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Wall Street Warns About Consequences of Lengthy Trade Fight

If tariff plans go through, a recession is on the horizon, Morgan Stanley analysts warn.

By Felice Maranz

(Bloomberg) -- Economists and analysts are warning about the ramifications of a long-lasting trade war between the U.S. and China, as Beijing has pledged to respond if the U.S. insists on imposing additional tariffs, while President Trump said new import taxes on a long list of goods could go “well beyond” 25%.

Stocks were slumping and bonds were rising, with the S&P 500 down as much as 0.7% to the lowest since June 28, and yields on 10-year Treasuries falling about 2 basis points to 1.88%.

Here’s a sample of the latest commentary:

Morgan Stanley, Michael Zezas

There’s still time for negotiations, but Morgan Stanley is treating a 10% tariff on $300 billion of Chinese goods as likely to go into place, for two reasons, Zezas wrote in a note. First, the Trump administration “historically follows through on tariff plans,” and second, “fundamental disagreements remain, making the benefits of escalation appear greater than cooperation to both sides.”

If tariffs escalate to 25% on $300 billion, and remain for four to six months, Morgan Stanley economists would expect a recession within three quarters, as the increase would have a “non-linear impact on financial conditions and growth.” That’s because about 68% of the next round will be consumer goods and autos and parts, with “more potential for immediate impact to the economy.”

At the same time, Zezas added that “weaker risk market performance could change this dynamic and our view.”

Read more: July 31, Morgan Stanley Said U.S.-China Risks Skewed Toward Tariff Escalation

Citi, Cesar Rojas

The current U.S. environment gives the Trump administration room to take a “more aggressive stance on trade,” while “prospects for even lower rates (as two of the Fed cuts drivers worsen) would reinforce this approach,” Rojas said. He expects the threatened 10% tariffs will come into effect.

Potential escalation “raises trade policy uncertainty and will continue to harm sentiment and business investment, as supply chains shift away from China,” and may weigh on capital flows as well, he warned.

Goldman Sachs, Jan Hatzius

“With one month until the effective date there is still some uncertainty as to whether they will be implemented,” Hatzius cautioned. He’ll be watching for the release of an order including the final tariff list, effective date and tariff rate, which Goldman expects in one to two weeks.

Hatzius also noted that imports on the proposed list are concentrated in “key sectors that have up until this point been nearly – if not completely – unscathed by tariffs,” like apparel, footwear, toys and cell phones. If companies pass more of these tariffs on to consumers compared with previous rounds, that will likely prove “unpopular politically,” with Trump’s challengers attacking his trade policy.

Thursday’s tariff announcement “tilts the risks” toward deeper Fed rate cuts, he said. Goldman now sees a 70% chance of a 25 basis point cut, a 10% chance of a 50 basis point cut, and a 20% chance of no policy change in September, and sees a 90% chance of at least one additional cut later this year.

Evercore ISI, Glenn Schorr

“Stay flexible” as tariffs go up and rates go down, Schorr wrote in a note focused on financial stocks.

“Markets have been choppy and Trump’s announcement for an additional round of tariffs could impact corporate confidence and banking near-term, but we’d also expect there to be an offset within trading as higher volatility and wider spreads contribute to a better quarter... stay tuned here, it’s early,” he said.

Schorr is keeping his estimates steady for now, and expects activity will “pick up (barring further tariff related pain) especially in M&A where dialogues have been robust and backlogs are up 8%,” compared with the prior quarter. He still favors Morgan Stanley, Bank of America Corp. and JPMorgan Chase and Co. BofA fell as much as 1.3% in early Friday trading; JPMorgan slipped 0.6% and Morgan Stanley slid 2.9% to the lowest since June 4.

AGF Investments, Greg Valliere

“After getting only a measly 25 basis point rate cut from the Fed, President Trump decided to ratchet up the trade war with China,” Valliere wrote. Trump’s “message to the Fed was clear — I’ll make sure that trade will be a major economic headwind for months to come, so you’d better cut rates further.”

That strikes Valliere as a “reckless gamble by Trump,” for three reasons: “There’s no reason to believe rate cuts can compensate for the uncertainty over tariffs”; there’s no guarantee Trump can “pivot and cut a deal with China this winter, which we believe is his pre-election scenario,” and the Fed’s goal of “higher inflation may be just around the corner, eliminating the need for more rate cuts.”

“The great unknown is whether Presidents Xi and Trump have an end game,” he said. “It’s looking like they may not, with the prospect that an escalating trade war may create more problems than the Federal Reserve can solve.”

Raymond James, Ed Mills

Market sentiment says “Trump may rattle the cage on these trade fights, but will not do anything to harm the economy/cause a real market sell-off before the 2020 election,” Mills said, citing conversations with clients. At the same time, Powell’s admission that trade developments will impinge on Fed policy “will only serve to reinforce the belief that there is both a Trump and Fed put on the market.”

While Mills acknowledges this dynamic, he believes “there consistently has been too much optimism for a resolution,” and there’s a “real risk of escalation.”

Raymond James also believes that “threats to weaken the U.S. dollar are likely the next phase in these trade wars.” He flagged concerns that China will weaken the yuan to offset the tariff impact. “With other central banks likely to ease more than the Fed, we see President Trump seeking to take executive action on exchange rates,” he warned.

Deutsche Bank, Brett Ryan

Thursday’s developments strengthen Ryan’s confidence in his call for a “meaningful growth slowdown in the second half of the year,” and raise the chances the Fed will cut rates by more than 75 basis points in total this year.

Deutsche Bank had since last August built into its growth forecast a drag of about 0.1 percentage point on 2019 real GDP growth from the Trump administration raising tariffs on $200 billion of imported goods from China to 25% from 10%; Ryan expected a 10% tariff on the remaining portion of imports from China would present a similar drag on growth, “mainly through diminished business fixed investment.”

But, “what makes this escalation more risky in our view is the goods now being subject to tariffs,” with top import categories including cell phones, laptops, toys and monitors. That’s likely to hit big tech companies like Apple Inc., he said.

If the tariffs are implemented September 1, Deutsche Bank doesn’t see “an obvious off-ramp for de-escalation.” With China probably willing to wait out the 2020 U.S. presidential election, “we see a protracted tariff trench battle as presenting further downside risks to our already below-consensus growth assumptions over the next several quarters.”


To contact the reporter on this story:
Felice Maranz in New York at [email protected]

To contact the editors responsible for this story:
Catherine Larkin at [email protected]
Steven Fromm, Scott Schnipper

TAGS: Fixed Income
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