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One Wall Street brokerage told clients Monday that the globe is "one step away" from recession as the world's two largest economies head to the G-20 summit meeting in Japan this week to try to hash out key issues and end a monthslong trade war.
While escalation isn't what UBS expects, a failed meeting between President Donald Trump and China's Xi Jinping that results in a new wave of tariffs would mean "major" changes to global GDP and market forecasts, global head of economic research Arend Kapteyn wrote in a note.
If the trade war escalates, "we estimate global growth would be 75bp lower over the subsequent six quarters and that the contours would resemble a mild 'global recession' —similar in magnitude to the Eurozone crisis, the oil collapse in the mid-1980s and the 'Tequila' crisis of the 1990s," he wrote.
The impact of a scuttled trade deal at the U.S.-China meeting in Osaka and agitated relations wouldn't be felt immediately, however, but grow in severity over several quarters as higher prices stifle demand and growth, the UBS researcher wrote. In the United States, the cumulative reduction in GDP would be about 1% over six quarters, 1.2% in China and 0.74% in Europe, Kapteyn wrote.
U.S. and Chinese negotiators are expected to begin discussions in Osaka this week before Trump and Xi meet, hoping to quell inflamed relations between Washington and Beijing, which have crumbled since late April. In a surprise move, Trump tweeted on May 5 that tariffs on $200 billion worth of Chinese goods would increase to 25% and that another 25% tariff would "shortly" be imposed on an additional $325 billion of imported goods from China.
Traders blamed the worsened trade outlook for an equity pullback in May, with the S&P 500 down 6.5% last month.
But further aggravation of the trade conflict could push global equities down 20%, Kapteyn said, with the prior U.S. outperformance relative to Europe eroding and emerging markets taking a heavy hit.
"In global sectors, Materials stands out as most vulnerable, but some defensive and crowded segments are also at risk amidst weaker growth," he added. "For a bottom up perspective, we lean on our prior work to highlight trade and crowded growth exposed stocks."
Source: U.N. Comtrade database, U.S. Department of Commerce, Federal Reserve Bank of St. Louis
The economist added that all major central banks would be forced to ease monetary policy, with the U.S. Federal Reserve compelled to cut interest rates by 100 basis points on top of an expected 50-basis-point cut in July. Such a push would pressure the yield on the benchmark 10-year Treasury note below its record low of 1.3%, the UBS economist predicted.
In China, the government would add another 150 basis points of total social financing growth, with GDP falling under 6%. China's total social financing is a catchall term for lending by banks and other institutions.
"Once policy makers have delivered the limited stimulus, investors will likely worry about them running out of options," the UBS team wrote. "In the trade escalation case, we expect US 10y yields to fall through all-time lows."