Throughout the month of May, tensions escalated between China and the United States regarding trade between the two global economic superpowers. After negotiations broke down early in the month, President Trump announced that the U.S. would be raising tariffs from 10% to 25% on $200 billion worth of Chinese imports. Trump added that U.S.-applied tariffs on Chinese goods entering the country could “go up very, very substantially, very easily,” as his administration is currently considering applying a 25% tariff to the remaining $300 billion of Chinese imports that is currently tariff-free. In retaliation, China announced an increase of tariffs on $60 billion of U.S. goods that too effect on June 1.
Markets remain hopeful that the two nations will come to a comprehensive trade agreement that will eliminate these tariffs and allow products to move freely across borders, but the risk remains that the situation continues to escalate into a full-blown trade war. While economists’ opinions differ on the magnitude of the effects of such an outcome, virtually all agree that the effects will be negative. The Organization for Economic Cooperation and Development estimates that further escalation would decrease global growth by 0.7% by 2021, and Morgan Stanley analysts opine that if the U.S. imposes tariffs on the remaining $300 billion of Chinese goods, the domestic economy would be heading towards recession.
We believe that the risk of further escalation between the U.S. and China is the single biggest risk in the financial markets right now, as both sides continue to “dig in their heels.” In response to this risk, we are advising our clients to shift to a more conservative posture, generally reducing portfolio allocations to global equities and higher-risk fixed income while building positions in short-term, investment-grade fixed income and cash.
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