Trump policies are increasing the risk of a recession, says JPMorgan economist

The latest shot in Donald Trump’s trade war caused barely a ripple on global markets, but the risk of recession is now at an ‘uncomfortably high’ level.

US President Donald Trump announcing tariffs on auto imports on Thursday Australian time. Picture: AFP

Markets are underpricing the risk of recession caused by Donald Trump’s policies, even if it’s unlikely to be deep or protracted, says JPMorgan global economist Joseph Lupton.

The latest shot in his global trade war – a 25 per cent US tariff on automotive imports – caused only a ripple in world financial markets when announced by the US President.

But his trade and immigration policies, together with government austerity, have raised the risk of recession to a level that’s “uncomfortably high”, Mr Lupton said.

“We should be mindful that risk assets can get hit here, if the US falls into a recession,” he said.

“With risk elevated like this, I think you want to start pricing in some of this recession risk.”

While the S&P 500 entered a “technical correction” earlier this month when it fell as much as 10 per cent from its record high, it subsequently bounced 5 per from that point.

“The US stockmarket is only back to where it was before the election,” he said.

“Credit spreads are still very tight, so I don’t think there’s a full appreciation of the risks.”

JPMorgan’s baseline forecast is that the US economy will grow at a slightly below-trend pace of 1.5 per cent for the next 12 months. Its official recession probability forecast is only 40 per cent.

Still, Mr Lupton said that while there were not the preconditions, such as excessive leverage, for a deep or protracted recession, the “tail risk” of a recession was “significant”.

Much of that is due to the trade war that is growing to levels not seen since the 1930s.

On his estimate, the average US tariff rate was about 7 per cent before the latest announcement. With the auto tariffs starting on April 3, it will rise to about 8.7 per cent.

That compared with about 3 per cent at the start of Mr Trump’s second term and about 1.5 per cent before the start of his first trade war in 2018.

If Mr Trump proceeds with so-called “reciprocal tariffs” after his “liberation day” announcement on April 2, plus 25 per cent tariffs on pharmaceuticals and computer chips – but excluding compensation for the value-added tax charged in some countries – JPMorgan thinks the average tariff will be 11 per cent.

JP Morgan senior global economist Joseph Lupton.

Mr Trump also said on Thursday that he planned to go ahead with tariffs on lumber soon.

But if he also takes account of VAT taxes, the average effective tariff would rise to about 20 per cent.

Goldman Sachs came up with a total of about 15 per cent with VAT.

So the US is looking at a vastly bigger lift in tariffs than it saw in early 2018.

At that time the trade war sparked a 10 per cent fall in the S&P 500 before Mr Trump changed course.

“Big picture, I would say this is already something that is much more meaningful – two to three times bigger than the first trade war,” Mr Lupton said.

In the first trade war of 2018-19, global manufacturing slowed from 5 per cent growth to zero by 2019, US manufacturing went from a 2.5 per cent growth rate in 2017 to a 2 per cent contraction in 2019, and the Federal Reserve changed from hiking rates that year.

“So it was a material effect,” Mr Lupton said. “But I think one of the things you have with trade wars is that the direct effects don’t add up to all that much in terms of inflation and growth.”

In terms of direct effects, he said the tariffs would subtract about 0.75 percentage points of economic growth and add about 0.75 percentage points of inflation.

“They’re not trivial, but they’re also not necessarily expansion ending on their own,” he said.

The much bigger effects of tariffs are what they do to business sentiment.

He said that regardless of what is announced on April 2, the direction of travel on tariffs was upward and the April 2 announcements would not be the end of it.

“Some clients are like ‘oh, once we get past April 2 all the uncertainty will be gone’, but that’s just foolish … there’s uncertainty for a while,” Lupton said.

A Bloomberg report on Monday said Mr Trump wouldn’t announce separate, sector-specific tariffs even on April 2. The market appeared to be positioned short as the S&P 500 rose 1.8 per cent on Monday despite what was essentially only slightly less negative news on tariffs.

But by Tuesday, Mr Trump was saying he planned to proceed with long-threatened auto import tariffs “fairly soon, over the next few days” ahead of the broader package next week.

And Mr Lupton said the economic policy risk went beyond the trade war.

“You’ve had a set of policies from the Trump administration spanning everything from the trade war to immigration, fiscal, tax policies to regulatory policies,” he said.

“There has been a tendency to focus on what I call the ‘goodies’ – the fiscal corporate tax cuts and things like this and deregulation – and fade the ‘baddies’ like the trade war and immigration.

“But the trade war certainly is much worse than people had hoped, the immigration flows have slowed to zero, and people are maybe more appreciative that those large immigration flows were an important part of US growth over the past couple years – both from a demand and supply side.

“And then, I think, most importantly, the views on fiscal, tax and spend are changing.

“Further tax cuts and further household income tax cuts are very hard to do.

“At best, the Congress and administration are looking for ways to pay for just the extension of the TCJA (Tax Cuts and Jobs Act of 2017) tax cut, which, as you know, expires at the end of this year.

“So just the extension of that is neutral for the outlook, because it’s already in place.

“To pay for it – it’s costing close to $US5 trillion over 10 years – they’re looking for spending cuts.

“So fiscal policy was expected to be a plus for growth but is now turning into a minus.

“You have the ‘Department of Government Efficiency’, which is turning out to be more of a department of government austerity, which involves spending cuts and lay-offs.

“These measures are taking what was supposed to be a ‘goodie’ and putting them in the ‘baddie’ bucket. You have a series of policies that are turning into headwinds to the US economy.”

He dismissed the idea of Mr Trump causing a recession to be in an expansion phase for the next election because “recession are very damaging events and people don’t forget the pain of a lost job”.

“I think there is a more nuanced version of that story that suggests that talking up the risks of recession is one way to get long-term borrowing costs down without actually generating a recession,” Mr Lupton said.

“There might be a logic to that but I think even that’s a very dangerous game.

“It would be far better to start generating some coherent policies that would promote growth and fiscal sustainability, and get people optimistic about some of the more deregulatory policies that he came into office on rather than some of these near-term headwinds around trade wars.”

Originally published as Trump policies are increasing the risk of a recession, says JPMorgan economist