Trump tariffs on steel and aluminum spark fears of higher inflation and retaliation
U.S. consumer sentiment index expected to be revised slightly lower but remain strong
Markets go into the weekend Italian election and German coalition news with little regard for tail risk
Trump tariffs on steel and aluminum spark fears of higher inflation and retaliation — The U.S. stock market on Thursday sold off sharply after President Trump announced that he will slap tariffs of 25% on steel imports and 10% on aluminum imports from any country.
The markets were somewhat surprised since press reports early Thursday suggested that administration moderates had convinced Mr. Trump to delay the decision. The fact that Mr. Trump went ahead with the announcement on Thursday morning indicated that the administration’s trade hardliners are in the driver’s seat.
The aggressive administration trade stance on steel and aluminum also does not bode well for the ongoing NAFTA talks. The markets will likely have a much bigger negative reaction if Mr. Trump were to make good on his threat to unilaterally withdraw from NAFTA since that would affect the supply chains and sales of many U.S. companies.
The steel and aluminum tariffs are negative for the U.S. markets due to upward pressure on inflation and the likelihood of some retaliation from China, Europe, and other countries. The new steel and aluminum tariffs add to previous Trump administration moves to slap tariffs on solar equipment, washing machines, and aluminum foil. As the list of tariffs grows, American trade partners are under pressure to retaliate in order to raise the cost on the Trump administration of imposing any more tariffs.
China is reportedly considering trade retaliation on U.S. exports of sorghum, soybean, and aircraft. Europe is reportedly considering retaliation on Harley-Davidson motorcycles (since the company’s headquarters is in Speaker Ryan’s home state of Wisconsin), bourbon (Majority Leader McConnell’s home state product), and various agriculture products.
President Trump’s steel and aluminum tariffs, which were imposed under the thin pretext of national security, substantially raised the possibility of an extended cycle of tit-for-tax protectionist measures. There remains an outside possibility that tit-for-tax trade measures could eventually mushroom into an all-out trade war. The markets are well aware that the Smoot-Hawley tariffs in 1930 were a factor that worsened the Great Depression.
U.S. consumer sentiment index expected to be revised slightly lower but remain strong — The market consensus is for today’s final-Feb University of Michigan U.S. consumer sentiment index to show a -0.4 point decline to 99.5, which would leave the index up by +3.8 points from January, less than the preliminary increase of +4.2 to 99.9.
The early-Feb index level of 99.9 was strong at only -0.8 points below the 14-year high of 100.7 posted in Oct 2017. The Conference Board’s U.S. consumer confidence index is in even better shape with the Feb index rising by +6.5 points to a new 17-year high of 130.8.
U.S. consumer confidence improved substantially in February despite the early-Feb plunge in the stock market. U.S. consumer confidence in February was bolstered by increased after-tax income due to the tax cut bill that took effect on January 1. Indeed, the Commerce Department on Wednesday reported that real disposable income in January rose sharply by +0.6% m/m, the largest gain in five years. The Commerce Department said that the increased income was driven by a $30 billion increase in one-time bonuses and a $115 billion annualized decline in personal taxes.
U.S. consumer confidence also has continued support from (1) rising home prices, which are boosting household wealth, and (2) the strong labor market and upward pressure on wages. Negative factors include (1) Washington political uncertainty, (2) rising interest rates, and (3) the recent downward correction in stock prices.
Markets go into the weekend Italian election and German coalition news with little regard for tail risk — The markets are not particularly worried about this Sunday’s key European political events when Italy holds a national election and the Germany’s Social Democrats announce whether members voted to approve a coalition government with Chancellor Merkel’s CDU bloc. The potential complacency increases the chances of a surprise and presents tail risk for the markets.
The odds favor consensus outcomes that have little market impact. Still, elections and votes in the U.S. and Europe over the past two years have produced some shocking upsets, which raises the possibility of a weekend surprise that shakes up the markets on Monday.
The German Social Democratic Party on Sunday will announce the outcome of the 2-week vote among its rank-and-file members. The announcement is expected to show that the party approved the grand coalition proposal with Chancellor Merkel’s party.
Many Social Democrats are unhappy about another coalition government with Ms. Merkel since they have lost political support under previous such coalitions. However, Social Democrats have little choice but to approve the coalition because if they reject a coalition and Ms. Merkel calls new elections, then they will likely end up with fewer seats than they have now. Support for the Social Democrats has fallen since the last election in October.
Moreover, Social Democratic leaders negotiated a favorable coalition deal with Ms. Merkel, which would allow them to promote their priorities.
The market risks from the Italian election are much higher, particularly since Italian law bars public opinion polling in the last two weeks of the campaign. That means that the markets do not have a good read on whether voters might be breaking to one party or another as the election arrives.
In Sunday’s Italian election, no single party or coalition is expected to win a working majority, possibly resulting in a hung parliament and new elections. However, the markets are counting on either a center-right coalition or a grand coalition between Berlusconi’s Forza Italia party and Renzi’s Democratic Party.
The main surprise would be if the anti-EU Five Star Movement has a much better-than-expected showing, which could put them in the position of blocking an establishment coalition. The markets would become very worried if Five Star gains enough seats to somehow work their way into power.
The Italian 10-year government bond yield on Wednesday closed at a tame premium of 130.3 bp above Germany’s yield, which is only +10.1 above the 2-1/2 year low of 120.2 bp posted in early-Feb.
A recent survey by Bloomberg found a consensus view that the odds for a Five Star victory are only about 10%. In that event, however, the consensus was that the Italian yield spread would double to 260 bp, a level not seen since 2013 when the Eurozone debt crisis was raging.