Global Economy Braces for a Fresh Trade Blow

(Bloomberg) --

The global economy, already forecast to post the weakest growth since the financial crisis, is bracing for a fresh blow with Donald Trump's latest threat to ratchet up his tariff war with China.

The U.S. president's abrupt announcement Thursday of 10% levies on $300 billion of Chinese goods -- expected to include smartphones, computers and clothing -- raises the risk of a global recession, testing the ability of central banks to prevent it with the limited monetary policy ammunition they have.

Read more: Trump Ratchets Up Trade War With New China Tariffs

Trump's threat came a week after the International Monetary Fund further lowered its global growth outlook and suggested that policy “missteps” on trade and Brexit could derail a projected rebound. And it was just one day after Federal Reserve Chairman Jerome Powell flagged tariff tensions as a reason for the central bank's first interest-rate cut in more than a decade, mentioning the word “trade” more than two dozen times during his news conference.

“The trade war between the U.S. and China is going to lead to slower growth in both of them,” said Jay Bryson, acting chief economist at Wells Fargo & Co. “You get a little bit concerned because central banks around the world generally don't have as much conventional ammunition to respond to a big slowdown as they did in other sorts of cycles.”

Treasury yields plummeted Thursday on the trade news, while U.S. stocks headed for their biggest weekly drop since May. The dollar extended losses.

After Trump's tweets announcing the new tariffs, the president told reporters that the 10% levy “is for a short-term period and then I can always do much more or I can do less depending on what happens with respect to a deal.” The tariffs could eventually rise to 25% or even higher, he said.

What Our Economists Say

“An escalation of the U.S.–China trade war piles downward pressure onto an already-slowing global economy and raises the chances of further monetary stimulus. If higher tariffs go into effect, chilling business confidence and hobbling market sentiment, we'd anticipate a further 75 basis points in rate cuts from the Fed by year-end, with the People's Bank of China moving in the same direction.”
-- Tom Orlik and Carl Riccadonna, economists
Click here to read the full note.

Hours before Trump's comments, IMF acting chief David Lipton told CNBC that the global economy is “fragile” and that “it makes sense for the central banks of the world to remain accommodative.”

Morgan Stanley analysts said in a note that a U.S. recession is likely within three quarters if the planned 10% tariffs on $300 billion of goods increase to 25% and remain for four to six months. That's because about two-thirds of the merchandise consists of consumer goods and autos and parts, which have the potential for greater economic impact than the prior U.S. levies.

“This raises the risk of a recession in the U.S.,” said Ryan Sweet, head of monetary-policy research at Moody's Analytics Inc. “Consumer confidence is still high but business confidence has really fallen sharply since trade tensions have escalated. Trade uncertainty is on top of businesses' mind. I'm more and more concerned you will start to see businesses cut back on workers.”

Trump's announcement came just before the Labor Department's payrolls report Friday, which is forecast to show job gains moderated to a still-solid 165,000 in July from 224,000 as the unemployment rate declined back to a half-century low of 3.6%. The payroll forecast echoes expectations for a gradual deceleration in the labor market, rather than a sharp decline.

Read more: U.S. Jobs Report to Offer Litmus Test for Fed

“While the direct impact of these tariffs (if imposed) will be modest, they have the potential to hurt global growth more substantially through a negative impact on already weak business sentiment,” JPMorgan Chase & Co. analysts Joseph Lupton and Olya Borichevska said in a note.

Key to the global growth outlook will be the reaction of major central banks. Deutsche Bank Securities Chief U.S. Economist Matthew Luzzetti and his colleagues said in a note that Trump's move increases the chances that the Fed will reduce rates by a half point next month.

The president's announcement “tilts the risks toward deeper cuts” in interest rates by the Fed, Goldman Sachs Group Inc. economists led by Jan Hatzius said in note.

The European Central Bank last week set the stage for another round of monetary stimulus in September to combat the euro area's severe slowdown, while Governor Haruhiko Kuroda said Tuesday that the Bank of Japan will consider more stimulus to prevent risks from materializing.

“The world is in a weaker position to combat recession because monetary policy space has been used, fiscal policy has been used,” Lipton said. “It would be more difficult to cope with recession so it's best not to cause one.”

--With assistance from Steve Matthews.

To contact the reporters on this story: Reade Pickert in Washington at epickert@bloomberg.net;Rich Miller in Washington at rmiller28@bloomberg.net

To contact the editors responsible for this story: Scott Lanman at slanman@bloomberg.net, Jeff Kearns

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