FIG Topics of Interest



To be clear, there are well-done studies showing that the recent tariffs have translated into higher prices for U.S. consumers. I am not contesting that research. The question is whether those studies give sufficient weight to all relevant variables for the longer run.
To see why the full picture is more complicated, let’s say the U.S. slaps tariffs on the industrial inputs (whether materials or labor) it is buying from China. It is easy to see the immediate chain of higher costs for the U.S. businesses translating into higher prices for U.S. consumers, and that is what the afore-mentioned studies are picking up. But keep in mind China won’t be supplying those inputs forever, especially if the tariffs remain. Within a few years, a country such as Vietnam will provide the same products, perhaps at cheaper prices, because Vietnam has lower wages. So, the costs to U.S. consumers are temporary, but the lost business in China will be permanent. Furthermore, the medium-term adjustment will have the effect of making China’s main competitors better exporters.
Another risk for China is this: As its access to U.S. markets becomes more difficult, China may be tempted to look to Europe. It remains to be seen whether the European Union will adopt additional protectionist measures, but China must consider that the possibility is more than zero.

To understand another feature of the longer-term perspective, consider that the impact of tariffs can be felt in at least two ways. In highly competitive markets, prices have to match costs, and so a cost-boosting tariff really does translate into higher consumer prices. (This is the case with many of the recent U.S. tariffs on China.) But for profitable branded goods, the economics aren’t the same. If the U.S. puts higher tariffs on Mercedes-Benz, for example, the prices of those cars will still exceed their costs of production. Mercedes, wishing to keep some of its strong market position, will probably decide to suffer some of the cost of the tariffs in the form of lower profits, rather than passing them along to its customers.

China has prominent brands as well, be it Huawei in electronics or other firms in exotic food products, and over time it aspires to climb the value chain and sell more branded goods to Americans. In fact China has an industrial policy whose goal is to be competitive in these and other areas. Tariffs will limit profits for these companies and prevent Chinese products from achieving full economies of scale. So this preemptive tariff strike will hurt the Chinese economy in the future, even if it doesn’t yet show up in the numbers.

There is also a broader reason why a trade war with the U.S. hurts China, and this gets to an important point with trade agreements more generally. A U.S. trade agreement with China would (if enforceable) certify China as a place where foreigners can invest and be protected against espionage, intellectual property theft and unfair legal treatment. That prospect of certification is now suspended. That makes investing in China less desirable for many multinationals, not just U.S. ones. That, in turn, limits Chinese domestic wages as well as long-term learning and technology transfer. A U.S. certification of China might even boost Chinese domestic investment, but again that is now off the table.

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“Matching the U.S. dollar-for-dollar on the U.S. tariffs would imply raising a 25% tariff on all U.S. imports, including those that go into China’s exports,” Setser said. “China certainly could do that, but it would in many cases damage China directly.”
Simply responding with its own tit-for-tat tariffs isn’t China’s most likely move, said Brad Setser, a former Treasury official who’s now a senior fellow for international economics at the Council on Foreign Relations.

Chinese policy makers could devalue the yuan to offset the impact of U.S. duties on China’s economy. The offshore yuan weakened 5.5% against the dollar in 2018, drawing Trump’s ire and fueling speculation that the country was deliberately weakening its currency. While it has fallen 1.3% this week, the currency rose on Friday after the People’s Bank of China set its daily fixing at a stronger-than-expected level.

However, China’s painful experience with devaluing the yuan in 2015, which prompted capital to flee the nation, is likely to dissuade a similar move, according to Tao Wang, UBS Group AG’s chief China economist and head of Asia economic research. “China doesn’t like the self-fulfilling outflows that come as a result of depreciation, which tend to diminish domestic confidence,” she said. “In addition, yuan depreciation last year angered the Trump administration and led to higher U.S. tariffs.”

