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Currency

Increased threat of a trade war is ramping up fears of a 'full-blown recession'

Even as growth ramps up to what could be the fastest rate since before the financial crisis, economists are worried that a trade war could tip the U.S. into a significant slowdown or even a recession.

Fears over a GDP pullback comes as President Donald Trump threatens another more severe round of tariffs aimed both at China and the European Union.

Specifically, the worry is that the duties could spark a larger global trade war that triggers inflation and kills U.S. growth just as it appears to be accelerating out of its post-crisis malaise.

“Our calculations suggest that a major trade war would lead to a significant reduction in growth,” Michelle Meyer, U.S. economist at Bank of America Merrill Lynch, said in a note. “A decline in confidence and supply chain disruptions could amplify the trade shock, leading to an outright recession. We continue to believe that the probability of a full blown trade war is low but the risks are rising and it remains a key uncertainty to our outlook.”

On the same day Meyer and her team released the report, Trump amped up the rhetoric another notch by threatening to hit European auto imports with a 20 percent tariff unless the EU relents on duties it imposes on American vehicles.

That threat comes on top of a presidential directive to the U.S. trade representative to find another $200 billion of Chinese goods for tariffs following a previous list of $50 billion worth. China has vowed that it will match the U.S. tariffs dollar for dollar.

Economists view the actual damage as limited in dollar terms, being only a small part of the total trade between the U.S. and its partners and the overall size of the domestic economy.

However, the concern is that the current parrying continues into a perpetual round of threats and retaliations that wrecks consumer and business confidence — both of which are around record highs — and provides a cost shock that could tip the economy into at least a brief recession.

“The good news is that we are still many steps away from a full blown global trade war,” Meyer wrote. “The bad news is that the tail risks are rising and our work and the literature suggest a major global trade confrontation would likely push the US and the rest of the world to the brink of a recession.”

To be sure, current data suggest that the trade situation would have to get extreme to send the economy into negative growth.

The Federal Reserve projects the economy to grow 2.8 percent for all of 2018, though it looks for GDP to slow to 2.4 percent in 2019 and 2 percent the year after before settling into a 1.8 percent longer-run rate. The Atlanta Fed is tracking second-quarter growth at 4.7 percent. Unemployment at 3.8 percent is also running at a generational low.

A baseline trade-war scenario would shave from GDP 0.3 percentage points to 0.4 percentage points in the first year then 0.5 percentage points to 0.6 percentage points in the second year — significant, but not recessionary, according to BofAML.

Still, the impact would slow much of the momentum the economy has seen during the Trump tenure.

The trade war scenario “suggests that the boost to growth expected from fiscal stimulus (e.g. tax cuts and greater federal government spending) will essentially be offset by the negative trade shock,” Meyer said.

In a more extreme scenario, though, an industrial production slowdown and an “uncertainty shock” could take hold and cause more damage.

“Combined with a tariff shock, we see a high probability that a major trade war would push the economy towards a full blown recession,” Meyer wrote.

BofAML is not the only firm worrying about more substantial impacts from what are now trade skirmishes.

Capital Economics said an uncertain future for the U.S. economy is being complicated by the back-and-forth battles.

“Trade tensions have escalated faster and further than we had originally anticipated,” Michael Pearce, the forecasting firm’s senior U.S. economist, said in a note. “We still think that protectionism alone is unlikely to kill the economic expansion. But it could worsen the slowdown we anticipate next year, and add to the domestic inflationary pressures that are already building.”

There are other issues at play, particularly when it comes to China.

Carried to the extreme, China would be unable to match the U.S. tit-far-tat as it exports much more than it imports in American goods. The nation then could seek a variety of other retaliatory measures, such as actions targeted at U.S. companies operating in China, currency devaluation or by dumping some of the $1.18 trillion in Treasurys it owns.

“With the China tariffs set to be introduced in two weeks’ time, we expect the trade rhetoric to remain intense,” Pearce said.

WATCH: Trump threatens auto tariffs against Europe.

Source: cnbc economy
Increased threat of a trade war is ramping up fears of a 'full-blown recession'

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