Financial Market Implications of the Trade War between the United States and China Financial Market Implications of the Trade War between the United States and China

The ongoing trade war between the United States and China entered its second year in 2019. Higher tariffs on imported goods have the potential to raise consumer prices, while those firms that cannot easily replace the intermediate inputs they source from China may experience higher production costs and supply chain disruptions. Firms may also choose to delay any capital investments requiring large fixed costs until the policy uncertainty is resolved. Though there are many different channels through which the trade war can affect the economic performance of the United States, the total overall effect is predicted to be moderate. For example, an August 2019 report issued by Goldman Sachs estimates that the total peak effect from the aforementioned channels will amount to 0.2 percent of US gross domestic product.

While it is unlikely that aggregate real economic activity in the United States will suffer many adverse effects stemming from the trade war, this paper establishes that from its inception in 2018, the trade war with China has had a statistically and economically significant impact on US financial markets. The author uses the event study approach pioneered by Rigabon and Sack (2005) to identify 28 event days between January of 2018 and August of 2019 when news events related to the trade war had an immediate impact on high-yield spreads, long-term Treasury rates, and US stock prices.

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