Winds of Trade Dustup May yet Stir Inflation

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Special Guest Blogger: Tim Kearney

Right now, markets are digesting the realization that there may not be a quick resolution to the trade dispute with China — such expectations probably were over optimistic to begin with. That there won’t be a quick resolution appears to have become the mainstream view. As a result, the Dow Jones Industrial Average is off more than 1,000 points from its October highs. The question now is how to analyze the economic impact of a protracted dispute. There is some confusion over the impact on U.S. inflation: to get a bit technical, the price impact comes from the interplay of the China supply curve and the U.S. demand curve.

From the Chinese point of view, supply is pretty much set: whom else can they sell to? China’s first response has been to weaken its currency by about 3%; a modest drop that will help a bit. A second line of defense is for Chinese companies to let tariffs eat into their margins somewhat. From the U.S. point of view, consumer demand — especially in the short term — has plenty of alternatives to buying from China, such as other sellers or delaying purchases until there is some clarity about what is happening. Importantly, consumers still have income to put to work, and likely will look beyond Chinese products. Further, rather than fully pass higher costs along to consumers, the U.S. supply chain may absorb some of the tariffs.

That doesn’t mean there won’t be inflation from the tariffs we’ve seen thus far; it means that the inflation impact is likely to be somewhat muted on the first cut. I do not believe the Federal Reserve will move quickly to rescue the Trump administration from what appears to be a self-inflicted (though promised) problem. Nevertheless, the longer the disagreement continues, the more likely a rate cut becomes. Cutting rates, however, will require economic adjustments — in the form of higher prices through the trade channel or a markedly slower economy.

Please follow global trade on pages 46–48 of the Voya Global Perspectives book.

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