Daily Comment (May 13, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Good morning, all!  Equities are soft this morning due to rising tensions in trade and the Middle East.  Here are the stories we are watching:

China responds: This morning, China decided to impose tariffs on $60 billion of U.S. goods starting June 1.  The decision was expected after the U.S. raised tariffs on Chinese imports last week.  The escalation in trade tensions will persist as President Trump continues to ratchet up pressure on China to secure a deal before he starts campaigning for reelection.  The sides were rumored to be close to an agreement as recently as 10 days ago, but negotiations took a turn for the worse after the U.S. accused China of reneging on the deal.  The trade tensions will likely weigh on exported goods such as soybeans.

Oil tankers attacked: On Sunday, two oil tankers from Saudi Arabia were attacked as the vessels were approaching the Strait of Hormuz.  It was also reported that four vessels from the United Arab Emirates (UAE) were sabotaged one day prior.  Although no group has come forward to take responsibility for the attack, it is widely perceived that Iran may have had some involvement due to Saudi Arabia’s and the UAE’s relationship with President Trump.  Iran has vehemently denied any involvement in either incident but has warned against “adventurism” within the region.

The rise of U.S. military presence within the Middle East may have added to mounting geopolitical risks in the markets.  Last week, in response to intelligence gathered by allied forces, the U.S. deployed military forces into the region in order to counter an escalation in Iranian aggression.  According to the intelligence, Iran has been mobilizing forces in Iraq and Syria in order to provoke the U.S. into military overreaction.  Intelligence officials believe Iran wants to escalate tensions in order to boost domestic nationalism as sanctions continue to weigh heavily on the economy.  Continued escalating tensions would be supportive of oil prices.

Car tariffs: On May 18, President Trump is expected to announce his decision on whether to impose tariffs on car imports and components.  In February, Trump received a report from Commerce Secretary Wilbur Ross about the possibility that autos represent a national security risk.  The president could use section 232 of the Trade Expansion Act to impose tariffs on cars in the same way he used it to impose tariffs on steel and aluminum.  Thus far, the report has not been made public but it is speculated to have concluded that autos do represent a security risk.  If true, this would be a serious escalation in trade tension with the U.S. and its allies, namely Europe, South Korea and Japan.  In addition, this could hurt automakers domestically as tariffs could potentially disrupt global supply chains.

The threat of rising trade tensions have put U.S. allies on edge as they struggle to deal with growing American protectionism.  South Korea, which has already renegotiated its trade deal with the U.S., is expected to ask for an exemption from the tariffs.  The EU, on the other hand, is expected to respond with tariffs of its own.  As global trade tensions continue to rise, we expect equities to suffer as uncertainty will deter business investment.

Fed news: Over the weekend, it was revealed that the White House is considering nominating Judy Shelton to the Federal Reserve Board.  She was a former economic advisor to the president and is known for her support of a return to the gold standard.  Her nomination would be unique due to the fact that people who support the gold standard are generally hawks and the president was believed to be looking for doves to fill the vacant board seats.  That being said, a return to the gold standard would be supportive for a stable trade balance.  We suspect Judy Shelton’s nomination could be a sign that the trade hawks, such as Wilbur Ross and Peter Navarro, now have the president’s ear.  If Judy Shelton is nominated we expect her to be confirmed rather easily as she does not have the baggage of the previous two nominations.

In other Fed news, Minneapolis Fed President Neel Kashkari stated on Friday that the Fed should take income inequality into account when deciding whether its goal of maximum employment is being met.  Income inequality has become a pressing issue following the financial crisis and Kashkari’s support for including it in rate decisions suggests that he favors holding rates at their current level or possibly easing.

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