Growing tensions between the U.S. and China could knock the nearly 40% rally in the U.S. stock market off course as billions of dollars of trade and supply chain ties hang in the balance, potentially compounding the harm inflicted by the coronavirus.
President Donald Trump in recent weeks has escalated his finger-pointing at Beijing for what he sees as its role in the spread of the coronavirus, threatening to impose tariffs or withdraw from the "phase one" trade agreement under which the U.S. agreed to roll back tariffs on Chinese goods in exchange for Beijing purchasing hundreds of billions of dollars of additional U.S. goods over the next two years. Most recently, the administration said it would bar Chinese airlines from flying to the U.S. starting in mid-June.
And China has not sat idly by. The Chinese government told two state-run agricultural companies to pause purchases of U.S. soybeans, pork and other farm goods after the White House accused China of a "cover-up" over the spread of the coronavirus and moves to end Hong Kong's special trade status as it no longer considers the territory autonomous from China. It also is far behind on its purchase commitments under the phase one deal.
"The economic ties that bind China and the U.S. together are coming under attack," Erik Lundh, senior economist for the Conference Board, said in an interview. "It loosens the cannon even more on the deck. I'm fairly pessimistic on the relationship over the coming months."
If more tariffs are piled on, the impact on U.S. businesses and consumers could prompt a correction in equity markets, James Knightley, chief international economist for ING Economics, said in an interview and a follow-up email.
"If we see trade tensions escalate and tariffs hiked, then I think it could easily knock 5 to 10% off equities, given corporate America is already facing immense upheaval given the economic consequences of COVID-19," Knightley said. "There is already a disconnection between equities (back at levels of last November) and an economy that is likely to have experienced the steepest peak-to-trough fall in output since World War II. Trade tariffs could be the catalyst for a reappraisal of this." The S&P 500 rallied by 39.6% as of June 3 since its coronavirus-era trough March 23.
Before the coronavirus became recognized as a pandemic, U.S.-China trade tensions were a major driver of markets since 2018, with news of dealmaking spurring modest gains but word of tariff escalation preceding steep falls. On Aug. 23, 2019, after Trump threatened to raise tariffs to 30% from 25% on $250 billion of Chinese goods in a little over a month, the S&P 500 fell 2.59%. When the phase one deal was announced in December 2019, stocks instantly rallied, though the gains fizzled out later in the day.
Beth Ann Bovino, U.S. chief economist for S&P Global Ratings, agreed that a setback in the U.S.-China trade relationship could damage markets' outlook for an economic recovery in the short term.
"The re-escalation of trade tensions between the U.S. and China will heighten market concerns that tit-for-tat protectionist actions will once again heat up," Bovino said in an interview. "This adds even more uncertainty to an already slow economic recovery, something markets don’t want to see."
Cost of tariffs
Even with the phase one deal, those economic ties were already fraying before the recent back-and-forth. In 2019, after several rounds of tariffs from both sides, total trade between the countries declined by $100 billion, to $558.87 billion, from 2018's peak, according to Census Bureau data. Purchases of Chinese goods, which amounted to 11.9% of U.S. consumption in 2018, fell to 9.5% in 2019 as tariffs made those goods more expensive.
"When you are attempting to get the economy back on its feet, you want all areas of spending to be strengthening," said Jay Bryson, managing director and acting chief economist at Wells Fargo Securities. "Something that exerts headwinds on growth at this time would be counterproductive to that objective."
Additional tariffs could further the push for labor-intensive production to move from China to South and Southeast Asia and sub-Saharan Africa as manufacturing global value chains are under enormous pressure and sourcing is at a premium. Picking up and moving supply chains would drive up costs for importers at a time when U.S. manufacturing and production is stressed after a 13.7% month-over-month fall in April.
The U.S. tariffs of 2018-2019 that were levied on Chinese goods added $52.9 billion in annual cost burdens to U.S. consumers, according to a report from the American Action Forum, a self-described "center-right" economic think tank led by former Congressional Budget Office Director Douglas Holtz-Eakin.
But not all are concerned.
Because the U.S. is importing less from China due to the virus, the administration has the latitude to raise tariffs with more minimal impact, Clete Willems, a partner at law firm Akin Gump and former deputy director of the National Economic Council in the Trump administration, said in an interview. When the economy is strong, it can to some degree absorb the price cost. It's the middle zone where concern grows, he said.
"Most folks nervous about the economic impact would argue in favor of raising the existing tariffs as opposed to new product tariffs," Willems said. "We're in a situation where we have a global economic slowdown and a lot less commerce between the U.S. and China at the moment, and the impact of tariffs is less than it otherwise would have been. If we're not buying that many iPhones right now, it's not that big of a deal."
Harm to US exporters
A withdrawal from the phase one deal — over which Trump said he was "very torn" in early May — would mean further sourcing troubles for industries already reeling from reduced demand and upended supply chains that were supposed to see relief from Beijing's promise to more than double its imports of a basket of 548 U.S. goods. In the first three months of 2020, China was already $21 billion off the pace needed to hit its commitments under phase one, according to Panjiva.
And China's reported order to state-run companies to halt farm purchases will only further muddy the waters for agriculture exporters caught in the crosshairs of the various U.S. trade conflicts. The U.S. Trade Representative's Office and White House did not immediately return requests for comment.
The deal's chapters on approvals of varieties of genetically modified organisms; establishment of a process to approve sanitary regulation issues with poultry, meat and dairy; and other non-tariff barriers were widely seen as a win for U.S. companies.
"It would be a huge mistake to terminate the agreement," Joe Glauber, senior research fellow for the International Food Policy Research Institute and the former chief U.S. economist for the U.S. Department of Agriculture, said in an interview, adding a withdrawal could mean "volatility" for the farm sector. "There are parts that are quite important to U.S. agriculture and most importantly, it marks a cease-fire in the destructive trade war which has been so damaging to U.S. agriculture."
The American Action Forum says that the phase one deal would have saved U.S. consumers $43.4 billion per year, though that analysis assumed that Chinese purchases would meet commitments.
Panjiva is a business line of S&P Global Market Intelligence, a division of S&P Global Inc.