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Outlook for US Economy Worsens as China Trade War Persists

Trade tensions and expectations of substantial tariff increases on imports from China are taking their toll on the U.S. and global economies, according to the June “Forecast Flash” from Global Insight by IHS Markit.

U.S. gross domestic product (GDP) growth is projected to slow to 1.5 percent in the second quarter, and average 1.8 percent through the second half of 2019–several tenths of a percentage point below last month’s forecast, said IHS Markit chief economist Nariman Behravesh and Sara Johnson, executive director of global economics.

First-quarter real GDP growth was reported at 3.1 percent in the U.S. Commerce Department’s second estimate, revised down 0.1 percent from the advance estimate.

“The markdown to near-term growth reflects a soft tone to the incoming data, as well as trade tensions and less-supportive financial conditions,” Behravesh and Johnson said. “This forecast includes the step-up in the tariff rate on imports from China indefinitely. Following 2.5 percent annual growth in real GDP in 2019, we look for 1.8 percent growth in 2020 and 1.7 percent in 2021.”

The economic forecast noted a “whipsaw” effect owed to trade conflicts between the U.S. and China that saw the Trump administration increase tariffs to 25 percent from 10 percent on $200 billion of Chinese exports to the U.S., not to mention threats to add more, including apparel and footwear. The administration also banned U.S. companies from doing business with Chinese telecom company Huawei.

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In retaliation, China announced increased tariffs on $60 billion of U.S. exports, suspended soybean purchases, threatened to cut off exports of rare-earth metals to the U.S. and announced “major actions” against U.S. high-tech firms. Meanwhile, the White House removed tariffs on Canadian and Mexican steel and aluminum exports to expedite passage of the U.S.-Mexico-Canada Agreement. This was immediately put in flux when President Trump announced new tariffs on Mexico and then suspended them in an attempt to force the Mexican government to better control illegal immigration into the U.S.

IHS Markit estimated that the announced trade actions, before retaliation and escalation, will further erode near-term global growth at least 0.2 percent to 0.3 percent.

As for China’s economy, IHS said the impact of the U.S.-China trade re-escalation on the country growth “will be noticeable, but not devastating.” The direct impact of a 25 percent tariff on $200 billion of Chinese goods will shave China’s economic growth about 0.3 percentage points over a year, the economists predicted.

“Moreover, the tariffs’ impact on China could be more limited, as a significant share of China’s exports is in processing trade–assembling imported components and re-exporting to final markets,” they said. “IHS Markit now predicts real GDP growth to be 6.2 percent in 2019, 5.9 percent in 2020 and 5.8 percent in 2021. Our forecast is based on the tariffs currently in place, not threatened tariffs. In response to higher tariffs, the government will most likely ramp up stimulus measures more aggressively to support economic growth.”

If the U.S. imposes further tariffs, China’s growth rate could be cut as much as 0.7 percent, the analysis noted.

“While all this is going on, there are signs of further softness in China’s economy and of rising financial stress, especially among small banks,” according to the economists.

In Europe, “the political terrain just got a lot rougher,” IHS said. The recent European parliamentary elections have worsened political fragmentation. Center-left and center-right parties lost support, whereas populists gained ground in some countries like Italy and Greens gained in places such as Germany.

“Against slowing global growth and simmering trade tensions with the United States, this change in the political landscape warrants cautious economic outlooks for the Eurozone and UK,” the economists said.

Among emerging markets, IHS said despite a few exceptions, the outlook “has deteriorated.” Argentina, Brazil and Mexico had real GDP contractions in the first quarter, with some of relation to weakening global growth, especially China. Some of it was also driven by the expanding trade wars.

“The U.S.-China conflict alone is devastating supply chains throughout Asia, although some countries, such as Vietnam, may benefit from trade diversion away from China,” the forecast said. “The recent announcements and revocations of tariffs against Mexico, and the elimination of duty-free exports from India by removing its developing-nation designation have added fuel to the fire. In response to this direct and collateral damage, IHS Markit has lowered the forecasts for many emerging markets in the past two months.”