Stay calm and keep shopping
October 11, 2019
Focus Area—Canadian Economics
U.S. President Donald Trump’s trade war with China has increased the chances of the U.S. economy slipping into recession next year. This past summer, stalled negotiations led the president to announce that he would be hiking the existing tariffs on about $250 billion worth of Chinese imports from 25 to 30 per cent on October 1. He also threatened to slap new tariffs of 15 per cent on over $100 billion worth of consumer products from China, including smartphones and laptops, starting in December.
Still, despite the damaging trade war, our view is that the U.S. economy will avoid a recession next year, given that trade isn’t as large a component of overall economic growth for the U.S. as it is for many countries in Europe, Asia, and Latin America. Nonetheless, U.S. economic growth will be much weaker. Real GDP will grow by 2.3 per cent this year and 1.9 per cent in 2020 (see Chart 2), compared with an increase of just under 3 per cent in 2018.
Fortunately, trade tensions between the world’s two largest economies have eased slightly, and President Trump agreed to postpone further increases in tariffs on Chinese imports from October 1 to October 15 as a goodwill gesture in advance of the resumption of negotiations in the middle of October. This also supports our view that the United States won’t slip into recession any time soon. China also agreed to ramp up purchases of U.S. agricultural commodities. And the Chinese government proposed that the negotiations between the two parties focus only on trade issues so as to avoid some of the more contentious national security issues dealing with technology transfers. President Trump indicated that he is open to this idea.
The trade dispute between the two countries has already damaged the U.S. economy. Since tensions ramped up about a year ago, the escalating tariffs have shaved about 0.3 percentage points from real GDP and have led to a loss of around 300,000 jobs. The tariffs act as a tax increase on both businesses and households. To date, firms have borne the brunt of the higher tariffs, as most of the Chinese imports affected by the dispute have been on business inputs.
However, this could change in December if the latest negotiations stall once again and President Trump goes ahead with his threat to implement tariffs on imports of popular Chinese-made consumer goods. Retaliatory measures by the Chinese have also damaged the U.S. economy. These include a near ban on purchases of U.S. agricultural products and several administrative measures designed to stall the activities of U.S. companies operating in China. The rising value of the U.S. dollar has also hurt exporters.
The uncertainty caused by the trade battles is readily apparent in investment spending, which ground to a halt in the second quarter of this year. Firms are wondering what products will face a higher tariff in the months ahead and which countries President Trump will target next. Will the tariff be 15 per cent or will the president boost it even higher if a foreign leader angers him? Given these uncertainties, businesses are reluctant to ramp up investment spending until some clarity emerges. They are also holding off on hiring plans. This is especially true in industries, such as agriculture and transportation, that depend on a healthy global economy.
President Trump has attempted to cushion the economic difficulties caused by the tariffs by providing farmers with $16 billion in aid, but it is unclear how much of that is actually going to farmers hurt by retaliatory tariffs implemented by China. The Trump administration has also permitted companies hurt by tariffs to apply for exemptions, but to date the process has been slow and overly bureaucratic.
In response to the growing weakness in the economy, the U.S. Federal Reserve cut its federal funds rate to 2.0 per cent in July, down from 2.25 per cent. It was the first reduction in interest rates since 2008. In September, the Fed cut the rate by another 25 basis points, bringing it down to 1.75 per cent. With inflation running below the Fed’s 2.0 per cent target, monetary authorities say they are confident that lower rates will help the economy cope with the fallout from higher tariffs without increasing inflation.
We expect one more cut in the federal funds rate before the end of 2019. Not surprisingly, there is a high degree of uncertainty concerning the direction of monetary policy over the near term. If inflation starts to accelerate due to higher tariffs, the Fed could quickly reverse course and restart the process of running a less accommodative monetary policy. Of course, this would anger President Trump who has already called for the Fed to reduce interest rates to zero or even drop them into negative territory.
Report: World Outlook Economic Forecast: Autumn 2019
Principal Economist, Forecasting and analysis