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US-China Trade War Could Induce Inflation Ramifications

The Trump administration announced Tuesday that it is prepared to impose 10% tariffs on $200 billion of Chinese-made products, ranging from clothing to television parts to refrigerators. Together with other tariffs already in the works, the latest move threatens to raise import prices on almost half of everything the U.S. buys from China.

One of the biggest disruptions to US equity and bond markets that could be caused by the escalating trade war comes in the form of inflation. Producer prices are ramping up in the US as the PPI experienced the largest jump in 6.5 years, accelerating 3.4% YoY for the month of June. China’s PPI simultaneously accelerated to a six-month high in June, increasing by a stronger-than-expected 4.7% YoY. Rising wholesale and other selling prices at businesses indicate that inflation pressures in the production pipeline are firming amid rising demand and tariffs on steel and other goods. Higher materials prices are also pushing up transportation costs of goods, with general long-distance freight trucking costs advancing 9.4% in June from a year earlier, the largest increase in a decade. For U.S. consumers, prices rose to the highest yearly rate since 2012, reflecting an economy that’s running hotter than anytime since the Great Recession. Headline CPI rose to 2.9% YoY while core CPI edged up 2.3% in June.

The original $34 billion in tariffs and China’s equal reaction only took effect in the month of July, so one can only speculate how much higher these figures could climb when compounded by even more encompassing tariffs. As an example of how powerful protectionist policy can be, Trump announced tariffs on imported washing machines in January, one of his earliest trade maneuvers. The latest consumer price index released by the Bureau of Labor Statistics showed the average cost of laundry equipment jumped 7.4% from April to May after leaping 9.6% in the previous month. This is compared with a 0.2% price increase for all items.

The inflationary pressure brought on by the trade war is significant as it comes in the midst of the US Federal Reserve’s tightening cycle. When rates go higher, they not only increase the cost of borrowing and diminish companies’ future earnings, but also pump up treasury yields. The central bank has raised the benchmark Federal funds rate twice in 2018, and is targeting at least two more hikes before the end of the year. The Fed’s preferred inflation measure, the core PCE hit their 2% target right on the nose in May, indicating that they are on track to continue with their planned policy.

However, should inflation be forced upward by trade pressures, it is possible the Fed could actually increase the pace at which they are raising hikes, or the increment by which they increase the federal funds rate. In the minutes from the June FOMC meeting, the committee indicated optimism for GDP growth and labor market conditions with unemployment remaining near historic lows. They noted “… participants generally judged that with the economy already very strong and inflation expected to run at 2% on a sustained basis over the medium term, it would likely be appropriate to continue gradually raising the target range for the federal funds rate to a setting that was at or somewhat above their estimates of its longer run level by 2019 or 2020.” Trade war induced inflation may be exactly what pushes their current target rates higher.

MRP wrote about the end of the bond bubble back in November, and although trade disputes have yet to take a toll on bond markets, higher inflation may prompt the Fed to raise rates faster to counter increased demand for treasuries and the resulting flattening of the yield curve. Or, perhaps, China could resort to the nuclear option of cutting back its purchases of US treasuries. China accounts for up to 20% of all US Treasury securities held by foreign central banks. A buying strike by Beijing or outright selling of US Treasuries could inflict major damage on US bond markets, driving yields higher and placing further strain on US stock market sentiment.

The US’ current tariff load on Chinese goods, combined with an additional $16 billion in tariffs coming soon, will total $250 billion, about half the value of all America’s imports from the Asian nation in 2017. While we do not yet know what the full scale of China’s retaliation will be, it’s important to remember that the country maintains measures beyond tariffs as well. These include increased regulatory oversight of American companies, slowing down approvals processes, canceling orders for U.S. goods and encouraging consumer boycotts. Very similar to how China dealt a severe blow to Japanese auto sales in 2012, pressure from the Chinese government could dent sales of American goods in the huge Chinese market. GM, for instance, sells millions more vehicles in China than it does in America.

It appears that both sides of this new trade battle have begun to entrench their positions for the long-haul and are in it to win. It is too early to speculate on the impact this conflict will have on growth, but inflated prices are a certainty.

While it will take some time for the real effects of tariffs to materialize, investors seeking exposure to companies that are insulated from the initial hits can invest in the iShares Russell 1000 Pure US Revenue ETF (AMCA), which focuses on companies that derive most of their revenue from the U.S.

Additionally, MRP added long-dated US treasuries as as Short theme on October 26, 2016. Since then, the Ultrashort 20+ Year Treasury ETF (TBT) has returned about 4%, underperforming the S&P 500’s 30% gain over the same period, but outperforming the iShares US Treasury ETF (GOVT) which declined 4.65%. If the Fed feels compelled to continue raising rates, or increasing their pace of rate hikes, 10-year treasury yields should climb well beyond 3%.

We’ve also summarized the following articles related to this topic…


Trade War: US announces tariffs on $200B more goods from China

In response to China’s retaliatory tariffs on $34 billion of U.S. goods announced Friday, the U.S. has announced 10% tariffs on another $200 billion of Chinese imports. After the announcement, the Chinese government said it would take “firm and forceful measures” against the tariffs but did not provide specific details. The USTR is accepting comments and will hold a public hearing August 20-23. If approved, the earliest the tariffs would go into effect would be August 31.

