Financial markets were of two minds last week about the impact of mounting trade tensions between China and the U.S. On the one hand, the escalating tit-for-tat tariffs still affect only a relatively small part of the two countries’ economies. The consensus baseline remains that the measures should not have a significant and lasting downward impact on the economy and stocks and, ultimately, may help bring about trade that is still free but fairer.

On the other hand, each escalation (the latest is the July 10 announcement by the Trump administration of its intention to impose import duties on an additional $200 billion of Chinese products) increases the market’s downside risk scenario of slipping, either on purpose or inadvertently, into a full-blown trade war that would significantly damage corporate earnings and the overall growth outcome. And there is a third possible scenario for international trade that hasn't yet captured the attention of markets: A “Reagan Moment” that h...

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