Why The Trade War Is Going To Get Worse Before It Gets Better

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by: William North
Summary

President Trump's recent tariff announcement caught many off guard, snapping the market back into reality.

The United State's Federal Reserve has proven it is willing to cut interest rates due to "economic uncertainty" caused by the trade war.

The Chinese are attempting to wait out President Trump's first term in hopes of a replacement with friendlier policies.

In the end, President Trump will likely raise the stakes as time progresses in an attempt to force the Chinese to the negotiating table.

The stock market received a shock back into reality on Thursday afternoon when President Trump tweeted that he will be adding a 10% Tariff on $300 Billion on Chinese goods starting September 1st, causing a swing of over 600 points lower in the Dow. The market had put the threat of a worsening trade war on the back burner as the S&P rallied to record highs, even with no material progress in the deal. The trade war narrative is likely to stick around for months, if not years, as there is little reason to believe that the trade war will be solved in the near future.

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American Ammunition: The Fed Put

I am not a big believer in coincidences, which is why I find it hard to believe that the tariff announcement on Thursday just so happened to occur the day after the Federal Reserve cut rates by 25 basis points versus the 50 basis points the President was hoping for. A main justification for the rate cut was due to "economic uncertainties", referring to the trade war. This gives President Trump the correct idea that going hard against China will lead the Fed to reward him by cutting rate. After the tariff announcement, traders instantly began pricing in the likelihood of two rate cuts by the year end, going along with President Trump's plan.

Additionally, President Trump has spent months creating the narrative that the Fed Chair he appointed, Jerome Powell, is harming the United States by not cutting rates fast enough. This creates a safety net politically for President Trump because if the Federal Reserve does not cut rates and the economy turns sour, he will just continue the narrative of blaming the Federal Reserve for any economic souring.

Chinese Ammunition: Time

"I think the biggest problem to a trade deal is China would love to wait and just hope" - Donald Trump

Each and every day that goes by, President Trump comes closer and closer to the end of his first term. Each and every day that goes by, President Xi's remaining term remains the same, indefinite. China has the ability to play the long game, whereas Trump's ability to negotiate will be limited, especially if he does not win a second term. If a Democratic challenger were to win over the Presidency, it is less likely he, or she, would go about trade the same as President Trump. Former Congressman Beto O'Rourke has "expressed concern over the long term impacts of tariffs", while Congresswoman Gillibrand "creates a trade war with China he's crushing our local farmers and it's making it impossible for them to make ends meet". Even front runner, Joe Biden, will likely take a different approach given the Obama's trade policies as Biden was Vice President. As a result, China has been quite slow in negotiating new trade terms with the United States.

Where does this leave us?

President Trump appears to be in the driver's seat at the moment with China just reacting to tariffs, rather than implementing them first. It is clear that President Trump has become fed up with the Chinese trade delegation, believing that they are just stalling in an attempt to wait for a new president that will likely go easier on China. In addition, the Federal Reserve has proven through its most recent rate cut that trade uncertainty is a valid reason to cut interest rates. As a result, President Trump will likely continue to ramp up the pressure more and more until the Chinese can no longer wait out President Trump's first in the hope of a more friendly replacement, supported by the fact President Trump has already discussed increasing the yet to be implemented tariffs from 10% to 25% in the upcoming future.

Why does this matter?

First, these tariffs are different than the others because they target many consumer goods that were previously shielded from tariffs. However, it is now expected that clothing, toys, and Apple's (NASDAQ:AAPL) iPhone will now be covered. That being said, the yuan has depreciated so rapidly and the Chinese do not appear to be defending it, meaning the currency depreciation will reduce the full blow the tariffs are meant to have.

Second, increasing uncertainty over the trade war could further discourage investment. Global businesses, especially those based in the US with manufacturing in China, are going to be very hesitant to invest large sums of money in either country because the trade landscape between the two countries is so cloudy. This is supported by US-China investment falling to a five-year low for the first six months of the year. Given that the hopes are dwindling, investment will continue to drop, harming businesses and GDP.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.