China owns $1.1 trillion of U.S. government debt, more than any other foreign nation. If it pared back its holdings in that $15.9 trillion asset class, that could be a potent weapon. 
However, China doesn’t really have other good options for where to park its $3.1 trillion in foreign-currency reserves -- the world’s largest stockpile -- making this an unlikely path, according to Ed Al-Hussainy of Columbia Threadneedle Investments.
“Any sharp moves higher in U.S. yields both adversely impact the valuation of their existing Treasuries stock and could spark a dollar rally,” the strategist said. “The financial and FX stability risks of this policy could outweigh the benefits.”
“There are some easy things for China to do,” including withdrawing from soybeans, he said.

Futures on the crop have dropped 11% since April 10.

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“Beijing’s policy focus is sticking to stabilization, rather than chasing a rebound,” said Zhuang Bo, chief China economist in Beijing at research firm TS Lombard. “Some parts of the economy are recovering and there is evidence of green shoots. Obviously, if the trade negotiation goes south with tariff hikes this week, China’s economic policy priority will shift back to easing and stimulus.”
The case for China to keep up stimulus to the economy strengthened, with further incoming evidence that the recovery is not yet self-sustaining as negotiators attempt to stave off an escalation of the trade war with the U.S.

Despite upbeat inflation and import data released in the past two days, the recovery remained fragile in April: Core consumer inflation, stripping out volatile food and energy prices, edged down. The main factory gauge pulled back, exports unexpectedly fell, fiscal income growth slowed, and new credit trailed all economist estimates.

Aggregate financing, the broadest gauge of new credit, fell to 1.36 trillion yuan ($200 billion) in April, according to data released by the People’s Bank of China Thursday. Shadow banking also began to shrink after a March expansion. That underscored weak borrowing demand as well as policymaker caution not to overdo the easing.
What Bloomberg’s Economists Say

“An unexpectedly large fallback in China’s April credit data raises fresh doubts about whether the economy has found a bottom. This reinforces our view that policy should remain supportive on both the broad based and targeted fronts.”
Chang Shu and David Qu, Bloomberg Economics in Hong Kong
Click here for the full note

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“A trade deal had been priced into markets, and now we are living through the fallout of altered expectations, so it wouldn’t be surprising to see continued volatility,” said Kristina Hooper, chief global market strategist for Invesco Ltd. “We’re going to see both sides playing a game of chicken.”
Here are some of the possible outcomes from this week’s negotiations:

Tariffs Rise, Talks Continue
U.S. Trade Representative Robert Lighthizer said tariffs on $200 billion in Chinese imports will increase to 25 percent from 10 percent at 12:01 a.m. on Friday. He also indicated the U.S. wants to keep talking.
The Chinese are preparing their own retaliatory duties on U.S. imports should Trump carry out his threat, according to people familiar on the matter. But they, too, are staying at the table.
“Both sides would walk away angry” if tariffs escalate this week, said Clark Packard, trade-policy counsel at the R Street Institute, a think tank in Washington. “But these two countries are the largest economies in the world. After a cooling-off period, they’ll come back to the table.”
“The negotiation is by nature a process of discussion, and it’s only natural to have differences," foreign ministry spokesman Geng Shuang told a briefing in Beijing. "We hope the U.S. will work along with China and embrace each other half way on the basis of mutual respect."
“My most likely scenario is that there’s no final resolution, not for some time,” said Chris Rupkey, chief financial economist at MUFG Union Bank NA. “They’re talking about changing the way another country is doing business. It’s like another country telling the U.S. to stop being capitalist.”
“This is something you have to take week by week,” said Ed Mills, managing director of Washington policy at Raymond James & Associates Inc. “Our base case for this week is that they find a way to delay the tariffs.”
But any preliminary accord would probably require final approval by Trump and Xi at a face-to-face summit. Even after a deal is signed, it could take years to see it succeed in correcting the trade imbalance. The threat of renewed hostilities won’t soon fade.

“The larger question is: can you get a deal, and can that deal stick? That’s where we’ve always been skeptical,” said Mills of Raymond James.

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The European Commission cut its growth forecasts for the euro area and slashed its projection for Germany as it warned that escalating trade tensions threaten to make the outlook even worse.
By Viktoria Dendrinou (Bloomberg) --

Most of the downgrades were less severe than seen in the previous report in February, apart from Germany, where the 2019 prediction was slashed to just 0.5 percent from 1.1 percent. Officials in Brussels warned that the downside risks to the region’s outlook remain “prominent.’

