Economic Risk And The Trump Factor

No model can capture it. No analyst can fully comprehend it. But it’s there and it’s not going away, at least not until the 2020 election. For good or ill, the Trump factor keeps on surprising, giving the President’s supporters reasons to cheer and opponents endless justifications to oppose his policies. The question is whether the escalating and widening battle on trade will benefit or impair the US economy in the near term and beyond? No one’s really sure at this point for the simple reason that Trump’s trade-related decisions are in flux and at times seem to evolve on a daily basis. This much is clear: the stakes continue to rise.

Indeed, on Thursday the President announced that he is planning to open up a new front in the trade war beyond the already high-stakes conflict with China. Late yesterday, he said that the US will impose a 5% tariff on all goods imported from Mexico until illegal immigration ends. The new tariff is set to begin on June 10 and continue “until such time as illegal migrants coming through Mexico, and into our country, STOP,” he advised in a Twitter post late yesterday. If the illegal immigration doesn’t end to Trump’s satisfaction (whatever that means), the tariffs will continue to rise, to as much as 25% by October.

This is no trivial issue. The US imported roughly $346 billion of goods last year. Assuming a 5% tariff translates to a $17 billion tax, rising to $87 billion if the levy is increased to 25% by the fall.

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The danger here is that what appears to be a simply policy tool is actually an ill-advised attempt to solve a complicated problem and in the process create havoc in a nuanced supply chain between the US and Mexico that’s developed over decades. Because third-party nations also use the US-Mexico trade channel, the potential for global repercussions can’t be ruled out.

Although trade hawks and opponents of immigration may find much to like in the President’s latest announcement, there’s no shortage of opponents, including some top Republicans.

“Trade policy and border security are separate issues,” said GOP Senator Charles Grassley in reaction to Trump’s announcement. “This is a misuse of presidential tariff authority and counter to congressional intent.”

Trade policy aside, the President’s latest pivot is a stark reminder that geopolitical/geoeconomic risk is raising economic uncertainty beyond the usual level. Commenting on Trump’s latest tariff plans, David Mann, global chief economist at Standard Chartered, notes:

This news does leave the world wondering whether Trump’s use of tariffs could become ever broader. This is a step change as previously we had been seeing delays in trade-related decisions on Europe and Japan as we thought the administration was so focused on China. It does add to the reasons to worry that any country running a trade surplus with the US could come into the spotlight in the future.

A higher level of trade-related economic turmoil comes at a time when US recession risk appears to be creeping higher, thereby raising the stakes and potentially laying the groundwork for trouble in the second half of 2019. Although recent data continues to show that an NBER-defined downturn remains a low-probability scenario, the Treasury yield curve is hinting at challenges in the near term. The gap between the 10-year Note and 3-month T-Bill slipped to a negative 16 basis points on Thursday, the lowest difference since 2007. The implication: economic contraction is lurking.

Although the historical record for the yield curve as a recession-forecasting tool is impressive, unique conditions in the here and now raise questions about the Treasury spread’s value for divining the future of the business cycle in 2019. For example, negative interest rates in Europe are creating unusually strong incentives to park euro-denominated assets in Treasuries. Indeed, a German 10-year bond at the moment is trading at a -0.18% yield. By comparison, the 10-year Treasury’s 2.22% current yield looks highly enticing by comparison – even after factoring in forex risk.

The implication: the Treasury yield curve’s inversion of late is less about the outlook for the US economy and more a reflection of the wide disparity between US and foreign interest rates.

It’s also worth remembering that whatever trade- and economic-related turmoil that Trump unleashes can disappear in a flash, should the President so decide via a new Twitter storm. Although that appears unlikely as trade solution for the immediate future, all the sturm and drang of the moment can, in theory, evaporate tomorrow. When and if that happens, economic activity could perk up.

By the same logic, however, the volatile situation of the moment could just as easily take yet another turn for the worse, depending on the President’s mercurial thought process. One possibility on the short list of additional risk factors that may be waiting in the wings: new tariffs on Europe.

Bloomberg yesterday reported: “Ten months after Trump and European Commission President Jean-Claude Juncker struck a Rose Garden truce meant to clear the way for negotiations to reduce tariffs on industrial goods and eliminate regulatory hurdles, those talks are showing few signs of going anywhere meaningful.”

Overall, the potential for Trump surprises appears set to rise in the months ahead. If the President is increasingly motivated to play to his political base as the 2020 election approaches (as he’s inclined to do), there’s more than a zero probability that there’s more macro-related shock and awe to come.

Economic growth in the upcoming second-quarter GDP report is already on track to post a substantially softer gain compared with Q1. Trump’s latest shift on trade policy with Mexico strengthens that outlook. Political risk, in short, is surging. The only question: What’s the final price tag for the economy? To be determined.

Meantime, keep an eye on the President’s Twitter feed. It may be useless for reliable estimates on the outlook for the economy, but it offers clues for when sentiment is about to be slapped across the head.   

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By James Picerno