Monthly Global Market Commentary March 05, 2018

Trade Wars and Fed Talks By Peter Goodall

Global markets were down last week. The S&P 500 (SPX Index) fell 3.13% this week on fears of a trade war. The MSCI World Index (MSDUWI Index) was down 3.23%.

Jerome Powell Speaks

New Federal Reserve Chair, Jerome Powell, testified before Congress early last week. He reaffirmed his belief that the US economy is strong and not at risk of overheating. This raised the likelihood that the Fed could possibly raise interest rates 4 times this year. Markets fell from recent highs on the news.

Trade Wars

Citing national security concerns, President Trump announced a 25% tariff on steel and 10% tariff on aluminum imports. This immediately followed a meeting between the president and industry leaders. No specifics have been announced, which led markets to be concerned whether this would impact US steel exporting allies. Many US allies have been outspoken about their dismay at the policy and are actively seeking exemptions.

As details are pending, it’s worth doing a deeper dive. Secretary Ross of the US Commerce department released guidance on steel and aluminum tariffs mid-February. They proposed a number of options: 24% tariff on all steel imports, a 53% import targeting specific countries (which included a few US allies, Turkey and Egypt), or a quota on steel imports. It is unclear what type of steel would be covered under the new tariffs. In the financial world, steel is subdivided into several categories based on its use and means of production.

Steel tariffs are nothing new and are typically ineffective. The news cycle has been quick to remember the 2002 Bush steel tariffs, a controversial move at the time. Those tariffs ended after WTO ruled that the US was in violation of its tariff-rate commitments. As part of the ruling, the WTO authorized more than $2B in sanctions against the US unless it withdrew the tariffs, which it did shortly thereafter. In 2016, the Obama administration targeted Chinese cold-rolled steel with a 500% increase in response to claims of Chinese dumping steel in US markets. While this resulted in a two-thirds decrease in Chinese steel exports to the US, it is believed the Chinese started exporting to the US via Vietnam as a means of bypassing the tariff. In January, China represented 48.72% of the global supply of steel. In its current form, the proposed tariffs appear more like the 2002 tariffs.

Investors are generally concerned about inflation and a trade war. Tariffs protect domestic industries by raising the costs of imports. This gives domestic companies room to sell their goods at a higher (or at least more competitive) price. For consumers, this results in higher prices which is expressed in inflation. Tariffs have a tendency to create more tariffs, as countries retaliate. Pundits have floated the idea of Chinese retaliation by targeting US soybean exports (farmers being more likely Trump supporters). This seems unlikely as they are not being directly targeted, would be impacted at significantly lower levels than elsewhere, and appear to have a work around for tariffs.

Conclusion

To a certain extent, the risk of aggressively rising interest rates and a weakening US economy are offsetting. While Jerome Powell has shown a greater tolerance for market volatility than his predecessors, he is monitoring the strength of the US economy.
The markets might be overreacting to President Trumps announcement. The system tends to self-correct. The President has a track record of making evocative declarations that get scaled back in practice (e.g., taking away guns prior to due process or building the wall). If we were to move forward with a flat tariff on all imports, it would likely violate the US commitments to the WTO since not all trading partners are dumping in the US.

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