The Market Today
Tariffs Take Center Stage, Send Markets Reeling
by Craig Dismuke, Dudley Carter
THOUGHTS ON TARIFF ANNOUNCEMENT
Trump Tariffs Unlikely to Move Inflation or Growth Needles, Bigger Risk Seen in Potential Escalation: President Trump announced a 25% tariff on imported steel and a 10% tariff on imported aluminum yesterday, triggering a risk-off move in the markets, as discussed below. The tariffs are expected to go into effect next week. A president is allowed to impose tariffs on imports in certain scenarios, including when it is deemed by the Commerce Department to be in the country’s national security interest. Returning steel and aluminum production to the U.S. is being characterized as such.
As for the economic impact, precision is difficult given the uncertainty of how the tariffs will be applied. The White House did not specify if the tariffs would apply to raw materials only, at the intermediate goods level, or at the final goods level. However, the first derivative effects should be minimal. Regarding GDP, Census Bureau data indicate the U.S. imported $37 billion in iron and steel last year along with $10 billion in nonferrous metals (which includes aluminum). Both of these figures are fractional relative to the overall economy, combining to make up just 0.2% of total GDP. Steel and aluminum manufacturers in the U.S. will obviously benefit, external trade figures will likely be noisy for a while, and consumer prices are likely to rise minimally. Despite MillerCoors complaint yesterday that a 10% increase in some of their aluminum can materials would “likely lead to job losses across the beer industry,” the tariffs would only push overall consumer prices up 4.8 bps if passed through in their entirety (it is expected that some of the higher costs would be absorbed before getting to the final consumer). This is roughly equivalent to a $0.09 increase in gasoline prices. As such, the additional cost to consumers, even in the worst case scenario, should not be excessively deleterious.
The bigger concern, as reflected by yesterday’s risk-off sentiment, is the potential escalation of protectionist policies from the U.S.’s trading partners. While the White House sees the move as leveling the playing field, other countries are unlikely to adopt the same view. Moreover, Canadian exports to the U.S. are likely to be most affected with only a small impact on China. Regardless, the Chinese government is in the midst of a domestic powerplay and may want to flex their global trade muscle to prove a point. In addition, there are rumors of fallout within the Trump administration which, as we saw last year, has the potential to roil markets.
The only economic report scheduled today is the University of Michigan’s February final report on consumer confidence, scheduled at 9:00 a.m. CT. Confidence continues to soar.
Yesterday – Tariff Talk Sent Stocks Within Widest Intraday Range Since February’s Vicious Volatility: Stock moves were unexciting for the first hour of Thursday’s session and turned positive after reports the White House wouldn’t announce tariffs on Thursday as was previously speculated. However, just before lunch, and in the presence of certain CEOs from those industries, the President indeed announced that the administration intended to put in place, as early as next week, tariffs of 25% and 10% on imported steel and aluminum. Steel company stocks rallied because of the presumed benefits to both price and quantity of their revenue equations. The broader market, however, tumbled in response to fears of the potential ramping up of trade tensions and higher raw material costs for other industries. As one example, United States Steel Corporation rallied 5.75% while shares of Caterpillar, which uses steel as a major raw material input in its products, dropped 2.8%. For the day, the Dow ended down 420 points, or 1.68%, and the S&P shed 36 points, or 1.33%. The flight out of equities created a bid for bonds and Treasury yields moved lower with the 2-year yield falling 3.8 bps to 2.21%, the 5-year yield closing down 6.0 bps at 2.58%, and the 10-year yield lower by 5.3 bps at 2.81%.
