The Trade War Begins – 07/09/2018

The developed market shrugged off trade war concerns this week. The S&P500 gained 1.56% while the MSCI World Index rallied 1.19%. The Chinese (MCHI US Equity) indices fell -0.87%.

Trade Tensions

Friday marked a possible start to the trade war. As talks broke down last month, the US launched 25% tariffs on approximately $34 billion of Chinese products. Beijing accused the US of launching “the largest trade war in economic history.” While responses to US markets have been somewhat muted, the Chinese markets have dropped over 10% in the past month. Reactions to the tariff news on Friday caused soy meal futures to plunge over 2% before regaining most of the ground as Chinese tariffs on US goods have not been explicitly confirmed.

Mexican Elections

Andrés Manuel López Obrador won the Mexican general elections on July 1st. Obrador will take office in December. He represents a continuation of the trend towards populism and nationalism. He is the leader of the left leaning MORENA party, which he founded in 2014. While his economic policies are more liberal, it is believed that his election will accelerate the path to NAFTA talks.

North Korea

Reports of continued missile and nuclear submarine development coming out of North Korea has raised doubts of the countries willingness to work towards nuclear disarmament on the continent. This is a potential catalyst for regional uncertainty.

US Jobs Report

June unemployment figures showed the US nonfarm payrolls rose 213,000 while the unemployment rate rose to 4%. The rising unemployment rate in conjunction with the strong payroll data suggests people on the sidelines (e.g., discouraged workers, students) have started entering the jobs market. It’s also possible that the data is showing some error (not uncommon given these statistics tend to be revised as more information comes in).

Conclusion

Trade uncertainty has been hammering the Chinese markets as they are being directly affected by the tariffs and are positioned to be disproportionately harmed. While the US markets are relatively muted, we have seen cracks in the smooth veneer. Specifically, the semiconductor industry has shown that it’s vulnerable. While China is the worlds workshop, America is providing the many of the technologically complex components that are used in manufacturing. Take Micron, a chip manufacturer that produces the Dynamic Random Access Memory (DRAM) chips used in data centers and personal computers. Over 77% of this US based company revenues are attributable to China and Taiwan. Over the past month, there is a much stronger correlation between the company and the broader Chinese market. The question still remains: who will ultimately bear the costs of the tariffs.

On the domestic front, improved employment figures, rising wages and a potential trade war set the stage for inflation. Rising incomes and more people working means there’s going to be more demand for goods. This tends to express itself as inflation, which erodes the purchasing power of people on fixed incomes. This should reinforce the likelihood that the Federal Reserve will follow through with the 4 rather than 3 interest rate hike scenario.

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