Markets & Economy

In a recent post, we discussed some of the sector implications that could result from recently enacted steel and aluminum tariffs. Here, we explore the potential second-order effects that a protectionist trade policy can have—both on the US, and on the broader global economy.

For the first time since the Global Financial Crisis, economies across the globe have been in the midst of a synchronized expansion. President Trump’s pro-growth policies, in the form of tax reform and deregulation, have arguably been positive developments in support of US participation in this uptrend. These pro-growth policies, however, stand in stark contrast to the administration’s more recent protectionist moves on trade, which we view as net negative.

Protectionism could escalate trade tensions and derail the global upswing. It is one of the key potential downside risks to economic growth we have flagged since late 2016, a risk that can have real investment implications. Protectionist trade measures—to the extent that they trigger tit-for-tat tariff escalation—pose a threat to the improving economic backdrop due to the broad negative effects these policies can have on global trade and growth.

Barriers to the free mobility of capital can disrupt supply chains, impair business and consumer confidence, reduce growth, lower expected returns on capital, and exacerbate inflation as supply is outstripped by demand—possibly leading to stagflationary conditions. The adverse effects could be amplified considering that we are already in an environment where signs of inflationary pressures are building via fiscal stimulus, tightening labor markets, and wages. Policymakers could then be forced to raise rates at a quicker pace than currently projected, increasing the possibility that financial conditions materially tighten.

It is still too early to assume that a trade war will escalate dramatically from here, and recent developments may amount to no more than just noise. However, the administration’s decision to use national security as justification for tariff implementation in an effort to circumvent World Trade Organization rules opens the door for trade partners to retaliate under the same pretext. Indeed, rhetoric from key trading partners has become increasingly worrisome. China has stated that it “will make a justified and necessary response,” while the EU threatened retaliatory tariffs targeting a range of US consumer, agricultural, and steel products should the bloc face US import taxes.

Depending on how things unfold, trade disputes have the capacity to pose a material risk to financial markets. While it is not yet possible to pinpoint how populist or pragmatic the administration will be, and we do not currently assign a high probability that events play out in the most draconian fashion, we will be closely monitoring ongoing trade discussions to assess the economic impact of any changes in trade policy.