Full-blown trade war shifts from risk to baseline forecast

After months of predicting a trade deal between the world’s two largest economies, economists at some of the biggest financial institutions are growing increasingly pessimistic.

Goldman Sachs Group Inc., Nomura Holdings Inc. and JPMorgan Chase and Co. are among those that have rewritten their forecasts as U.S. President Donald Trump threatens to impose a 25% tariffs on around $300 billion of additional Chinese imports.

Analysts at Nomura have made that hike in duties — which would mean practically all of China’s exports to the U.S. are hit by tariff hikes — their baseline forecast. They see it as a 65% probability before year-end, and most likely to come in the third quarter.

“The U.S.-China relationship has moved further off track over the past two weeks after a period of what appeared, on the surface, to be steady progress towards reaching an admittedly narrow agreement,” Nomura economists wrote in a note. “We do not think the two sides will be able to get back to where they seemed to be in late April.”

The effect of the conflict between the two nations is spreading from trade and investment flows to the technology sector and more. Shares in voice recognition company Iflytek Co. plunged following news it is on a list of Chinese technology firms that may face restrictions from the U.S. That follows on from big falls in the share prices of surveillance companies Hangzhou Hikvision Digital Technology Co. and Zhejiang Dahua Technology Co. on Wednesday when it was reported they were on the list.

Goldman Sachs economists warned that without signs of progress over coming weeks, implementation of the further tariffs could easily become their base case. “While we still think an agreement is more likely than not, it has become a close call,” they wrote.

Those duties would have a material hit to inflation and lift the core PCE price measure in the U.S. by 0.6 percentage point, on top of the 0.2 percentage point already felt from tariff hikes. It would also, combined with limited Chinese retaliation, hit U.S. GDP by 0.5% and Chinese GDP by 0.8% over a three-year period, Goldman’s team estimated.

Direct trade effects of the new tariffs would be positive for the U.S. but negative for China, Goldman said. The U.S. will be hurt more by the hit to real incomes from faster inflation, and tighter financial conditions, they calculated.

Deal in 2035?

It’s not just Wall Street sounding more pessimistic. A senior Chinese government researcher said Wednesday China and the U.S. could be stuck in a cycle of “fighting and talking” until 2035. Zhang Yansheng, who previously worked at the nation’s top economic planning body and is now a prominent Beijing think tank, said none of the key American demands can be “realized in the short term.”

Read More: Chinese Government Expert Sees Trade Tensions Lasting Until 2035

JPMorgan analysts on May 17 said their new baseline is for the status quo — that is, all the rounds of tariff hikes to date from the two countries — staying in place well into 2020.

“We also take seriously the alternative, more severe scenario of moving into a full-blown tariff war, i.e. 25% U.S. tariffs on the remaining $300 billion Chinese imports in the second half of 2019,” the JPMorgan team wrote.

Such a move would see the yuan slide through 7 per dollar, JPMorgan chief China economist Zhu Haibin said on a conference call on the new projections earlier this week.

What Bloomberg’s Economists Say

“In an extreme case, where the U.S. imposes 25% tariffs on all Chinese imports, and keeps them in place for an extended period, China’s growth could fall to 6% in 2019 and 5.4% in 2020, even assuming that the government steps up stimulus.”
— Chang Shu, David Qu and Tom Orlik

Morgan Stanley is one bank that’s still clinging to the view that the latest increase in protectionism will prove temporary. But their economists say that view has a time limit.

“There is only a relatively short window left to address the trade-tensions risk such that global growth stays on the recovery path in line with our baseline,” Morgan Stanley economists including Chetan Ahya wrote Monday. “The impact on global growth is non-linear — the risks are firmly skewed to the downside and the window for resolution is narrowing.”

Their time limit: about four weeks.

Trade War

Now read: Trump widens assault on Chinese tech firms

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Full-blown trade war shifts from risk to baseline forecast