More Tariffs, More Uncertainty

by: Richard A. Anderson

Earlier this month, President Trump announced the United States will impose a new 10% tariff on $300 billion worth of goods imported from China. The new tariffs, which are set to take effect on September 1st, could have a more direct impact on U.S. consumers because the list of target goods include clothes, toys, cell phones, electronics, and other retail items. Up until this point, tariffs levied by the U.S. against Chinese imports have targeted goods that are used mainly as inputs in the manufacturing process, such as steel and aluminum. Those tariffs affected the costs for U.S. companies, but those increases were not necessarily passed through to the consumer. These newest tariffs could hurt consumer’s wallets.

The announcement by President Trump came only days after U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steve Mnuchin returned from Shanghai following a meeting with Chinese officials, where the two sides failed to reach a major breakthrough in negotiations. In addition to his disappointment in the lack of progress in reaching a trade deal, President Trump shared that China has failed to deliver on promises to buy more U.S. agricultural goods and to curb the sale of fentanyl.

Chinese officials responded to the new tariffs by suspending purchases of U.S. agricultural products and devaluing its currency. Chinese purchases of U.S. agricultural products are a major sticking point in the trade talks between the countries, but the devaluation of the Chinese yuan is a far bigger issue. The People’s Bank of China, the country’s central bank, allowed its currency to weaken above the level of 7 yuan per U.S. dollar. This marks the lowest level against the dollar since 2008.

The U.S. responded by officially designating China as a “currency manipulator.” The U.S. designating China as a currency manipulator is more bark than bite. The move doesn’t allow the U.S. to take any additional action against China and the U.S. can’t force China to fairly maintain its currency value. This is just another negotiating tactic that will strengthen the administration’s hand in talks with Chinese officials.

The U.S. has battled Chinese officials about the manipulation of its currency since before President Trump took office. The U.S. previously labeled China a currency manipulator back in the early 1990s during the Clinton administration.

Devaluing its currency allows Chinese exports to be cheaper in international markets. The fear is this could lead other countries to devalue their own currencies, which could lead to a spiral of devaluations that would damage global growth and increase protectionist policies.

This represents another ratcheting up in trade tensions between the two countries that have been negotiating a trade deal for more than fourteen months.

The U.S. and China are set to resume trade talks in early September. It is possible the new tariffs are a negotiating tactic to get China to make concessions in trade talks or deliver on the promises they have previously made. There has been some recent chatter amongst political commentators that the trade talks between the U.S. and China could drag on into next year. For President Trump, finalizing a deal in 2020 could help in his push for re-election as it would be fresh in voters’ minds. For Chinese officials, they may want to wait for election results before locking in a trade deal.

In the meantime, the unresolved trade issues leave more questions than answers and increase uncertainty. Will the U.S. increase the newest tariffs from 10% to 25%? Will China further devalue its currency to offset higher tariffs? Could China, as the United States’ largest creditor, dump U.S. treasury bonds?

This uncertainty is especially problematic for businesses. Economic uncertainty stemming from trade remains a headwind for businesses, particularly when determining capital expenditure plans. Business investment is the second largest component of U.S. GDP, trailing only personal consumption expenditures. More companies have indicated they are holding off on plans to build new plants and purchase new equipment due to the uncertain economic impact of the trade negotiations.

The timing of the new tariffs is not surprising, though.

President Trump’s tariff announcement came less than 24 hours after Fed Chair Jerome Powell announced the Fed is cutting interest rates by 0.25%. President Trump has been outspoken in his criticism of the Fed, arguing that interest rates should be much lower. President Trump was clearly unhappy with the Fed’s decision and additional tariffs could be a means to get the Fed to deliver a series of interest rate cuts.

The on-going trade negotiations with China have sent the markets lower. The graph below shows how different equity indices have performed since the market’s close on July 30th, the day before the Fed’s monetary policy announcement.

08122019_Equity Index Performance.png

When it comes to trade talks with China and market reaction, there seems to be a pattern we see on repeat. This is a loop that has occurred throughout the trade negotiations with China over the past fourteen months.

08122019_Trade Loop.png

Based on this cycle, it seems we are in the markets decline on fears of a trade war phase. The question that no one can answer is whether the two sides can make positive progress towards a trade deal. Each party continues to try to punish the other with tit-for-tat tariffs, but it’s only a matter of time before the economic implications are felt. The U.S. economy has fared better than the Chinese economy throughout the trade talks because it is less dependent on trade. But as business and consumer confidence start to wane, the margin for error in trade talks and monetary policy is becoming smaller.

We continue to remain optimistic a trade deal will get hashed out, though the timeline could be longer than originally anticipated. With both the U.S. and Chinese economies waiting in limbo for a trade deal, both sides should be motivated to get a deal done. We’ve seen, though, that this may not be motivating enough to bring the two sides together.

While the U.S. and China continue to engage in a game of high-stakes chicken, markets will respond to every new piece of information as it is received. Therefore, we believe you should expect more frequent periods of heightened volatility, particularly around Fed policy meetings and U.S.-China trade negotiations.

Author’s Bio:
Richard A. Anderson is a portfolio analyst at HIGHLAND Financial Advisors, LLC based out of Wayne, NJ. HIGHLAND Financial Advisors, LLC is a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management services to help clients focus on what matters most to them.

Richard graduated from Ramapo College of New Jersey where he earned a Bachelor of Science degree in Business Administration with a concentration in Finance. Richard joined the firm in June 2013 and is responsible for assisting HIGHLAND’s Wealth Advisors in developing portfolios to help individuals, families, and institutions reach their financial goals. He is a Level III Chartered Financial Analyst® (CFA) candidate. For more of Rich’s thoughts on the markets and sports, follow him on Twitter and connect with him on LinkedIn.