despite the U.S. tariffs and retaliatory comments from these trading partners, financial markets haven’t reacted much to the latest developments, and early this week they are expected to turn their attention to U.S.-North Korean talks, which get underway on Tuesday.

“Traders are factoring in a “trade policy put” that partially offsets the damaging effect of individual news items on this topic, writes Nicholas Colas, co-founder of DataTrek Research, in his latest market note. “If U.S. equity markets start to suffer from too much White House bluster on the matter, so the thinking here goes, the president will have no choice but to back off. True or not, the idea explains the muted market response to date.”

But if trade tensions escalate and Trump doesn’t back off on tariffs, as BofA Merrill Lynch economists fear, then markets could feel the pressure. 

“We see risks to the view that ‘cooler heads will prevail’ on trade,” the BofA economists write.  “Our concern is not so much irrational action, but that the US and its trading partners could rationally engage in tit-for-tat protectionism, with growing economic costs, in order to test each other‘s resolve. But we remain hopeful because market and electoral discipline could break up this dynamic.”

“There’s nothing good about tariffs,” said David Kelly, chief global strategist at JPMorgan Chase, at the Pershing Insite conference last week in Orlando, Florida.

White House trade policy policy is “creating uncertainty” in corporate America, said Vince Reinhart, chief economist at Standish Mellon Asset Management, part of BNY Mellon Asset Management North America, who shared a panel with Kelly. “Where would a company locate a plant in the mid-U.S.? Based on the trade situation, CEOs should wait. “

The situation could become even more complicated If U.S.-North Korean negotiations on nuclear weapons end in disappointment. In that case, U.S. tariffs against China will be “back on the table,” said Jack Ablin, chief investment officer of Cresset Wealth Advisors, in a recent CNBC interview.

“The likelihood of an outright trade war with China is probably 30 to 40%,” and if it happens that would be “enough to create a sizable [downward] catalyst” for the U.S. stock market, said Alblin.

As of the end of the first quarter, the U.S. was running a $93.4 billion trade deficit for goods and services with China, according to the Census Bureau. Its had a $30.4 billion deficit with the EU but a $4.2 billion surplus with Canada.

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