U.S. Trade Deficit, Market Cap Surplus
What happened last week?
The S&P 500, Dow Jones, and Nasdaq gained 1.74%, 2.15%, and 1.65%.
Oil prices declined $2 a barrel when President Trump pressed for greater OPEC+ supply to bring down prices when addressing the World Economic Forum. Such a dynamic would help cool inflation and hobble Russia’s ability to wage war in Ukraine.
Trump also spoke about trade, both tariffs and taxes as incentives to manufacture in the US, and he called on China to pressure Russia towards a ceasefire. He demanded rates drop immediately although the Fed is expected to hold steady on January 29. We note that oil prices and 10-year Treasury yields, at 4.62% on Friday, often move in tandem.
3 Things to Know
Equities, Bonds Rally in Relief After Overblown Tariff Fears
Donald Trump’s inauguration as the 47th US President followed the script of his campaign. As promised, his swearing in was immediately followed by many consequential executive orders and pronouncements of policy changes to come.
We believe it marks a change towards higher risk, higher reward US policies aimed at changing the nature of the US economy.
With promises of large tariffs on “Day 1,” the announcement of new tariffs on Canada, Mexico and China “likely” on February 11 fell short of market fears. It left the legitimate chance that the new tariffs can be bargained away for concessions on border controls and illicit drug trade.
The relief from greater trade fear, coupled with fundamental strong news on the corporate earnings front, sent equities sharply higher over the past week and bond yields mixed.
At the same time, the news is likely just the very beginning of a long period of trade uncertainty.
US business confidence is surging on deregulation hopes and greater tax clarity. At the same time, the predictability of US policy has been reduced. The potential reward for the US comes with risk of unintended consequences. The chance that tariffs generate retaliation and supply shocks in not insignificant. We have reduced confidence in the US inflation outlook this year as a result.
Tariff Threats Remain a Bargaining Chip
Full and broad imposition of the new tariffs on Mexico, Canada and China would raise nearly 10X the tariff revenue than more targeted tariffs on China in 2018 if one assumes a static impact on trade flows.
This is a potentially large share of US economic activity and much larger one for Canada and Mexico. But these are estimates at the extreme end of what is likely if Mexico and Canada instead absorb costs associated with US border control.
We imagine similar dynamics may play out in US trade disputes to come with Europe. The Trump administration is keen for Europe to step up the financing of its security and potential reconstruction costs for Ukraine. Tariffs are unrelated to these issues but may still be used by the US as negotiating leverage.
Threats a Likely Feature of Policy in the Coming Years
The fact that the US exports less than it imports suggests Trump will have much greater leverage than trading partners when picking a tariff fight.
For many individual trading partners, the significance of exports to the US is much larger than the significance to the US of these imports. Mexico and Canada are the clearest examples of this.
But this is not to suggest there will be no pain from a trade conflict. US firms that rely significantly on China’s economy for both inputs and consumer demand have been sharp outperformers to local Chinese shares.
In general, the equities of US firms have been great beneficiaries of global supply and demand sources, making the best of the wider world. While it is possible to produce more goods in the US and reduce imports, the net of this may not be consistent with continued outperformance of US equities.
For many large cap firms in the US and elsewhere, their business is not a close reflection of local macroeconomic measures.
See our weekly CIO Strategy Bulletin for more details