Are Trade Wars Deflationary Or Inflationary: Here Is The Answer

When it comes to trade wars, such as the tit-for-tat escalation currently being waged between the Trump administration and the rest of the world, one burning question that investors have to answer is whether the outcome of such a trade feud will be inflationary - in the form of rising consumer costs as import prices rise as corporations pass on tariffs costs to end buyers - or deflationary - as the impact of escalating tariffs eventually results in a broader economic slowdown: the answer will determine not only capital allocation and monetary policy decisions but would have sweeping economic consequences across the globe. 

Now, thanks to an analysis by SocGen, we have an answer: it depends, or rather "Inflationary short term, disinflationary medium term."

To approach the problem, SocGen parsed the newsflow for keywords that are associated with inflation and linked with “trade war”-related keywords, and repeat the same exercise for disinflation/deflation.

Since March 2018, the French bank observed that the “trade war” newsflow linked to inflationary and disinflationary scenarios has been growing. This highlights the nuanced impact of the trade wars, which SocGen "expects to be inflationary in the short term, and disinflationary in the medium term."

And while there is a temporal aspect, as of late SocGen has found that the deflationary impact of the trade war has been dominating. Here's why:

The escalating tariffs war between the US and the rest of the world is disrupting global supply chains and increasing the cost of imported goods in the short term. However, it could also spell the end of the reflation story that has supported the markets since February 2016. In fact, the global growth re-synchronisation story, driven by the recovery of Europe in 2017, has already been delayed.

One place where the immediate adverse, and thus deflationary, impact of trade war is clearly visible is the decoupling of growth stories is clearly visible in the degree of underperformance of EM equities (impacted by strong outflows from EM assets) versus Nasdaq 100, both of which are generally used to leverage growth expectations.

But the clearest take on whether trade wars result in higher or lower prices, is in the bond market itself, where concerns over the growth outlook are reflected in the relative performance of long vs short duration assets. And it is here that the outperformance of long-duration sectors (defensive) versus short-duration sectors (cyclical) has been observed across the board. However, SocGen concedes, the negative sentiment could be overdone, and if pushed enough, inflation could persist longer than expected.

Ultimately, the market outcome of the trade war will be determined by China, whose economy is already slowing and where recent policy easing has indicated that Beijing is shifting its posture to one where it intends to support its economy. This is perhaps also why despite the gathering storm clouds, SocGen remains somewhat optimistic on Emerging Markets, even as the bank keeps its "overweight" rating on 10Y Treasuries:

From an asset allocation standpoint, we remain cautious but constructive on EM equities. We keep our overweight position on US Treasuries and continue to expect the 10y yield to remain strongly anchored at the 3% level in a late-stage cycle dynamic where the 10yT is increasingly contingent on neutral rate expectations. Medium term, we believe EM equities should benefit from their yield-enhancing status, as China will continue to play the role of anchor, in an environment of further monetary policy tightening in developed markets.

Of course, it's not that simple because while China has ample opportunity to further cut the RRR, or the main rate, or to ease via various short and medium-term lending facilities, or by unleashing another credit-fueled stimulus as it did in early 2016, any aggressive intervention in the economy, especially if it results in the yuan falling further, will lead to accusations of interference by the US, which then in a feedback loop could lead to even further trade war escalation, resulting in even greater slowdown.

Comments

GoldmanSax Thu, 07/12/2018 - 13:24 Permalink

Trade wars are a race to give govt. more money. Free trade means no govt. restriction on trade. Doctors in the US enjoy govt protection of their monopolies on health services. I want access to 3rd world doctors and medicines. We have to compete with 3rd world and so should doctors. 

hxc JibjeResearch Thu, 07/12/2018 - 14:54 Permalink

In fact, Jefferson believed we would eventually not even need that tiny govt. He thought capitalism/technology combined with humans maturing would eventually lead to what we now call market anarchism or "anarcho-capitalism," like an inverse karl marx (TJ was intelligent, hardworking, and a good person, to further bolster my point).

