Extreme outcome avoided

Investors have suffered serious whiplash over the past five weeks. After shaking the foundation of the global trading system on “Liberation Day”, as he termed the 2nd of April, US President Donald Trump has been backing down.

The good news is that the most extreme scenarios are now much less likely. Recession risks have fallen and so has the possibility of a severe market response. The main reason is that the US and China agreed to a trade truce last week, putting most of the tit-for-tat import taxes on hold for 90 days. The bad news is that this is unlikely to be the end of Trump’s trade wars. More uncertainty and, probably, volatility lie ahead. But for now, we can all sleep a bit sounder.

Embargo
Tariff levels between the two largest economies jumped so high that it would have effectively been an embargo. The trade truce will come just in time for American retailers to keep shelves stocked for the second half of the year, particularly for the Christmas shopping season. It will also be a huge relief for Chinese manufacturers.

Chart 1: Change in US tariffs on Chinese imports

Source: Yale Budget Lab

As for the broader US-China relationship, the trade agreement should be seen as a ceasefire, not a complete reset. For one thing, it does little to address the unbalanced trade relationship between the two countries that led to the tariffs in the first place. Moreover, the tensions that have built up in recent years are likely to continue as the US strains to maintain its military and technological lead over China. However, both sides recognised that mutually assured destruction in trade is in neither country’s interest.

Still high
After all the sound and fury, US import tariffs on Chinese imports have fallen from 145% to 41%. China’s retaliatory import tariffs have been lowered from 125% to 10%. Your degree of optimism will depend on your starting point. The 41% tariff level looks fantastic if you are anchoring off 145%. However, it is still very high when compared to 11%, where it was at the start of the year.

Since China is a large supplier to the US, the effective tariff rate on the overall American import basket is still around 14%, according to calculations by Yale University’s Budget Lab, compared to less than 3% when Trump took office. While the “reciprocal” tariffs imposed on the 2nd of April on 60 countries were suspended (including those on Chinese imports), the 10% across-the-board tariff looks set to remain, as was the case in the recent US-UK deal.

Therefore, American consumers still face higher prices, while businesses are likely to experience disruptions to their supply chains. This is likely to put downward pressure on US economic growth, and business activity across the globe. For instance, Walmart, the largest retailer in America, warned last week that it would not be able to absorb the full impact of tariffs, and would have to pass some of the cost increase on to consumers. It is the biggest single importer of goods in the US. Trump posted on social media that Walmart and other businesses should “eat the tariffs” instead, but this would imply smaller profit margins.

In other words, the trade war is not over, but its intensity has eased for now. It is anyone’s guess what happens after the 90-day grace period, but the pattern so far suggests that Trump will continue making deals. As one commentator put it, we’ve gone from “Liberation Day” to “Capitulation Day.”

The stock market response borders on euphoric. The S&P 500 has gained 19% since the April 8 low and is back into positive territory for the year. Other equity benchmarks from around the world are also above pre-Liberation Day levels, as if nothing changed.

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