Well, the streak had to come to an end. The market decline in February ended the longest run of positive months on record. It was nice while it lasted!
The reasons are well known. Bubbling fears about inflation pushed bond yields up. Expectations for Fed policy were ratcheted up a notch as a result, especially after the massive budget deal a couple weeks ago. And just to keep things interesting, on the 1st of March President Trump imposed his third and most significant round of trade sanctions on steel and aluminum imports (lumber was sanctioned in April last year while solar panels and washing machines were hit last month).
The latest trade news hit stocks on Thursday, and the main indexes closed broadly lower for the week. The S&P lost -2.0% while global equities were off -2.3%. Small-caps held up relatively well with just a -1.0% loss.
Trade Wars are Easy, Until They’re Not
As noted above, this week was really all about trade policy. Over the last few months the administration has been investigating both steel and aluminum imports on ‘national security’ grounds, and on Thursday the President announced his plan. He plans to impose a 25% tariff on all steel imports and a 10% tariff on aluminum imports.
The market reaction was swift – steel manufacturers rallied 5%-10% while steel consumers were clobbered (auto makers, for example, were down 3% to 4%).
This move isn’t unprecedented. In March 2016, the Obama administration levied tariffs of more than 200% on certain Chinese steel products. But the scope of this proposal is much broader, applying to all imports.
So which countries will be hit the hardest by the tariffs? Well, it’s not China. As you can see below, almost 50% of our steel imports come from Canada (16%), Brazil (13%), South Korea (10%), and Mexico (9%). Hardly countries we have national security concerns about.
China comes in 11th at roughly 1% of all our steel imports. This works out to just $2bn, a tiny number. To put it in perspective, in 2016 the U.S. imported $463bn from China in total.
And as it turns out, the U.S. isn’t exactly at the mercy of strangers when it comes to steel production. We produce 61.5% of all the steel we consume.
Ironically enough, half of the steel we export actually goes to Canada – the new found national security threat. I’m sure they will happily pay the tariff while our exports to them go untaxed.
As with all tariffs, this will ultimately be a tax on consumers. For example, Wilbur Ross made the case on CNBC Friday that about 1 ton of steel goes into making a car. He noted that the price of a ton of steel is $700 or so, so a 25% increase in material costs would bump up the car sticker price by just $175. He claims no big deal. But 17mm cars were sold in the U.S. in 2017 so we are talking about an additional $3bn flowing from consumers to steel manufacturers. But of course, you have to do the same math for anything consumers buy that has steel or aluminum in it. For example, the Beer Institute (yes, that’s a real thing apparently) made the following claim on Friday:
“According to third-party analyses, this 10% tariff will create a new $347.7 million tax on America’s beverage industry, including brewers and beer importers, and result in the loss of 20,291 American jobs.”
Now the jobs number seems a little precise, but regardless, this is serious if the price of beer is going up!!
And I can’t believe I’m going to do this, but I’m going to quote the Wall Street Journal editorial page. Usually I read it to get well and truly frustrated every morning, but they did have a couple useful nuggets on Friday:
“Mr. Trump seems not to understand that steel-using industries in the U.S. employ some 6.5 million Americans, while steel makers employ about 140,000. Transportation industries, including aircraft and autos, account for about 40% of domestic steel consumption, followed by packaging with 20% and building construction with 15%. All will have to pay higher prices, making them less competitive globally and in the U.S.
Instead of importing steel to make goods in America, many companies will simply import the finished product made from cheaper steel or aluminum abroad….Mr. Trump has handed a giant gift to foreign car makers, which will now have a cost advantage over Detroit..”
I can’t believe I just did that. Won’t happen again.
And then there is the risk of retaliation. Will Canada levy tariffs on Harley’s? How about China putting a tax on Boeing imports or Levi’s? What happens with the NAFTA negotiations?
From The Economist:
“Chrystia Freeland, Canada’s foreign minister, promised her country would “take responsive measures to defend its trade interests and workers”. Mexico is reportedly planning retaliatory measures, too. The Chinese are unlikely to refrain from action. In 2009, after Barack Obama imposed safeguards on Chinese tyres, China responded with (illegal) restrictions on America’s chicken-feet exports. America’s agricultural sector is bracing itself for retaliation.”
Will the proposed policy turn into law? It is far from a sure thing given this administration. Next week will be interesting.
From Three Dots to Four
The other major event this week also came from the government, but this time the Fed. Federal Reserve Chairman Jerome Powell testified in front of Congress this week. His speech was widely watched because investors are trying to get a handle on what he thinks about inflation and future policy changes. Key points include:
1) His general remarks were more hawkish than anticipated. He was generally upbeat on growth prospects and the odds of inflation hitting the 2% target this year.
2) Probably the key phrase was the following because it actually acknowledged the chances of the economy overheating:
“In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis.”
3) With this Powell is breaking from Yellen’s legacy. Her comments were always in the context of attempting to achieve maximum employment. His are now tilting towards avoiding overheating.
What this meant is that the odds of four hikes this year kicked higher to 1 in 3.
Tim Duy noted the following about Powell’s testimony:
“Bottom Line: What of the implications for policy in the wake of Powell’s visit to Capitol Hill? If the testimony reflects the views of the FOMC, and the FOMC’s concern has shifted to overheating, then the odds are high that enough dots shift up in the next Summary of Economic Projections that the median dot shifts to from three to four (I may have been too sanguine on this issue). Second, the median dot for 2019 will likely shift up to a firm three. But most important is that policy may now be on a hair trigger more than I anticipated.”
The next Fed meeting is March 20th and 21st.
And Then There is Italy
Well if you haven’t had enough of politics pushing the markets to and fro, you’ll be happy to know Italy holds another election Sunday. And this one should be entertaining. Not only because Italy has managed to have 65 different governments in the last 72 years, but because there is no clear leader.
Five Star Movement (created by a former comedian) is running ahead in the polls, as you can see below, but Forza and the Northern League are tied together in a right-wing electoral alliance.
And guess who leads this alliance? None other than Silvio Berlusconi. This man is resilient. Despite numerous sex scandals (he bought us bunga bunga parties), more than 20 trials on charges ranging from false accounting to bribing judges, and a tax fraud conviction, he stands a chance of winning an outright majority. Now he cannot be Prime Minister because his conviction bars him from office until 2019. But he says he would run again next year if given a mandate.
He’ll be 83 then.
Have a good weekend.
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