The Effects of Trump's Trade War on U.S. Financial Markets

Existing studies usually investigate the effects of Trump’s trade war on U.S. financial markets by the event-study method. We take an alternative approach by integrating trade war-related news into one single "trade war shock" based on a structural vector autoregression model identified via event day heteroscedasticity and then exploring its effect on various financial variables. We find that the identified trade war shocks consist of both growth news shocks and risk premium shocks. The former reflects shocks to investors’ cash-flow expectations, and the latter arises from shifts in the risk appetite or changes in the cash-flow uncertainty, both of which not only generates significant impacts on financial variables such as stock prices, treasury yields, and BAA corporate bond spreads but also explains a sizable fraction of their fluctuations. Additional analyses that employ stock prices in the S&P 500 index to explore the role of firms’ global value chain exposure during the trade war show that firms with high output exposure to China’s market suffer significantly more from the trade war, while input exposure does not cause a persistent significant difference.