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Why we could see a recession in 3 quarters: Morgan Stanley

The fallout from recent escalations in trade tensions could drag global economies into a recession within a year, according to at least one major Wall Street firm.

If the U.S. were to move forward with imposing a 25% rate of tariffs on about $300 billion worth of Chinese imports, and China were to retaliate, “the global cycle will be at risk,” Morgan Stanley chief economist Chetan Ahya wrote in a note Sunday.

“We could end up in a recession in three quarters,” he said.

A recession is defined as two consecutive quarters of negative economic growth.

In May, the U.S. slapped 25% tariffs on $200 billion worth of Chinese goods, abruptly ending a multi-month trade war ceasefire between the two countries. Beijing, in response, imposed retaliatory levies on some of $60 billion worth of U.S. goods at the beginning of June.

The Trump administration has since threatened to slap tariffs on another $325 billion worth in Chinese goods, which would tack on duties to thousands of products including clothing, cosmetics and electronics that had not previously been affected.

With these further levies in mind, Ahya laid out a cascade of events that would result in a global downturn.

“First, implementing the tariffs will increase costs. Companies may not be able to fully pass on higher tariffs, which will erode profitability,” Ahya said. “Consumers, facing higher prices, may pull back on demand.”

“Second, the tariffs’ impact will spill over into the domestic and global supply chains and consequently global trade flows. Third, over the medium term, multinational companies will incur additional costs as they develop alternative supply sources,” he added. “Fourth, global corporate confidence will take a hit, and companies will pull back on capex [capital expenditures], which will weigh on aggregate global demand. Finally, corporates with global footprints will face additional downward pressure on growth and profitability from their international operations.”

Some of Ahya’s warnings have already been reflected in major companies’ earnings calls with investors over the past several weeks. Management teams for retailers including Walmart (WMT) and Target (TGT) signaled that tariffs would lead to increased prices for consumers, and Home Depot (HD) warned of “roughly a billion dollar impact” to its business due to the latest increase in tariffs.

Meanwhile, major global economies have shown signs of softening against a backdrop of trade tensions, with trade-sensitive manufacturing sectors having contracted in the eurozone and several countries in Asia in May.

And while the U.S. economy was shown to have expanded at a better-than-expected 3.1% in the first quarter, economists are anticipating slower growth in the second half of the year. Goldman Sachs on Sunday lowered its second-half growth forecast by half a percentage point to 2%, in part due to the impact of the escalating trade war.

Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck

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