After Tariffs on More Imports from China Finalized; We see Further Escalation Seems Likely

The White House has proposed a lower tariff rate than we expected (10% vs 20-25% expected) but those tariffs would apply almost immediately to a larger amount of imports than we expected (roughly $180-190bn). This should boost core PCE inflation by 3bps at a 10% rate, and by a cumulative 8bps if the rate steps up to 25% at the start of 2019.

The Trump Administration has released the final version of the $200bn in imports from China that it plans to subject to additional tariffs. Tariffs will initially take effect at 10% on those products but are scheduled to increase to 25% on January 1, 2019. In its initial phase, this is a less restrictive outcome than the roughly 20-25% average tariff rate we had assumed.

By contrast, the amount of imports subject to immediate tariffs is greater than we assumed. We had expected that the Administration would revise the list and that a portion of it would be implemented in a later stage. Instead, the list is mostly unchanged and we estimate that $180-190bn of imports (2017 levels) will be subject to tariff in one round starting September 24.

Overall, we expect that the initial 10% tariff on this list should boost core PCE inflation by roughly 3bp (yoy), and by a cumulative 8bp if the rate steps up to 25%. We expect the effect on real GDP growth in the US to be very modest as well.

Of the over 6000 items on the initial list, the Administration removed about 300 in full or in part, amounting to about $10bn. The removals were widely distributed across sectors, and the composition of the final list closely resembles the initial list, with the shares of intermediate (48%), capital (30%), and consumer (22%) goods remaining roughly in line with those in the initial list. A full updated list of imports subject to tariffs is in the appendix.

The White House statement indicates that “if China takes retaliatory action” against farmers or other industries, the US “will immediately pursue phase three, which is tariffs on approximately $267 billion of additional imports.” In light of China’s previously announced plans to impose retaliatory tariffs on $60bn of imports from the US, we believe the US could announce plans to impose tariffs on “phase three” within the next couple of weeks. However, if the Administration follows a timeline similar to that of past tariffs, these tariffs would likely not be implemented until early next year.

In the interim, financial markets are likely to focus on the potential for an agreement between US and Chinese officials that could reverse these tariffs. We would not expect a resolution prior to the midterm election on November 6. Two potential milestones after the midterm election include a potential meeting between President Trump and Chinese President Xi at the G20 meeting scheduled November 30 and the potential escalation of US tariffs at the start of 2019.

While the situation is highly uncertain, at this stage we believe it is likely that the White House will propose an additional round of tariffs in the next few weeks and we believe there is a slightly greater than 50% chance that the tariffs will take effect in early 2019. Although there is a fair chance that US and Chinese officials will ultimately reach an agreement to reverse the tariffs, we believe reaching such an agreement this year will be a challenge.