Trade Tensions Are Likely to Rise Further

Trade tensions have risen over the last several days, as the US has begun to move forward with a first round of tariffs on imports from China and announced the potential for up to $400 billion in additional imports that might be targeted with tariffs if China retaliates.

At this point, we believe the first round of tariffs is likely to be implemented as planned on July 6. While a formal round of negotiations between US and Chinese officials has not been scheduled prior to this deadline, it remains a possibility. However, even if negotiations take place, it is not clear what agreement could be reached in the near term that would prevent tariffs from taking effect.

We believe the odds of implementation of the proposed 10% tariffs on an additional $200bn of imports from China are lower, for two reasons. First, if the White House wants to respond to Chinese tariffs, there are intermediate steps available like imposing tariffs on the additional $16bn list published June 15. Second, we expect the political costs of tariffs to increase as the amount of imports subject to the new tariffs grows. We attempt to replicate the process USTR would use to create the next $200bn list of imports subject to tariffs, and find that the share of consumer-focused goods would rise, and the ability to substitute imports from other countries would fall, compared with the first round.

That said, a lower tariff rate on a larger amount makes the proposed tariffs somewhat more credible than the prior proposal. More importantly, in order for proposed tariffs to be useful in a negotiating strategy, trading partners must believe the risk is real. We do not expect the Trump Administration to be able to convince trading partners these proposals are real without also convincing financial markets. If so, it seems likely that trade concerns could rise further over the next few months.