The trade imbalance has prompted fears among global businesses of what shape China’s “firm and forceful measures” would take, as it cannot be a direct retaliation on $200 billion of imports. With tariffs of $34 billion and potentially another $16 billion already announced, China has only about $80 billion of U.S. imports remaining to tax.

The measures could result in China attempting to disrupt operations of U.S. companies with a presence in China. Chinese regulators could delay or deny licenses or launch investigations on American businesses. China could even extend its measures to consumer boycotts or limiting visits to the U.S. by Chinese tourists which could carry significant impacts to the U.S. economy. In 2016, nearly 3 million Chinese nationals visited the U.S. and spent $33 billion. SCDive


Trade War: China Has Arsenal of Non-Tariff Weapons to Hit Back at Trump

While China may jack up existing tariffs beyond the 25 percent level imposed so far, it could also inflict significant pain by increasing regulatory oversight of American companies, slowing down approvals processes, canceling orders for U.S. goods or encouraging consumer boycotts.

Big American companies including Walmart Inc. and General Motors Co. host large operations in China and have plans for expansion that could be stymied. China has used these tactics before, notably against South Korea and Japan during previous political spats, with carmakers from the two nations among the victims.

One example: Japanese automakers took a major hit in their China sales in 2012 after the fight over disputed islands in the East China Sea worsened. Another: China put a huge a dent in tourism in South Korea by banning package tours in 2017 amid a dispute over a missile shield.

Then there’s the currency. China has pleased trading partners in recent times by allowing greater appreciation of the yuan, but there is no guarantee it will stick to this. And of course there’s also the “nuclear option.” While it seems unlikely as China would also suffer greatly, it could offload some of its huge hoard of U.S. Treasuries. B


Trade War: Chinese Tariffs on U.S. Energy Would Signal a New Attitude

Since the 1990s, China has made it a priority to secure adequate energy imports to fuel its economic growth. Acquiring this energy was, and to some extent still is, a major driver of China’s foreign policy. The fact that China now feels comfortable creating obstacles to the acquisition of some energy from abroad suggests several things.

First, and most obviously, China has assessed that tariffs on this energy trade will cause the U.S. more pain than they will cause China. In a very short period of time, the U.S. has become a significant exporter of crude oil, liquefied natural gas (LNG) and refined energy products. In 2017, the value of U.S. energy exports to China was greater than what either Turkmenistan or Qatar sent to the Middle Kingdom. It represented 6 percent of all U.S. energy trade.

If it makes good on its threats to impose retaliatory tariffs on energy trade, China would also be communicating its confidence that the new energy abundance is here to stay. Just last summer, it instituted new policies aimed to aggressively bring down coal use by substituting natural gas. This policy led to a 15 percent increase in natural gas consumption in 2017 and a 28 percent increase in natural gas imports. B


Trade War: America Cannot Win the Trade War

To Donald Trump, America has all the good cards to easily win the trade war on China. Superficially, that seems to be the case, as China does maintain a big trade surplus with the US. In a tit for tat trade war, China will soon run out of imports from the US to tax on as the US keeps expanding the scope of China’s exports under punitive tariffs. If the tariff wall against imports from China were to drive out multinational companies from China, China would lose its status as a manufacturing powerhouse. The tariffs, on the one hand, and the tax reform to lure American companies to locate their businesses back to America, on the other hand, would, according to this line of thinking, sap China’s manufacturing clout. There is also the concern that China’s real estate bubble could be very vulnerable to financial shocks.

Unfortunately, China’s market is now much too big for multinational companies to give up their foothold in China. And whereas America’s home market is stagnant, China’s market is still growing very fast. As to the financial shock argument, it should be noted that China has been quite vigilant and has been working on deleveraging for about two years now.

China will suffer from the tariffs. But the Chinese are more likely to be united as they perceive the trade war as instigated by America. Some businesses will fail. But in all likelihood, Xi Jinping’s rule will outlast Trump’s. Ultimately, party politics and rebellion within the Republican Party will end the folly of trying to turn the clock of globalization back. SA


Trade War: The US is running out of Chinese exports to tax

The United States could soon run out of Chinese goods to tax if a trade war continues to escalate. On Tuesday, it released a 195-page list of Chinese exports worth $200 billion facing a 10% tariff. The move came after China retaliated Friday against US tariffs on $34 billion worth of goods by taxing American exports to the same value.

US tariffs on a further $16 billion of Chinese exports are coming soon, taking the total under threat to $250 billion. President Donald Trump has threatened to go much further — possibly targeting as much as $550 billion. But that number exceeds the total value of Chinese goods imported by the United States last year ($506 billion) and there are signs that US officials are already beginning to struggle to compile new lists of targets.

Tuesday’s list includes live trout, which hasn’t been imported from China for decades, as Bloomberg first noted, as well as obscure items such as badger hair. It also includes more recognizable exports, such as soy sauce and rice. They’re among thousands of things that could soon get more expensive to import from China. CNN