Trade warfare or shade warfare? | USAEMALL.com

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Good morning. There is unambiguously good market news out there, if you look hard enough. Vanguard, the investor-owned fund manager, is cutting fees not only on passive stock index trackers but also on its active bond funds. Shares of other fund managers fell sharply on the news. Hurrah for cost competition, and here’s hoping it reaches the corners of finance where it is most needed: private assets, investment banking and card networks, for starters. Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.

Pricing uncertainty

Here are some questions. Take a moment to answer each on a scale of 1-5, with 5 being a strong yes, 1 being strong no and three being perfect equipoise:

1. Will negotiations during the one-month tariff reprieve for Canada and Mexico lead to tariffs significantly lower than 25 per cent?

2. Can Europe earn a similar tariff reprieve?

3. Were the Mexico and Canada reprieves part of a plan, or was the decision taken by President Donald Trump yesterday?

4. Were the reprieves motivated, in part, by markets’ negative reaction to the original tariff announcements, and does the market recovery after they were announced mean a softer US position on tariffs is more likely?

5. Are any concessions that any country with significant US trade surplus can offer enough for Trump to keep tariffs low — say, below 5 per cent?

Unhedged thinks the answers to these questions are very important to how markets will act in the short and medium terms. We answer “3” to all of them. We have no idea about any of it. If you answered with more confidence on any of those points, we want to take whatever pills you are taking. For now, all we can do is map the market’s reaction and try to sketch the consensus view.

So where did US markets settle yesterday?

• The yield curve flattened slightly, with short-term (three-month and two-year) Treasuries inching up and long-term (10- and 30-year) Treasuries inching down. The simplest read on this is the market is nudging up its inflation expectations and shading down its growth expectations. The fact that inflation-protected yields fell more than nominal yields supports this reading. But the moves were small and it was just one day.

• The S&P 500 dropped less than a per cent. Small caps — which readers will remember were a large early beneficiary of the Trump trade, given their exposure to the domestic economy — were off 1.3 per cent.      

• The higher odds of tariffs were reflected in a stronger dollar, which (as our colleagues at Lex point out) may help to explain the poor performance of Big Tech companies yesterday, as their heavy foreign revenues are shrinking in dollar terms. 

• Domestically focused cyclicals, particularly the transports (Norfolk Southern, JB Hunt, Union Pacific, FedEx and UPS) did not have a good day. This also highlights the way tariffs might spook investors in companies leveraged to the US rather than the global economy.

• Domestically focused defensives (healthcare companies, Walmart, Costco, Kroger and Waste Management) were up 1-2 per cent. 

• Domestically focused energy companies, particularly refiners such as Valero and Marathon and pipeline companies such as Targa and Williams, did nicely too. Higher US energy prices help them. 

• The stocks we and everyone else thought would take the biggest tariff hit — automakers and homebuilders — did fall 2-3 per cent. We still don’t know what tariffs will be imposed on a sustained basis, but some additional tariffs are being priced in. 

• Gold rose nicely, whatever that might mean. Maybe it’s the lower inflation-protected (ie real) yields? Or central bank buying? Or a flight to safety? Or the tooth fairy?

All of this tells a more or less unified story. The market is in a bit of a defensive crouch, though given how expensive stocks remain and how moderate the aggregate moves were yesterday, not a very deep one. Maybe this is because the market doesn’t like high tariffs and the possibility of tariffs went up, the Mexican and Canadian reprieves notwithstanding. Or maybe it’s because the market simply doesn’t know what is going on in any area of economic policy, and it doesn’t like that. Once again, Unhedged is pretty neutral between those two explanations.

China tariffs

Trump’s will-he-or-wont-he-tariffs on Mexico and Canada have been the focus of the market and the media, for good reason. But Trump also hit China with 10 per cent across-the-board tariffs. These will matter too.

China has long been in the tariff crosshairs. Trump hit China with trade duties in his first term, which were built upon by Joe Biden. The new tariffs are additive, “bringing the effective tariff rate to around 15 per cent”, according to George Magnus of the Oxford China Centre. These are much softer than his campaign promise of 60 per cent across-the-board tariffs on day one. China appears to have gotten off easy, then. But the new tariffs will have an impact, and there are risks of more in the future. 

The US is heavily dependent on China for machine tools, appliances and cheap knick-knacks (“miscellaneous manufactured articles”): 

That leaves several US industries exposed. Consumer companies such as Whirlpool and Apple, low-price retailers sellers such as Dollar Tree and industrial companies including Caterpillar fell yesterday. But for all these companies it is hard to tease out the direct impact of higher input prices from the indirect impact of the higher dollar.

China will feel some pain, too. Though China surprised the world when it hit its year-end growth target last year — largely by juicing exports — its manufacturing sector is still struggling. Yesterday, its January manufacturing PMI survey came in below estimates and showed the sector is flirting with contraction:

Additional tariffs — and the threat of even more down the road — will weigh on exports and general “animal spirits” in the manufacturing sector, said Ben Uglow of Oxcap Analytics. They will also make it harder for the Chinese government to support consumer sentiment and consumption. This could all be offset to some degree if China lets the Renminbi depreciate — but that would invite US retaliation.

Pressure on China may rebound on the US economy, too. While the rest of the world has battled inflation, China has been fighting deflation. Chinese price growth has been well below US and western inflation for the past few years, and has occasionally dipped into deflation:

Many have suggested that China has “exported deflation”, or at least disinflation, by selling goods at prices outpaced by inflation in the west. To the extent that is true, US consumers may face a jump in CPI as prices for Chinese goods rise. They may also see higher prices on domestically produced goods, as US companies pay more for Chinese equipment. 

The Trump administration seems to think that any pain China tariffs cause in the US will be worth it for the boost provided to domestic industry. That may be. But the pain will come first. 

(Reiter)

One good read

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