When the US kicked off 2018 by imposing tariffs on solar panels and washing machines, it was not expected the trade disputes would escalate into a full-fledged war. However, such optimistic sentiments in the market have dissipated since mid-June.
The escalation of the trade war has caused an abrupt fall across various stock markets, especially in China. Shanghai Composite fell nearly 8% after China retaliated to the US tariffs on $50 billion worth of Chinese products, which the Trump administration later escalated to be a $200 billion list. Emerging market currencies are also under huge depreciation pressure from capital outflows.
To help evaluate whether the market response is warranted or exaggerated, we measured the trade impact of additional import tariffs based on standard economic theory, namely two key parameters—the tariff pass-through rate and the price elasticity of demand.
On that basis, we estimate that, with the 25% of import tariffs, the expected increase in import tariffs could hover around 5%, while the reduction in import volume could reach 20%. This is equivalent to a net reduction of about 15% in import value, or a maximum loss of $5 billion (15% of $34 billion). Furthermore, the direct impact could even be smaller due to trade rerouting and substitution by third countries.
The New Normal: Reactive Markets