Market Extra: Stock market investors are acting as if a genuine U.S.-China trade war has erupted

Has a tit-for-tat tariff spat between China and the U.S. shifted from a skirmish to a full-blown trade war?

That is certainly how financial markets have been reacting. Tensions took a turn higher on Tuesday, after President Donald Trump late Monday threatened to impose tariffs on as much as $450 billion in Chinese goods, further ratcheting up tensions between the two largest economies in the world.

Trump asked his administration to compose a list of $200 billion in China goods for levies and promised that he would impose an additionally $200 billion in duties if Beijing retaliates.

Those comments come after the U.S. president on Friday announced tariffs on $50 billion worth of Chinese imports, eliciting a swift rebuke from Beijing.

“Further action must be taken to encourage China to change its unfair practices, open its market to United States goods, and accept a more balanced trade relationship,” Trump said in a statement on Monday, accompanying the most recent tariff request.

Wall Street doesn’t like the escalation of tensions, which appeared to some as if the rhetoric between the two countries had devolved into a more concrete dispute — one that could ripple through global economies.

The Dow Jones Industrial Average DJIA, -0.41% is on track to tumble more than 300 points and wipe out all of its gains for 2018 on Tuesday. Futures for the benchmark YMU8, -1.38% are down 330 points, or 1.3%, at 24,687. The S&P 500 index SPX, -0.21% and the Nasdaq Composite Index COMP, +0.01%  are also on track to see sharp drops of at least 1%.

In Asia, the Shanghai Composite SHCOMP, -3.78%  closed down 3.8%, hitting its lowest level since April, while the Nikkei 225 index NIK, -1.77%  slid by 1.8%.

Investors broadly fled assets perceived as risky and headed for those considered havens, including Treasurys. The benchmark 10-year Treasury note yield TMUBMUSD10Y, -1.72% was currently at 2.88%, compared with 2.926% late Monday in New York. Bond prices rise as yields fall.

Meanwhile, the yen USDJPY, -0.65% also viewed as a safe asset in times of turmoil, strengthened to ¥109.71, versus ¥110.55 in the previous session.

“The tit for tat brings the two sides closer to a trade war. The Trump administration appears to think it can strong-arm China in making concessions by scaling up the amount of trade it imposes tariffs on. However, China is adamant about not wanting to look weak in this conflict with the U.S.,” wrote Louis Kuijs, head of Asia economics at Oxford Economics, in a Tuesday research note.

The U.S. imported $505 billion in goods from China last year, while China only imported $130 billion in U.S. products. That imbalance has left Trump and his administration feeling as if Beijing has less negotiating power in the dispute. But others warn that the country could use other measures to hit back at America.

“Specifically, China could start selling off some of its massive holdings of Treasury bonds. The country owns some $1.18tn of Treasuries, or 30% of all foreign official holdings of Treasuries, which is not to mention their holdings of agency bonds and others,” wrote Marshall Gittler, chief strategist and head of education at ACLS Global.

Ray Dalio, co-chief investment officer of Bridgewater Associates, noted that the power struggle could escalate the conflict beyond trade, as the two sides bring in and wield the other “carrots and sticks” they have — in the economic, military and cyber arenas, for example.

“What is moving the disagreement from a dispute to a war is the fact that there are no international rules or international organizations (like WTO) that the disagreeing parties are willing to go to for binding arbitration, so they use carrots and sticks to test each other’s strengths, pushing each other until one backs down,” Dalio wrote in a post to LinkedIn.

In any case, the threat of tariffs has been a major bugaboo for investors, because it introduces an element of uncertainty that typically rattles nerves. It also can dent economic expansion, even if the levies are relatively tiny in the scheme of the economic powers at loggerheads.

Raphael Bostic, the president of the Atlanta Fed, said on Monday that trade concerns are already beginning to reflect in sentiment, referencing conversations he has had with market participants.

“I began the year with a decided upside tilt to my risk profile for growth, reflecting business optimism following the passage of tax reform,” Bostic said.

“However, that optimism has almost completely faded among my contacts, replaced by concerns about trade policy and tariffs. Perceived uncertainty has risen markedly. Projects already underway are continuing, but I get the sense that the bar for new investment is currently quite high,” he said.

The recent China-U.S. tariff conflagrations come about a week after the Group of Seven world leaders meeting ended with Trump declining to sign a joint communiqué, citing what the president viewed as an act of bad faith by Canadian Prime Minister Justin Trudeau.

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