New York (CNN Business)President Donald Trump’s escalating trade war against China threatens to inflict a powerful shock to the American economy that not even the Federal Reserve can fully absorb.
The Fed cut interest rates this week for the first time in nearly 11 years, effectively lowering the odds of a recession in the United States. Just 24 hours later, Trump raised those odds by vowing to unleash tariffs on $300 billion of US imports from China, which will for the first time directly impact American shoppers.
The new front in the trade war will only add to the downturn in manufacturing spanning the globe. It will further dent shaky business confidence and could even puncture the optimism among consumers. In short, little good can come from these new tariffs — and the ensuing retaliation from Beijing.
“It could be incredibly damaging to the global economy. The risk of a recession has gone up because of the ratcheting up of the trade war,” said Kristina Hooper, chief global market strategist at Invesco.
Trump blindsided investors on Thursday by announcing an abrupt end to the trade truce between the United States and China. Although talks will continue, Trump tweeted that he plans to impose a 10% tariff on the remaining US imports from China.
US stocks plummeted on the tweet, a selloff that deepened on Friday. Cash rushed into ultra-save government bonds, sending Treasury yields to multiyear lows.
“That’s telling me there is a lot of concern we are headed toward a significant global slowdown,” Hooper said.
Trump has also kept open the possibility that tariffs on China will go up to 25%.
Consumer goods targeted
Beyond the direct impact of the tariffs, the escalation in trade tensions risks dealing a sizable blow to business confidence.
The on-again, off-again nature of the trade war makes it difficult for CEOs to plan for the future. Instead of hiring workers and opening new factories, many companies may decide to sit on the sidelines.
“Tariff man is back and more dangerous than ever to our economy,” Peter Boockvar, chief investment officer at Bleakley Advisory Group, wrote in a note to clients on Friday.
In an interview with CNN Business, Boockvar argued that the only thing keeping the United States out of a recession is the strength of consumer spending.
However, Trump’s tariffs would impact a wide swath of consumer products, likely resulting in higher prices on items including apparel, footwear and electronics such as smartphones, laptops and tablets.
In 2018, 42% of apparel and 69% of footwear sold in the United States was imported from China, according to the American Apparel & Footwear Association.
“This is going to damper consumer spending,” Boockvar said.
If the tariffs go into effect, Boockvar said there is likely a greater than 50% chance the United States succumbs to a recession.
How will China respond?
It’s possible that Trump, spooked by market turmoil, backs down on his latest tariff threat. Another possibility is that the looming tariffs force Beijing to make enough concessions to allow both sides to claim victory. In either case, that would be a huge positive for the economy.
But some observers fear Trump’s increased pressure on China will backfire, provoking retaliation that deepens the economic pressure.
“Trump’s gambit is unlikely to work,” Michael Hirson, Eurasia Group’s practice head of China and Northeast Asia, wrote in a note on Thursday. “Chinese President Xi Jinping cannot afford the perception that he has been blackmailed into a deal by Trump.”
A spokesperson from China’s Ministry of Commerce said in a statement that although China does not want a fight, the country “will fight if necessary.” The official said that China will have to “take necessary countermeasures,” but did not explain what that retaliation will be.
Beijing’s options include firing back with tariffs of its own, restricting the supply of the rare-earth minerals that the global tech industry relies on, and devaluing the country’s currency.
Piling onto the global factory slowdown
Even before this week’s trade escalation, the world’s manufacturing industry was in a severe slowdown.
The Barclays global manufacturing confidence index dipped further into negative territory in July. Barclays said it’s “yet another warning of an ongoing global industrial recession.”
US factory activity tumbled in July to the weakest level in nearly three years.
Many blame the trade war for the global manufacturing downturn, but that may only be partially true.
Lakshman Achuthan, co-founder of Economic Research Institute, said the factory slowdown began before the trade war erupted in the spring of 2018.
“The trade war is entirely a negative. It is piling on top of the cyclical downturn,” Achuthan said.
In other words, the United States is self-inflicting a shock at a time when the global economy was already exposed.
“People don’t understand. We are slow walking toward a window of vulnerability. A negative shock we thought we could withstand becomes a recessionary shock,” Achuthan said. “We’re definitely on recession watch.”
Others doubt that the 10% tariffs on China will be very destabilizing because the Federal Reserve is coming to the rescue with more easy money.
“The risk to growth is somewhat small,” said Aditya Bhave, senior global economist at Bank of America Merrill Lynch, pointing to the Fed’s rate cuts as a cushion.
Risk of a ‘feedback loop’
Some have speculated that Trump is escalating the trade war to get the Fed to listen to his pleas for lower interest rates.
That would be a risky gamble because there is no guarantee the Fed will act, nor that the rate cuts will work.
“It simply makes no sense to risk a global recession in order to get the Fed to cut rates,” Win Thin, global head of currency strategy at Brown Brothers Harriman, wrote in a note to clients on Friday.
Bhave said it’s possible Trump turned up the heat on China because he feels emboldened by the Fed’s rate cuts.
“We think the Fed is inadvertently encouraging a more hawkish stance on trade,” he said.
Wall Street is already pricing in the chances of more rate cuts later this year in response to the spike in trade tensions.
“There is a risk we get stuck in a feedback loop,” Bhave said. “The Fed keeps cutting rates, trade policy keeps getting more hawkish and the Fed runs out of ammunition to fight the next recession.”