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Wall Street strategists urged calm after the latest threats from President Donald Trump after a series of tweets Sunday afternoon. Trump warned that tariffs on $200 billion worth of Chinese goods could rise to 25% on Friday.
“President Trump’s announcement that the tariff rate on $200bn of imports from China will rise from 10% to 25% lowers the odds of a successful conclusion to US-China trade talks and raises the odds of further tariff escalation. However, we think it is more likely that the increase will be narrowly avoided and believe the odds of tariffs increasing on Friday are 40%.”
“Unless China walks away from the talks (which is not necessarily the same as Vice Premier Liu canceling his trip but rather having no talks at all), we do not expect an escalation of trade tensions into a trade war. Still, we note that the probability of a ‘Trade War today, Trade Deal tomorrow’ scenario remains high, with the potential to accelerate US inflation and to extend the timetable for a US-China trade deal into the 2020 electoral year. We are cautiously optimistic on a US-China trade deal in 2Q but with the tariffs-threat to remain as a way to get concessions from China and to enforce the agreement.”
“There are no clear reports indicating what led President Trump to harden his stance on trade talks, with media reports suggesting it was designed to “send a message” or was in response to China backtracking on previously negotiated points. The timing of the threat suggests it is a tactic designed to increase leverage going into final trade negotiations”.
Raymond James
“The progress towards a US-China deal has been up-ended with renewed tariff threats by President Trump (25% tariff on $200 billion in Chinese goods by Friday + 25% on $325 billion more), apparent balks by the Chinese (especially on tech transfers), and the threat of the Chinese delegation canceling this week’s round of negotiations. We have previously seen President Trump threaten a new tariff package in the lead up to last year’s G20 meeting last year, only to use it as negotiating leverage, leading to speculation that this is President Trump seeking to use the new tariff threats to get a deal across the finish line. Based upon our conversations with our trade contacts, there appears to be a universal belief that this is not negotiating leverage, but what was almost a done deal last week, has derailed in recent days. There is some hope that negotiations could be salvaged, but this situation highlights how tenuous any US-China deal remains.”
“With that in mind we would not take the President’s tweet as referring to an action planned that is set in stone but rather more an expression of frustration as talks have dragged on without reaching a resolution. We expect that any near-term downside moves by the equity markets could be quick to reverse as the US Presidential election of 2020 and a goal of “Made in China 2025″ remain paramount respective agenda items for the leadership of the US and China. In our view these key dates along with the potential considerable economic cost of a protracted trade war (for both countries as well as for their allies and trading partners) will dictate a positive resolution to the current trade dispute sooner than later notwithstanding a near-term ‘increase in hostilities.’ We suggest that investors consult their shopping lists for stocks that might have ‘gotten away’ from them in the recent rally should some ‘tweet-linked’ volatility waft through the markets and push stock prices lower.”

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“This is an unprecedented situation,” said Arlan Suderman, chief economist for INTL FCStone Inc., who has been analyzing commodity markets for almost four decades. “This will impact food prices globally.”
What started with a few dozen dead pigs in northeastern China is sending shock waves through the global food chain.
Last August, a farm with fewer than 400 hogs on the outskirts of Shenyang was found to harbor African swine fever, the first ever occurrence of the contagious viral disease in the country with half the world’s pigs. Forty-seven head had died, triggering emergency measures including mass culling and a blockade to stop the transportation of livestock. Within days, a government notice proclaimed the outbreak “effectively controlled.”
It was too late. By then, the disease had literally gone viral, dispersed across hundreds of miles in sickened animals, contaminated food, and in dirt and dust on truck tires and clothing. Nine months later, the contagion has spread nationwide, crossed borders to Mongolia, Vietnam and Cambodia, and bolstered meat markets globally.
While official estimates count 1 million culled hogs, slaughter data suggest 100 times more will be removed from China’s 440 million-strong swine herd in 2019, the Chinese zodiac’s “year of the pig.” The U.S. Department of Agriculture forecast in April a decline of 134 million head -- equivalent to the entire annual output of American pigs -- and the worst slump since the department began counting China’s pigs in the mid-1970s.
“China will clearly need to import substantial amounts of pork and likely other meat and poultry to satisfy demand,” Luciano told analysts on an April 26 conference call. Chinese meat purchases may also boost sales of soybean meal, a source of livestock feed, in North America, Brazil, and Europe, he said.

