Morgan Stanley: Recession within a year if trade war gets any worse

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NEW YORK: Investors may still be underestimating the full risk to the global economy from a trade war, even after US stocks capped the worst month of the year.

A recession could begin in as soon as nine months if President Donald Trump pushes to impose 25% tariffs on an additional US$300bil of Chinese exports and China retaliates with its own countermeasures, according to Chetan Ahya, chief economist and global head of economics at Morgan Stanley.

"My recent conversations with investors have reinforced the sense that markets are underestimating the impact of trade tensions," Ahya wrote in a note. 

"Investors are generally of the view that the trade dispute could drag on for longer, but they appear to be overlooking its potential impact on the global macro outlook."

The rift between the Trump administration and China has escalated as each side blames the other for the breakdown in talks. Over the weekend, Trump celebrated his trade policies and the recent move to impose tariffs on Mexican goods in response to illegal immigration. 

Trade tensions between the US and European Union are also simmering.

China issued a White Paper on Sunday that said the escalating trade war between the world’s two largest economies hasn’t "made America great again.” 

Instead, the paper argued that Trump’s trade policies have hurt the US economy by increasing production costs, causing prices hikes, damaging growth and people’s livelihoods and creating barriers to US exports to China.

"It is foreseeable that the latest US tariff hikes on China, far from resolving issues, will only make things worse for all sides,” according to the white paper.

Those comments came as both governments escalate their dispute by imposing higher tariffs and threatening each other’s companies. So far, there’s no sign that either side is looking to de-escalate or resume negotiations.

While stocks have declined, investors are still overlooking the impact the trade war will have on the global macroeconomic outlook, Ahya wrote in a note on Sunday. 

Growth will suffer as costs increase, customer demand slows, and companies reduce capital spending, he said.

As the negative effects of the tariffs become more apparent, it may be too late for political action, according to Ahya. Policies to ease the impact are likely to be too reactive and slow to take effect.

"With the latest developments suggesting that trade escalation is still in play, the impact of trade tensions on the global cycle should not be underestimated," Ahya wrote. – Bloomberg