That being said, we are not a big govt country in a sea of libertarian countries, but a big govt country in a sea of even crazier govt countries.

In reply to by JibjeResearch

666D Chess Thu, 07/12/2018 - 13:32 Permalink

It doesn't matter whether trade wars are inflationary or deflationary, anything is bullish for stocks. The entire thing is 100% rigged. The USA has a professional conman in the White House. 

camel717 Thu, 07/12/2018 - 13:35 Permalink

"They're the worst thing that could ever happen to our country! We love being financially raped by the rest of the world because it's our duty to run the world's economy even if it sets us back!" - Liberals

nsurf9 Thu, 07/12/2018 - 13:52 Permalink

Are Trade Wars Deflationary Or Inflationary: Here Is The Answer

NASDAQ Composite hits 7817.51 and makes another new world record, new higher than high, higher highs and punches though the 5th dimension of all time higher than highest high resistance.

. . . during trade war.

mosfet Thu, 07/12/2018 - 13:59 Permalink

Every time you hear the word tariff just substitute the word tax, cause that's all is it. 

Real Americans are getting a major stealth tax hike with tariffs (more inflation), after a token tax cut earlier in the year that only resulted in larger corporate buybacks (even more asset inflation w/o wage increases).

From the article,

True: "disrupting global supply chains and increasing the cost of imported goods"

Meaningless BS: "it could also spell the end of the reflation story"

NAchodwarf Thu, 07/12/2018 - 14:03 Permalink

Listen up bitches...its a tax. A very clever tax to replace the lost income from the corporate tax rate and the tax give back to the plebs. It's also a distraction to keep peoples eyes off the rising debt, failing economy and inflationary spiral were entering. But more taxes are coming my 4:20 hoes

Keep a weather eye out on the treasury auctions and any signs of treasury dumping. Oh did Russia dump 1/2 of there treasuries in May? My bad.

 

Winter is coming. Read up on Zimbabwe, or you'll be Powels bitch fo'shizzel 

Vendetta Thu, 07/12/2018 - 14:54 Permalink

Trade is supposed to be about importing what one cannot build themselves due to lack of know how or not having the natural resources to build or produce.  

The current rendition of so called free trade is exploiting labor globally and selling into markets that greater ability to actually afford the products at the price chosen to sell at. Exploiting both the consumer and labor.

whomever believes it is merely a scheme to increase govt revenues (though it will temporarily) has been misinformed by whomever their sources of information are.  Tariffs make it uneconomical to produce outside the borders of a country if the tariffs are high enough to offset the cost advantage of dirt cheap labor and indifferent foreign governments to corporate abuses of all sorts

Jack's Raging … Vendetta Thu, 07/12/2018 - 15:18 Permalink

Tariffs are a State's attempt to keep producers on their tax farm and under their thumb, rather than someone else's. Also, they are frequently invoked by persons who would rather disadvantage someone else, rather than improve their own competitiveness.

In the 20th century, the markets of the USA became far from free. After WWII, the advantage was still maintained for a few decades due to to the legacy of disproportionate and extraordinary technological advancements in the USA, as well as the rest of the modern world reduced to rubble. Neither of those conditions exist today. They will never return until we have honest money. No tariff nor trade policy will be able to restore the US economy while the USA holds fiat reserve currency status.

In reply to by Vendetta

truthalwayswinsout Thu, 07/12/2018 - 16:05 Permalink

Where do people make this stuff up?

There is only one thing that causes deflation and that is debt destruction. When you have debt destruction you have deflation.

We have massive debt destruction right now and we are in a deflation the likes of which we will not see again for a hundred years.

The only thing stopping it from taking effect is China and the 10,000's of Ponzi schemes it is juggling.

Leguran Thu, 07/12/2018 - 17:10 Permalink

Isn't the word for this situation  STAGFLATION. The Johnson-Carter type of economic malaise. Remember Gerald Ford's Whip Inflation Now (WIN) buttons and nonsense. We have had the good times from monetary expansion. Now comes the bad times as everything gets evened out (revision to the mean, normalized, etc.) in the economy.