Wall Street is afraid of the wrong thing when it comes to Trump's trade wars

Pixabay/skeeze

A steel mill worker.

• Wall Street is on the fritz again about rising bond yields.
• The concern stems from a misguided fear that tariffs and a potential trade war will raise inflation more than they hurt growth.
• "Tariffs and other protectionist measures do not create inflation, they just lead to a temporary increase in the price level," writes Roberto Perli, ex-Federal Reserve economist and partner at Cornerstone Macro LLC, in a research note.

Rising US bond yields are making stock investors nervous again - but many on Wall Street are worried about the wrong thing.

The spike in 10-year note rates above 3% in particular has soured sentiment among equity traders, driving further losses Wednesday following a brutal session Tuesday.

However, there's reason to believe the fears of possible inflation underpinning the rise in longer-term market interest rates may once again prove premature, and thus be followed by a pullback.

The confusion stems in part from the conflicting message sent by a mix of large tax cuts and sharply expansionary budget deficits, meant to bolster economic growth, alongside an increasingly protectionist trade stance that has many economists rethinking their rosy GDP forecasts for 2018.

After an initial round of tariffs on steel and aluminum that alienated many US allies, the Trump administration has begun more targeting China more aggressively, raising fears of a full-blown trade conflict between the world's two largest economies.

"Tariffs and other protectionist measures do not create inflation, they just lead to a temporary increase in the price level that the Fed would likely look through," Roberto Perli, ex-Federal Reserve economist and partner at Cornerstone Macro LLC, wrote in a research note.

"Instead, trade conflicts create a clear downside risk to growth, both domestically and globally; that higher risk would likely induce the Fed to scale down its projected pace of rate hikes."

Andy Kiersz/Business Insider

Fed officials have been cautious not to get ahead of policy announcements when asked about the potential damage to the economy from looming trade conflicts.

Still, many including Fed Chairman Jerome Powell have cautioned against the risks of turning away from global trade.

"The tariff approach is not the best approach," Powell told a congressional committee in March. "The best approach is to deal directly with the people who are affected rather than falling back on tariffs."

San Francisco Fed President John Williams, who is set to take over the powerful role of New York Fed chief, told Spanish newspaper El Pais this week that "if the conflict increases" it would hurt economic growth.