Yesterday, the S&P 500 dropped 2.5%, its worst day in six weeks. President Trump’s new announcement of about $50 billion in tariffs targeting Chinese imports has sparked new trade-war concerns. The U.S. will also restrict Chinese investment in the U.S.

In response, China’s Ministry of Commerce has posted a statement saying that China will target a list of 128 U.S. products, which which accounted for about $3 billion in 2017 imports. According to the statement, if China and the U.S. cannot come to an agreement, 120 of the items, such as wine, ginseng and fruits, will see a 15% duty. And the other 8 items on the list, such as pork and recycled aluminum goods, will be taxed 25%. The ministry did not itemize all 128 products.

Given what China could have done, the response is pretty mild, so far. For example, China is an important market for many international companies; China could have announced broad sanctions against U.S. companies and the goods they supply, including possibly banning them from doing business in China.

Today, China’s U.S. ambassador noted that China may reduce its purchase of U.S. Treasuries. China holds about 1/5 of U.S. Treasuries held by foreign entities. As the largest foreign buyer of U.S. debt, a cutback could raise the cost of borrowing for the U.S. Due to the recent tax cut, Washington will likely need to sell more Treasuries to raise money as tax revenue decreases. In addition, the Fed is seeking to reduce its bloated balance sheet and will be reducing its purchases of Treasuries.

So far, China’s signal is that it won’t be pushed around, but it is open to negotiation. And if the two sides can’t reach an agreement, it has more weapons in the arsenal to use for retaliation.

It is debatable which country holds more leverage over the other, but it’s fair to say that in a clash of two giants, in a full-blown trade war each side could inflict significant damage on the other’s economy. So far, the announced measures likely won’t have a huge impact, but it is the possibility for escalation that has spooked the markets.

We note that President Trump’s tariff plan leaves an opening to lean on the World Trade Organization to help mediate some of the disputes. It also leaves flexibility how the $50 billion will be calculated, so it appears the tariff announcement may be a tactic to get China to the table faster to renegotiate the two countries’ trade relations.

Keep in mind the recent precedent. Recall that in the beginning of the month, the president announced steel and aluminum tariffs that originally sounded like they may be across the board. But soon the tariffs were softened with exemptions for the biggest importers to the U.S. Thus, the fact that the China tariff plan leaves some leeway suggests to us that the two sides may come to a resolution.

However, China is not going to fold under pressure from the U.S. so the Trump Administration will need to compromise some to get a deal done.

This morning, we sold TAL Education (NYSE: TAL) from our portfolio. Based on our research, we don’t think that the moves by China’s education ministry we discussed last week will cause significant detriment to TAL. However, the concerns over escalation into a full-blown trade war could continue to pressure the market, and in particular Chinese stocks, we decided to take the gain on TAL. Our entry price was $30.88, and exit price $38.15.