There’s a binary outcome for the stock market tied to the ongoing trade talks between the U.S. and China, according to Goldman Sachs.
Put simply, the implementation of additional tariffs could lead to another stock market pullback, while a trade deal is set to boost stocks.
According to Goldman’s proprietary Financial Conditions Index (GSI), financial conditions have tightened since the latest escalation of trade talks, which began on May 5, with an ominous tweet from President Trump threatening to raise existing tariffs on Chinese goods to 25% from 10%.
“We find that FCI reactions to trade war news are primarily driven by the stock market, with dollar appreciation and credit spread widening playing a smaller role and Treasury yields providing only a partial offset,” the analysts wrote, led by chief U.S. economist Jan Hatzius.
In the week following President Trump’s May 5 tweet, the stock market slumped, with the S&P 500 (^GSPC) ending the trading session on May 13 roughly 5% below its prior intraday record high from May 1.
That’s the kind of reaction Goldman Sachs expects should trade relations deteriorate further.
If we see tariffs on another $300 billion worth of Chinese imports, Goldman sees the FCI tightening even more, along with a 4% pullback in stocks.
Trade tensions aren’t just high between the U.S. and China. Europe is also in the crosshairs of President Trump’s trade policy, as the U.S. is a major importer of European cars. And so, the impact of auto tariffs could have domino effects.
“If auto tariffs are imposed as well, we estimate a 7% decline in equity prices,” the Goldman analysts wrote, noting a further increase in the FCI following this scenario.
But Goldman’s base case is that a trade deal is reached, along with a “staggered reduction” in the current tranche of tariffs. With this scenario, the FCI eases and stocks rise 4%.
Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.
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