Stock market takes sharp hit on Trump’s Chinese trade broadside
U.S. durable goods orders should remain strong
U.S. new home sales expected to recover part of 2-month loss
Expectations for BOE rate hike by summer should support sterling
Stock market takes sharp hit on Trump’s Chinese trade broadside — The Trump administration on Thursday went ahead with its announcement that the U.S. will slap $50 billion per year worth of tariffs on Chinese products. There will be a 15-day public comment period before the final list of tariffs is announced. The list of products could involve as many as 1,300 specific imports. The U.S. IP retaliation package will also include major restrictions on the ability of China to invest in the U.S., with that provision taking effect in 60 days.
The Trump administration did not seem to leave any room for China to negotiate its way out of the tariffs, meaning the tariffs seem likely to go through in 15 days. President Trump said later in the day that the amount of the tariffs could go even higher to $60 billion per year.
The big question now is how China will respond. China will likely respond with some offers of cooperation and negotiations. However, the size of the package suggests that Chinese President Xi Jinping, who was just effectively designated as “president for life” by the National People’s Congress, will likely be forced to retaliate to some degree so that he doesn’t look weak domestically. There have been reports that China plans to retaliate with tariffs on U.S. ag exports to China such as soybeans, sorghum, and hogs. The idea would be to put political pressure on Mr. Trump by hurting the parts of his base that are located in rural America.
If China does retaliate, Mr. Trump could decide to hit China with another round of tariffs in a spiraling tit-for-tat trade war. Mr. Trump has said that he thinks it would be easy to win a trade war, which means he may show little restraint in hitting China even harder.
On the brighter side, the Trump administration on Thursday said that a number of nations would get an initial exemption from the steel and aluminum tariffs that take effect at 12:01 AM ET on Friday. These countries include the EU, Australia, Argentina, Brazil and South Korea. Mexico and Canada have already been given exemptions as long as NAFTA talks are proceeding. These temporary exemptions as least mean that any retaliatory action from those nations will be deferred until they see if they will actually be subject to the tariffs.
The Chinese tariff package and steel-aluminum tariffs are clearly bad news from a macroeconomic standpoint. The tariffs will force U.S. consumers to pay higher prices for imported products and will push inflation higher, thus putting more pressure on the Fed to raise interest rates. In addition, any retaliation by China and other affected countries against U.S. exports will hurt the U.S. economy. Basic economic theory teaches that tariffs are a lose-lose proposition that carry a deadweight loss.
The U.S. stock market fell sharply on Thursday as the market fretted about a U.S.-Chinese trade war. The Chinese negative tariff news added to Wednesday’s worries about higher interest rates after the FOMC raised its Fed-dot forecast for the funds rate in 2019-20.
U.S. durable goods orders should remain strong — The market consensus is for today’s Feb durable goods orders report to show an increase of +1.6% and +0.5% ex-transportation following Jan’s report of -3.7% and -0.3% ex-transportation. Meanwhile, Feb core capital goods orders (ex defense and aircraft) are expected to show a solid gain of +0.9% m/m, more than offsetting Jan’s decline of -0.3%.
On a year-on-year basis, durable goods orders have been very strong over the past year and rose by +7.0% y/y in January for both the headline and ex-transportation series. Core capital goods orders in Jan were also strong at +6.3% y/y.
The U.S. manufacturing sector is seeing a strong inflow of orders due to the strong U.S. and global economies. In addition, the weak dollar is helping U.S. exports. Order flow should remain strong in coming months as global growth remains strong and as the U.S. Jan 1 tax cuts help to boost capital investment. Manufacturing confidence remains strong as seen by the 14-year high of 60.8 seen in the Feb ISM manufacturing index and the strong Feb ISM manufacturing new orders sub-index of 64.2.
U.S. new home sales expected to recover part of 2-month loss — The market consensus is for today’s Feb new home sales report to show a +5.2% increase to 624,000, recovering a majority of Jan’s -7.8% decline to 593,000. New home sales spiked higher by +13.0% in November to a 10-1/4 year high of 696,000 units, but then more than gave up that gain in Dec-Jan with a combined monthly decline of -15.4%.
U.S new home sales should remain solid due to strong consumer confidence and strong home demand in general. However, new home sales are seeing some headwinds from tight supplies, high prices, and rising mortgage rates. The 30-year mortgage rate in the past two months has risen sharply by about +40 bp to a 4-year high of 4.36%.
Expectations for BOE rate hike by summer should support sterling — GBP/USD on Thursday rallied to a new 1-3/4 month high after the BOE meeting, although it then fell back to close the day slightly lower. GBP/USD remains near the top of its 2017/18 rally. Bullish news this week included (1) the Brexit 21-month transition agreement with the EU, and (2) the 75% market odds for the Bank of England to raise interest rates another notch at its May meeting in response to above-target inflation. The BOE on Thursday voted 7-2 to leave rates unchanged, with two dissenters favoring an immediate rate hike.