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 per cent tariffs on additional US$300 billion ($460b) of Chinese imports and China retaliates with its own countermeasures, according to Chetan Ahya, chief economist and global head of economics at Morgan Stanley.
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, tweeting:
"When you are the 'Piggy Bank' Nation that foreign countries have been robbing and deceiving for years, the word TARIFF is a beautiful word indeed! Others must treat the United States fairly and with respect - We are no longer the 'fools' of the past!"
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.