More tit-for-tat tariffs in the U.S.-China trade war could set the global economy up for a recession, according to Morgan Stanley.
"If talks stall, no deal is agreed upon and the U.S. imposes 25% tariffs on the remaining $300 billion of imports from China, we see the global economy heading towards recession," Chetan Ahya, Morgan Stanley's chief economist and global head of economics, said in a note Monday.
President Donald Trump has slapped higher tariffs — from 10% to 25% — on $200 billion worth of Chinese goods and China retaliated by raising duties on $60 billion of U.S. goods to as high as 25% starting June 1. Trump had also threatened to impose 25% tariffs on an additional $325 billion of Chinese goods "shortly."
The escalated trade tensions sent shock waves through the financial markets. has fallen 3.4% since Trump's tariff threat, while the Dow Jones Industrial Average has tumbled about 800 points. Trade bellwethers Caterpillar and Boeing have been under pressure and chipmakers which have high revenue exposure to China also took a huge hit amid the trade war.
If no trade resolution is reached between the world's two largest countries, the central bankers would adjust their monetary policy to provide support for the deteriorating economy, said Morgan Stanley.
The economist predicted the Federal Reserve would cut rates all the way back to zero by spring 2020. China would again upsize its fiscal stimulus to 3.5% of GDP, Ahya said.
"But, a reactive policy response and the usual lags of policy transmission would mean that we might not be able to avert the tightening of financial conditions and a full-blown global recession," Ahya said.
The economist also warned that investors could be underestimating the impact of the trade war as China could put up "non-tariff barriers such as restriction of purchases." In addition, companies may not be able to fully pass though the higher cost to consumers, Ahya said.