Chief economist update: A tariff for a tariff

"If your opponent is temperamental, seek to irritate him. Pretend to be weak, that he may grow arrogant. If he is taking his ease, give him no rest."
- Sun Tzu, The Art of War

Trump must be fuming and scratching his golden hair. Not that China retaliated for his lifting of tariffs on goods imported from China - Trump and his dog expected as much - but that the financial markets reacted more to Beijing's tit for his tariff tat.

The Ministry of Finance of the People's Republic of China announced (before the opening bell on Wall Street) that it's imposing increased tariffs on a total of 5140 products imported from the US (worth around US$60 billion) starting on Saturday, 00:00 hours on the 1st of June.

As per Bloomberg, this includes:

25% tariffs on 2,493 items from current 10%
20% tariffs on 1,078 items from current 10%
10% tariffs on 974 items from current 5%

US equity markets dropped. The S&P 500 index and the Dow closed 2.4% lower with the Nasdaq diving by 3.4% overnight. Ten-year US Treasury bond yields declined by 5 bps to 2.4% - its lowest level since March.

The VIX index (the fear gauge) jumped by 28.1% to a reading of 20.55 - its highest level since early January.

Suddenly, the IMF's forecast for a second half lift in global growth is at risk and worse. According to Gregory Daco - Oxford Economics' chief US economist: Imposing tariffs on all U.S.-China trade would reduce global gross domestic product by 0.5 percent by 2020 ... if the bilateral tensions spiral into a full-blown global trade war, we would expect this to trigger a global recession.

The Fed's forward guidance of steady rates until the end of the year has turned the slope of the yield curve (yield on 10-year Treasuries less 3-month T-bills) positive after it inverted in late March - a precursor of a US recession.

The decline in 10-year US bond yields in recent days has begun to re-flatten the yield curve.

So much so that financial markets are betting that steady interest rates wouldn't be enough given recent developments in the Sino-US trade stoush and the financial markets' reaction to it.

The CME FedWatch Tool shows the probability that the fed funds rate would remain at 2.25%-2.50% at the Fed's December 2019 FOMC meeting has dropped to 26.1% from 45.8% a week ago (before the tariff flare-up). The odds for a 25 bps rate reduction increased to 41.3% from 39.8%, and for two rate cuts, to 24.7% from 12.5%.

Read more: Wall StreetBeijingBloombergNasdaqUS TreasuryVIX
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