Daily Comment (June 30, 2017)

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] N.B.  Due to the upcoming Independence Day holiday, the next issue of the Daily Comment will be published on July 5th.  We want to wish you a happy and safe holiday!

We expect a quiet trade today; it’s a summer Friday, there’s a holiday looming, Canada is off today for Canada Day (Happy 150th!) and markets have been rather choppy recently.  A pause to consolidate makes sense.  The key issue we are seeing is a rapid shift in policy expectations.  Although the Fed has been on a tightening path for some time (arguably since the onset of tapering), it appears the ECB, BOE and BOC are in the process of either ending stimulus or beginning to tighten.  Tight policy almost everywhere (the BOJ being the last holdout) hasn’t been a feature in the financial markets since 2007.  Thus, some concern is probably warranted.  However, as we note in this week’s AAW (see below), economic conditions generally would not indicate that a major selloff is in the offing.  Thus, if one occurs, it will probably come from something other than the economy.

Other news items of note:

A trade war brewing?  President Trump ran a campaign promising to restrict trade to boost U.S. growth and jobs.  According to Mike Allen at Axios,[1] the vast majority of Trump’s cabinet opposed deploying steel tariffs.  The report puts the vote at 22-3.  However, Trump was one of the three, thus the plan is expected to move forward.  Tariffs on steel could hit 20% and the report suggests that other items, including aluminum, semiconductors, paper and appliances, could be next.  Trade wars are tricky; it’s hard to avoid self-inflicted wounds.  Raising the price of steel will adversely affect consumers (automakers, for example) and bring inflation.  And, depending on the price elasticity, it can actually reduce demand to the point where domestic steel producers could be harmed.  For example, if the price rises to the point where automakers reduce their steel consumption and substitute carbon fiber or plastic, all could be worse off.  In addition, retaliation is always possible.  If the U.S. hits Chinese steel exports with a tariff, expect China to hit American exports to China, such as agriculture products.  This could get quite interesting.

Rising tensions with China: The issues with China are really a string of tit-for-tat headlines.  The U.S. has approved a $1.4 bn arms sale to Taiwan.[2]  China is building new military facilities in the South China Sea islands.[3]  The U.S. has cut off China’s Bank of Dandong from the U.S. financial system over ties to North Korea.[4]  The bank is rather small but the move is likely designed to send a clear signal to other Chinese banks about their business dealings with North Korea.  It is becoming apparent that the warm ties from earlier meetings between President Trump and Chairman Xi have dissipated.

The G-20: The world group meets next week but already it looks like it will generate lots of news.  Yesterday, we noted that Chancellor Merkel, the host of this gathering, will strongly oppose protectionism and isolationism and made no attempt to veil her displeasure with the U.S.  President Trump announced yesterday he will meet with Russian President Putin; there are reports the administration intends to surround Trump with staff to avoid any compromising images from developing.  These meetings are usually non-events, but this one may be full of “fireworks.”

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[1] https://www.axios.com/exclusive-trump-plots-trade-wars-2450764900.html?utm_medium=linkshare&utm_campaign=organic

[2] https://www.wsj.com/articles/trump-administration-proposes-1-42-billion-in-arms-sale-to-taiwan-1498770781

[3] http://www.reuters.com/article/us-southchinasea-china-islands-idUSKBN19L02J

[4] https://www.wsj.com/articles/u-s-to-sanction-chinese-bank-over-north-korea-financing-1498763996