Overnight – Uneasiness Spreads to Global Markets as Tariff Talk Remains Ramped Up: It has by no means been close to the turmoil seen early last month, but equity sentiment has been less than stellar to start the month of March. After taking U.S. markets lower in yesterday’s session, tariffs have been the major topic around the globe and have weighed equally as heavily on foreign equity exchanges. A 2.5% loss for Japan’s Nikkei led losses across Asia and Germany’s DAX has so far shed 2.2% to help push the Stoxx Europe 600 down 1.5%. The materials sector, which contains metals producing companies, has led the European index lower and is near the bottom of the Nikkei. The Nikkei’s downturn was also partially driven by a spike in the Yen following comments from the BoJ Governor that he expects to begin debating an exit from easy policy in fiscal 2019 (starts April 2019), when they expect inflation to reach 2%. President Trump’s tariff announcement was the original catalyst, but the responses from leaders of key U.S. trade partners fanned the flames of fear of retaliatory responses. There is evidence of a risk-off event in European yields with curves there flatter and lower but the Treasury curve is hardly changed after yesterday’s decline.
Manufacturing PMI Hit an Almost 14-Year High: The ISM’s Manufacturing PMI ticked up 1.7 points to a near 14-year high (May 2004) of 60.8. Improvement in the employment index (third best since 2011) was the primary positive contributor while inventory growth (second best of the cycle) and supplier delivery time (second best since 2010) made smaller contributions. Keeping a lid on the index in February were lower readings on both new orders and production; both, however, remained towards the top of their recent-year ranges. Looking elsewhere, despite the weakness that was evident in the 4Q17 GDP trade data and January’s advanced goods trade report, both the import and export orders indexes rose. The prices paid index hit its highest level since May 2011. Despite some weaker activity in other datasets recently, the ISM survey continues to support a story of solid growth.
Powell Presented a More Balanced Assessment on Day Two: While Fed Chair Powell didn’t back away from his optimistic outlook for the economy, he did seem to offer more of a nod to the Committee’s more dovish members. Powell sent yields climbing early Tuesday during the first half of his testimony after telling members of the House that his outlook had strengthened and that could affect his updated forecasts when officials gather in a few weeks. On Thursday, Powell told a group of senators that while the outlook was stronger, “There’s no evidence that the U.S. economy may be overheating.” He noted the Fed didn’t “see any evidence of a decisive move up in wages.” He added nothing ”suggests to me that wage inflation is at a point of acceleration,” but he still expects “you’ll begin to see wage increases coming.” He still concluded the expectation was for the Fed “to gradually raise interest rates,” saying “ That is the path we have been on and my expectation is that will continue to be the appropriate path. …The thing we don’t want to have happen is to get behind the curve of inflation and have to raise rates quickly and cause a recession.”
Dudley Said Four Hikes a Year is Consistent with a Gradual Pace of Tightening: During Chair Powell’s testimony and just before President Trump announced tariffs on imported steel and aluminum, NY Fed President Dudley spoke in Brazil at an event focused on, ironically, global trade systems. Dudley addressed both trade and monetary policy, saying “Protectionism is not the answer” and calling trade barriers a costly way to protect jobs that can often backfire with unintended consequences. On monetary policy, any ground that Powell gave to the doves Thursday Dudley took back. After cautioning against longer-term risks posed by deficit-increasing fiscal policies, he said the tax cuts and federal spending agreement had turned fiscal policy “quite stimulative so any worries you had about U.S. economic growth, which I think were already pretty subdued, I would think in the near term are even more subdued.” He remarked it’s still to be seen if the Fed will need to hike faster going forward, but went on to say that “If you were to go to four, 25-basis-point rate hikes I think it would still be gradual.”
ICYMI – February 2018 Monthly Review: Market volatility, essentially absent in 2017, re-emerged in February as a hotter-than-expected January hourly earnings number followed an optimistic Fed Statement and sent yields climbing. Fears of faster inflation forcing the Fed to do more spooked equities and sent the major indexes to their biggest intraday point drop in history and second most volatile week since the financial crisis. Several other inflation indicators, including the January CPI report, proved firmer than expected before Minutes from the January Fed meeting described a better-than-expected near-term outlook than in December, a message echoed by Chair Powell before Congress. Fed Funds futures ended pricing in a 100% chance of three 2018 hikes for the first time. Click here to see the full monthly review.