Trump's trade moves put his favorite economic report card at risk

President Donald Trump appears determined to make sweeping changes to America’s trade agreements.

And an escalation in trade tensions, or perhaps the outbreak of a trade war, imperils the stock market rally that the administration has said is a “report card” for its economic initiatives and that has been one of Trump’s favorite brags during his time in office.

On Thursday, the stock market got slammed with the Dow losing more than 700 points and the benchmark S&P 500 dropping 2.5% in a broad-based sell-off.

Most market observers pointed to the Trump administration’s plan to impose tariffs on $50 billion worth of Chinese imports as the proximate cause of this market stress. China imposed additional duties on $3 billion of U.S. imports on Friday in response.

Since Trump’s election, the Dow has risen 27% while the S&P 500 is up 25%. Both indexes, however, are now in the red for the year following Thursday’s sell-off.

“Protectionism will cut against the benefits of the recently enacted Tax Cut and Jobs Act,” said Michael Gapen, U.S. economist at Barclays.

“Anti-trade policies, particularly tariffs, act like a tax on consumers and business by raising the cost of trade,” Gapen adds. “By creating uncertainty, they also weigh on asset valuations, which could weaken households’ ability to sustain spending, and they likely reduce the incentive for business to invest. The initial reaction of US equity markets, which fell about 2.5% following the announcement, is consistent with this view and not surprising.” (Emphasis ours.)

Yet whether these policies result in a full-out trade war between the U.S., China, and other global trading partners or serve as just a blip which stresses markets for a few days remains uncertain.

Greg Valliere, chief global strategist at Horizon Investments, said Friday that, “The media loves an eye-catching headline so hype about a ‘trade war’ is good for ratings and subscriptions.

“But [Thursday’s] action strikes us as relatively mild, setting the stage for talks that could save face for all involved – especially for Donald Trump, who wants splashy victories but often retreats as the fine print emerges.” (Emphasis ours.)

Tariffs on steel imports announced by Trump earlier this month, for instance, are now suspended for a number of trading partners including Canada, Mexico, and the European Union until at least May. Additionally, economists do not see Trump’s trade plans or a reaction from the Chinese as the beginning of a trade war or a development that will likely impact the overall positive outlook for the U.S. economy.

“We will say again…that we do not believe trade wars will materialize,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets.

“Moreover, this tit-for-tat on tariffs which we believe will punctuate the backdrop through the near-term is unlikely to have a material impact on US economic activity. Needless to say, prudence demands that we all watch this closely. But if we take a step back from this political noise here is a fundamental truth: the US economic backdrop remains in very fine shape.”

Direct impacts to GDP data from action on trade, however, may not satisfy financial markets which have been far more volatile in 2018 and are clearly expressing unease about the current political environment.

“We would argue that the standard procedure of tracing through higher import prices to lower corporate margins or real incomes of households [due to tariffs] is of limited value,” said Gapen.

“The indirect effects are what really matter, including the likely Chinese response and any adverse effects that increased uncertainty may have on business investment and hiring plans.”

In 2017, markets had both solid economic data and the anticipation of earnings-boosting corporate tax cuts to lean on. In 2018, the present situation for earnings and the economy remains solid, but it is the future that appears to be holding investors back.

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Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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