US-China Trade War

The perils of escalation

Erik Norland, Senior Economist, CME Group

What a difference a weekend makes. Equities closed higher in the first week of May, buoyed by a strong US employment report and hopes that the US and China would finalize a trade deal in Washington this week. Then, on Sunday afternoon (early Monday in China), Washington announced that the 10% tariffs on $200 billion of Chinese goods would increase to 25% on Friday and that 25% tariffs could, perhaps, be applied to an additional $300 billion of Chinese goods. This news sent shockwaves through equity, fixed income, currency and commodity markets. 

Our analysis of the impact of the trade war has been pretty much spot on thus far. We estimated that a 10% tariff on $200 billion of goods in addition to higher tariffs on a smaller set of goods would slow China’s economy by about 0.1-0.2%. In fact, according to China’s official GDP estimates, growth has slowed from 6.5% to 6.4%. Fallout from the trade dispute has been limited thus far by a weaker Chinese currency and an easing of Chinese monetary and fiscal policies. 

The most recent escalation will be more difficult to offset, however. A 25% tariff on $200 billion of goods could take 0.3-0.4% off Chinese growth. Meanwhile, a 25% tariff on an additional $300 billion of Chinese goods could wipe off an additional 0.5% from growth, bringing the total cost of the trade dispute to 0.8-1.0% of Chinese GDP.

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