Will Trump’s trade war cause a global recession?
Summary
Investors are worried. At least the economy is starting from a position of strengthIN ITS SCOPE and severity, the trade war took markets by surprise. On April 3rd, the day after President Donald Trump laid out an unprecedented array of tariffs, the Russell 3000, one of the broadest measures of the American stockmarket, fell by 5%. It then fell by 6% on April 4th, when China announced that it would strike back with a duty of 34% on all American goods. Market pricing in a range of asset classes tells a worrying story: investors are expecting a severe economic slowdown.
Gold has fallen in recent days and the dollar has weakened—the opposite of what normally happens in times of trouble. But elsewhere things are almost unanimously gloomy. Oil has sold off, with the price of a barrel of Brent crude falling from $75 to $66, as has copper. In many countries bank stocks have tumbled; a bad sign, since financial firms are particularly exposed to the economic cycle. Boutique investment banks, which make money from mergers and acquisitions, have done especially badly. Klarna, Medline and Stubhub, three private firms that had hoped to list on public exchanges, have delayed their offerings. The VIX, a measure of stockmarket volatility, has jumped. Bank analysts are busy raising their estimates of the likelihood of a global recession this year. JPMorgan Chase now puts the chances at 60%.
There are also more precise measures of investors’ expectations for global growth. One is to compare “defensive" stocks and “cyclical" ones. Defensive stocks, comprising companies such as consumer staples and utilities, are not so exposed to the economic cycle, since the weekly supermarket shop is the last thing people cut back on. By contrast, cyclical stocks, such as airlines and carmakers, depend greatly on animal spirits. In the past week global cyclicals have underperformed global defensives by eight percentage points—the biggest gap since the beginning of the covid-19 lockdowns in 2020. Our analysis suggests that these price movements are consistent with a mild global recession.
Price movements in American markets are the most severe, but not by much. Over the past month the MSCI World, which captures about 85% of market capitalisation across 23 rich countries, has fallen only slightly less than American indices. Although the cyclicals-defensive sell-off in emerging markets and Japan is less acute than in America, the sell-off in Europe is almost as bad. Investors have lowered their expectations for American corporate earnings this year by 1.5%—the same as for earnings in Europe. This is consistent with academic evidence published before Mr Trump took office, which concluded that American tariffs would cause as much or more economic pain outside America as within.
The good news is that the global economy faces Mr Trump’s tariff onslaught from a position of relative strength. A composite measure of global growth in March, derived from surveys of purchasing managers, rose from its February reading, and indicated particular strength in the services sector, which is so far unaffected by tariffs. A “current-activity indicator" produced by Goldman Sachs, which comprises a range of high-frequency indicators, suggests that global growth is only marginally below potential. Across the OECD, a club of mostly rich countries, unemployment remains below 5%.
America’s starting-point is even stronger. On April 4th statisticians revealed that the economy added 228,000 jobs last month, well above expectations. Old news, it is true. Yet real-time data tell a similar story. A weekly index produced by the Dallas branch of the Federal Reserve suggests that the economy is growing by over 2% a year. Goldman’s activity indicator shows America outperforming other rich countries. Although Mr Trump has committed one of the worst policy blunders of all time, he was lucky enough to inherit a strong economy. How much pain can it take?
