All week long, the market has been preoccupied with the hurried effort to strike a new trilateral trade deal to replace NAFTA, which the Trump administration is intent on renaming in order to dispense with what the President says is a “negative connotation” associated with the old acronym.
There was real progress on that front on Monday as the U.S. and Mexico settled differences on the way to striking a bilateral deal that paved the way for Canada to return to the table. Now, the race is on to come up with an inclusive agreement that will pass muster on Capitol Hill.
The read-through for the trade dispute with China is not good. Trump and administration officials variously indicated that Beijing would “have to wait” now that the ball is rolling with Mexico and Canada (and possibly Europe). That, after low-level negotiations between David Malpas and a Chinese delegation held earlier this month went nowhere.
The second round of 301 investigation-related tariffs went into effect on 23rd, affecting $16 billion in Chinese goods. That was the second tranche, and brought the total amount of Chinese imports subject to duties in connection with the 301 probe to $50 billion.
The next round is set to see the Trump administration slap tariffs on $200 billion in additional Chinese imports. That would mark the most serious escalation yet and earlier this month, Beijing announced that if Washington moves ahead with that, China will impose “differentiated tariffs†on some $60 billion in U.S. items.
You might recall that late last month, Trump directed Robert Lighthizer to ponder hiking the proposed tariff rate in the next round to 25% from 10%, an apparent effort to raise the stakes and force China to relent.
Well, on Thursday afternoon, Bloomberg’s Jennifer Jacobs reported that according to a half dozen sources, “Trump has told aides he wants to move ahead with the plan to impose tariffs on $200 billion in Chinese imports as soon as the public-comment period concludes next week.”
To be clear, this is bad news for any number of reasons. First, it has the potential to negate the positive sentiment engendered by the progress on NAFTA. More importantly, it could catalyze a fresh leg weaker in the yuan, which the PBoC has gone to great lengths to stabilize this month. Finally (and we’ve talked about this at length), from here on out, it will be impossible for the administration to avoid a scenario where additional tariffs end up bleeding over into consumer prices.
Last month, SocGen’s Omair Sharif spent quite a bit of time documenting the read-through for inflation if Trump does indeed move forward with tariffs on an additional $200 billion in Chinese goods. “Unlike a similar $50 billion list unveiled in April, which was composed largely of industrial supplies and components, the proposed $200 billion tally includes a slew of finished consumer itemsâ€, Sharif wrote, referencing the USTR list published last month, before reminding you that “according to the Peterson Institute, consumer goods account for about $44 billion, or nearly 23%, of the proposed list.â€
(SocGen)
He went on to explain what this would mean for inflation as follows:
With about 4.5% of the core CPI subject to a 10% tariff, and assuming that it is entirely passed on to consumers, the impact from the implementation of the tariffs would be around 45 bps on the yoy core CPI rate. As we saw with tariffs on laundry equipment this year, tariffs on household appliances could ripple through into retail prices relatively quickly.
Again, that assessment was based on the assumption of a 10% tariff on the new list. A couple of weeks later, Bloomberg quoted Sharif on the way to explaining what would happen in the event the tariff rate is 25% in the next round as opposed to 10%. Here’s the relevant excerpt:
Implementing the tariffs would complicate the Federal Reserve’s decision-making on interest rates. Omair Sharif, an economist at Societe Generale in New York, said a 25 percent tariff on the entire $200 billion product list could cause inflation to surge by 1.1 percentage point. Assuming the levies get passed along to customers, the annual increase in the consumer price index, excluding food and energy, would jump to 3.4 percent from the current rate of 2.3 percent.
As noted there, this muddies the waters for the Fed. If tariffs start to push up consumer prices at a time when inflation is already starting to show nascent signs of overshooting, it could prompt more hawkishness, thus driving the dollar higher and exacerbating the risk-off sentiment that would already accompany heightened trade frictions.
As soon as the headlines hit on Thursday, USDCNH spiked:
(Bloomberg)
This was just about the last thing emerging markets needed on a day when fears of contagion from Argentina and Turkey are showing up across developing economy assets.
One more time: the biggest tail risks right now are a further escalation in the trade conflict between Washington and Beijing and the prospect that any such escalation could prompt a renewed bout of dollar strength.
I hope you enjoyed your stay at all-time highs on U.S. benchmarks, because this certainly undermines the bull case.
As previously noted this is probably the melt up. Between the trade war, November elections, and Trump legal issues it’s all downhill from here.
It would be nice to share your enthusiasm for the Mexico-US deal but it looks to me as if this was a ploy to hurt Canada, as the President was piqued by the Canadian Prime Minister. Yes, that petty. As you have noted it’s not really a deal so much as a heads of agreement, and the auto component of the deal looks difficult if not impossible.
Trump doesn’t like multilateral agreements. He shares this predilection with a former leader of his ancestral homeland and I reckon it’s for the same reason: easier to bully. It is truly bizarre that the personal is ruling the logic of national and international self-interest but it does seem to be true.
He’ll be scratching his head as to how to avoid zero auto tariffs with the Europeans, but I imagine he’ll find a way.
Going ahead with more hits on China is not going to lead to anything happy. China will not back down and will do whatever it takes.
Comrade Vlad! The golden shower tape! Leak it! The world will look more kindly on you!
The new NAFTA is a nothing burger. Mexico is basically saying they are already in compliance, I doubt Canada will have much problem. It is as if you did not like your dessert and they took it back into the kitchen and put on some more whipped cream. Trump is sitting in his chair clapping like a toddler with no idea of what is actually going on.
Yikes, inflation at 3.4%. i can’t even wrap my head around that one. The Fed will be way behind the curve.
If that 3.4% rate were sustained, it would necessitate a much more aggressive domestic rate hike schedule to throttle it down. This aggressive rate hike schedule is something that our domestic debt laden economy would have difficulty dealing with. I don’t think such a situation is even partially sustainable. Could you imagine a 0.5% quarterly rate hike?. It would send shock waves throughout the global economy and further potentiate the currency issues that you have detailed out so well in the last 6 months. The surprise element alone would send even our strong domestic equity market into, at minimum, a significant correction.
Thanks again for helping all of us understand all of the global intricacies of what’s going on. So many moving parts. Debt and leverage, something our POTUS is enamored with, can bite back fiercely when provoked. He can’t declare bankruptcy this time.
I find it difficult to understand how one country (USA) can force another country (Mexico) to impose a minimum wage on specific private companies (auto makers).