Natixis - Is the market overreacting to the US-China trade war? Yes if only focusing on trade measures

Author: Judith Huismans

 

  • On July 6th, the US-China trade war fired the first round of tangible bullets on $34 billion worth of imports both from US and China sides. The financial market had been snubbing the risk of a trade war at the beginning, but such optimistic sentiment has dissipated since mid-June 2018. The escalation of the trade war has caused an abrupt fall across various stock markets, especially in China. Emerging market currencies are also under huge depreciation pressure from capital outflows.

 

  • To help evaluate whether the market response is warranted or exaggerated, this note aims at measuring the trade impact of additional import tariffs based on standard economic theory, namely two key parameters − the tariff pass-through rate and the price elasticity of demand.

 

  • On that basis, we estimate that, with the 25% of import tariffs, the expected increase in import tariffs could hover around 5% while the reduction in import volume could reach 20%. This is equivalent to a net reduction of about 15% in import value, or a maximum loss of $5 billion (15% of $34 billion). Furthermore, the direct impact could even be smaller due to trade rerouting and substitution by third countries.

 

  • While the direct impact seems small, one should not forget that financial markets react to expectations of an additional escalation of a trade war, let alone a full-fledged technology arm race, which would bring even more uncertainties to the world.

 

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