Daily Comment (June 15, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s Friday, the close of a very busy week.  Today will be active, too.  Here’s what we are following:

Tariffs: As expected, the Trump administration leveled tariffs on $50 bn of Chinese imports this morning.  The action will be broken into two tranches; the first set, applied to 818 product lines and $34 bn in value, will come into force on July 6.  The remainder, on 284 product lines and $16 bn in value, will be applied later after further review.  These tariffs will affect mostly aerospace, robotics, manufacturing and auto parts.  China has already indicated it will retaliate[1] in kind, with the focus being on agricultural products.

In other trade news, Mexico is considering another $4 bn in tariffs[2] that would be applied to corn and soybeans.  We note that soybeans peaked near $10.62 per bushel in late May; this morning, prices are trading at $9.28 per bushel, down just over 12.5%.  Corn is acting in a similar fashion, down 13.7% from the recent high.  Although trade fears are playing a major role in the weakness, we note that growing conditions are nearly perfect.  Soils were moist, but favorable breaks in the rain allowed the crop to be planted on time.  Now we are seeing warm and wet conditions, which will offer the promise of another bumper crop.

In addition to Chinese tariffs and Mexican retaliation, the president wants to put tariffs on foreign cars before the midterms.[3]  The Reagan administration implemented “voluntary” import restraints on steel and cars in the 1980s[4] but conditions were much different then.  Country of origin could be more easily determined at that time.  Now, auto manufacturing is truly global, with parts and production dispersed around the world.  Optically, a foreign auto tariff could be popular before an election but actually executing it could prove harder than it looks.

In watching how markets are taking this news, it is clear that equities are not pleased.  Tariffs should be considered inflationary (it’s a consumption tax on imports, after all) but bond yields are continuing to decline, suggesting that long-duration buyers are confident the Fed will raise rates enough to counter the potential inflationary impact of tariffs.  We are less confident; our position is that Trump is Nixonian in his stance on monetary policy and, once policy tightens enough to “bite,” Chair Powell will find himself the target of tweet eruptions.  But, so far, nothing like that has happened so the bond market is focusing on the economic depressant effect of tariffs.

Merkel under siege[5]: Chancellor Merkel actually leads two parties, the Christian Social Union (CSU) and the Christian Democratic Union (CDU).  The CSU, though conservative, is a regional party.  It operates only in Bavaria and currently holds 46 seats (out of 709) in the Bundestag.  The CDU, on the other hand, has 200 seats and operates in the other 15 German states.  The CSU is generally more conservative on social matters and less market oriented compared to the CDU.  The CSU has been quite uncomfortable with Merkel’s open border policy on refugees.  Recently, Horst Seehofer, the leader of the CSU and current interior minister, offered a plan to tighten Germany’s asylum program.  Part of this plan would give German police the power to prevent asylum seekers from crossing into Germany if they have registered as refugees in another EU state.  This policy runs in direct contradiction to Merkel’s border and refugee policy.  It’s likely that Seehofer is worried that the AfD, a right-wing populist party, could gain a majority in Bavarian elections expected later this year.  The AfD holds an anti-immigrant policy stance that, as in other countries, has become favored among right-wing populists.

There have been rumors that this internal spat could lead to a collapse of the Merkel government.  We doubt that’s the case but it is clearly undermining support for Merkel, and her government is rather fragile anyway.  What it is clearly doing is focusing Germany inward during a period when leadership would be welcomed.  For example, Italy is threatening to scuttle the recently negotiated Canada/EU free trade deal.[6]  A distracted Germany makes such events more likely.

A new Colombian president: Ivan Duque appears likely to become the next president of Colombia in Sunday’s elections.  He is 42 years old and, if elected, would become the youngest president in the nation’s history.  A conservative, he is supported by former President Alvaro Uribe.

Bitcoin is not a security:The SEC ruled yesterday that Bitcoin and Ethereum are not securities.  It isn’t clear who will become the regulator (our bet is that the CFTC will get the role), but Initial Coin Offerings are securities.  Bitcoin jumped on the news.

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[1] https://www.reuters.com/article/us-usa-trade-china-ministry/china-promises-fast-response-as-trump-readies-tariffs-idUSKBN1JB0KC

[2] https://www.reuters.com/article/us-usa-trade-mexico-exclusive/exclusive-mexico-studies-tariffs-on-billions-of-dollars-of-us-corn-soy-idUSKBN1JA353

[3] https://www.politico.com/story/2018/06/14/trump-tariffs-foreign-cars-midterms-627528

[4] Robert Lighthizer, the current USTR, was a deputy USTR when these voluntary restraints were negotiated. https://www.nytimes.com/1984/09/20/business/voluntary-import-restraint.html

[5] https://www.ft.com/content/e6a9315a-707f-11e8-92d3-6c13e5c92914

[6] https://www.ft.com/content/13ce4184-6fe5-11e8-92d3-6c13e5c92914?emailId=5b234205317bb80004a73d83&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22