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“We suspect transitory factors may be at work,” Powell said, adding inflation should return to the Fed’s target over time, and then be symmetric around its objective.
“If we did see inflation running persistently below, that is something the committee would be concerned about and something we would take into account when setting policy,” he said.

Powell said the Fed believes a few issues were holding back inflation but it’s likely they are transitory like the change in cellphone rates that impacted inflation several years ago. “We’re going to be watching these things carefully to see if that’s the case,” he said.

“Transitory was word of the day,” said Michael Schumacher, director rates at Wells Fargo. “If you look at pricing for fed funds futures for the end of 2019, it moved by about nine basis points. The market is looking a lot more reasonable.”
Schumacher said the market also reacted to the fact that Powell stressed that the Fed is not moving in either direction at this point, though it sees improvement in the global economy and less threat from risk factors, like trade and Brexit.

“They’re in the middle at this point, not sitting on either end of the teeter totter, which is what they had been telling people, but the market didn’t really believe it,” he said.

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The Federal Open Market Committee is all but certain to hold interest rates steady at the close of a two-day meeting in Washington and repeat in its policy statement at 2 p.m. that the central bank will be patient in making future moves.

The meeting includes no updated forecasts, though Chairman Jerome Powell will give his assessment at a press briefing 30 minutes later.

“The concern for many committee members remains the downside risks to inflation,’’ said Lindsey Piegza, chief economist at Stifel Nicolaus & Co. in Chicago. “Further downward pressure on prices could force the Fed to move from a neutral policy stance to a defensive policy stance sooner than later.’’

Most changes in the Fed’s statement are likely to be in its description of current conditions, reflecting the first-quarter growth of 3.2 percent, which was more than expected, and job growth of 196,000 in March. The committee may upgrade its characterization of the labor market, consumer spending and housing activity.

“The economic data is generally improving, but that is unlikely to matter much until core inflation picks up,’’ said Sarah House, senior economist with Wells Fargo Securities in Charlotte, North Carolina. “There is a high bar for additional tightening until core inflation consistently meets 2 percent.’’

“There is no great reason to tweak anything,’’ said Stephen Stanley, chief economist at Amherst Pierpont Securities in New York. “They are waiting to see the whites of the eyes of inflation before moving again. The main impetus for any cut would be a weakening in the economy.’’

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As central bankers meet Tuesday and Wednesday, they’ll see an economy growing strongly while the core inflation rate slowed to 1.6 percent last month. That’s well below their 2 percent goal and continues a persistent undershoot which has prompted a year-long review of the Fed’s price strategy.
“A big part of the policy rethink has to be making the costs and benefits of these trade offs more rigorous and explicit,” said Julia Coronado, founder of MacroPolicy Perspectives LLC in New York. “How much signal do they want to take from the turn down in core inflation given the growing leverage in the corporate sector that could make the next recession deeper?
Just last month Fed officials were divided over whether to raise a capital buffer on the largest banks. They’ll include a panel on financial stability at a Chicago conference in June on the conduct of monetary policy.
“If financial conditions ease, growth will be higher and monetary policy should respond” with tighter policy, said former Fed Governor Laurence Meyer. Yet central banks’ response to financial risk is often a story of “not yet, not yet, not yet – too late!’’
Fed officials discuss financial stability risks at most policy meetings. The Fed Board in Washington even publishes a semiannual report focused specifically on financial risks. But the committee’s communication on the topic can appear confusing and contradictory.
“How much froth in leveraged lending is the Fed willing to tolerate in exchange for 20 basis points on inflation?’’ Coronado asked a New York Fed advisory panel earlier this month.

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