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Trade Wars: Return of the Tariffs

There have been a fair amount of headlines and we have received more than a few questions about the “trade war” with China, in light of the recent increase in tariffs levied on Chinese imports. Although the ongoing trade negotiations cover a wide range of issues, the tariffs are designed to make Chinese goods less attractive by raising their cost for American importers. It is unclear whether the tariffs are the ends or the means for the Trump Administration, but they are now in place for the time being. The President has said that Chinese companies are paying the tariffs and that Americans are bearing very little of the increased costs. Neither of these points are true and it is unclear (at least to us) whether the President believes these things or is playing to his political base. Regardless of anyone’s opinions on the tariffs, here are some apolitical things to keep in mind:

  • American businesses pay the tariffs. It remains to be seen whether businesses will absorb the higher costs or pass them on to customers. Either way, inflation indicators may begin to tick up in the coming months as import costs rise. The US economy appears to be quite strong at the moment and time will tell how much of an impact these protectionist policies will have.
  • If we do see inflation data accelerate, it will put upward pressure on interest rates. However, it will be interesting to see how the Fed responds to tariff-induced inflation, which is arguably different than inflation driven by other factors.
  • China does exercise some control over its currency, the yuan. It weakened against the USD until Trump’s election, strengthened as campaign posturing did not come to fruition, weakened again when Trump started tweeting about tariff’s lasy year, strengthened when the tariffs were delayed, and is now weakening again as increased tariffs are implemented. Notice a pattern? Its actually not unique to this episode of trade wars. Currency fluctuations often offset the impact of tariffs. So expect China to weaken the yuan as protectionism rises and strengthen as free trade resumes.
  • There are some commentators (and they’re generally commentators rather than actual investors, although there are a few of those too) who say that the American’s hands are tied because China owns a lot of US Treasury bonds and can sell them at will to drive up US interest rates. Fortunately, this is hogwash. They do own US Treasuries and can sell them, but that would create all sorts of problems for China. Additionally, we’re skeptical that liquidating their Treasury holdings would even impact rates much as there are plenty of buyers.

The above factors may influence currency and fixed-income markets quite a bit. Within equities, we have long favored underweighting equity exposure to China relative to other emerging markets. This is partly due to concerns about rule of law, questionable economic data, and corporate balance sheets, but also due to geopolitical issues such as domestic politics in the US and China and the interactions between the two. It is anyone’s guess how the trade talks progress (if at all) from here, but we are following carefully and managing portfolios accordingly.