By Mike Dolan, Editor-At-Large, Financial Industry and Financial Markets
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Already-nervy markets were greeted on Tuesday with a full-blown trade war and major diplomatic row, as fears of a first-quarter economic downturn erased hopes that the U.S. economy will sail through the disruption unscathed.
U.S. tariff hikes against Canada, Mexico and China are set to go ahead and have already been met with retaliatory measures from Beijing.
Wall Street smells trouble. The S&P500 recorded its deepest loss of the year on Monday, notably on a day when Germany’s defence-spurred DAX index clocked its biggest daily gain in more than two years.
In fact, all three major U.S. stock indexes are back in the red for the year, as Treasury yields hit near 5-month lows, the dollar recoiled and high yield corporate credit spreads have widened the most since October.
Three Federal Reserve interest rate cuts this year are once again being priced into money markets, one more than the Fed has indicated.
Given all this, today I’m taking a deeper look at how Donald Trump’s administration seems to have undermined domestic confidence – and the economic outlook – with policy uncertainty as much as any direct impact from new measures.
Today’s Market Minute
* A trade war has erupted after Trump hit Canada, Mexico andChina with steep tariffs. China has retaliated immediately.Canada and Mexico are poised to do the same. * Trump has paused U.S. military aid to Ukraine after hisfiery clash with Volodymyr Zelenskiy, in what Democrats say”kicks the door open” for Russian aggression. * Trump says Japan and China cannot keep reducing the valueof their currencies, as it is “unfair” to the US. * With less than two weeks to go before a March 14 deadline,Congress is nowhere close to a deal to avert another governmentshutdown. * A key ingredient in Coca-Cola and M&M’s is being smuggledin growing quantities from war-torn Sudan.
Low US policy visibility equals big economic trouble
Markets spent so much time figuring out the direction of Trump’s economic policies, they might have missed the risk that no one ever really knows what’s next.
Designed in part to keep rival negotiators guessing and calculated to wring concessions, the new Trump Administration’s deliberate ambiguity on trade tariff policies or geopolitical alliances may take its toll if domestic business doesn’t know what exactly they’re planning for.
For the economy, that’s proving toxic. A hiatus in business and household decision making marks the biggest threat to the lengthy expansion and still-expensive Wall Street.
Business and consumer surveys suggest it’s getting harder to understand what prices or policies will prevail moving forward and are likely seeing projects, employment, deals and investments postponed until the coast clears. Whether it will ever truly clear during this government is now a salient question.
ISM’s February survey of manufacturing firms showed both new orders and employment readings slip back into contraction mode after post-election buoyancy, while tariff-irked inflation expectations are back on the rise. S&P Global’s poll of businesses in the U.S. dominant service showed overall activity turned negative last month for the first time in 16 months.
In some cases, the uncertainty is skewing behaviour to such a degree that it’s weighing directly on key components of gross domestic product calculations.
Net international trade, for example, is a major input into GDP math. But as U.S. firms rushed to frontload imports to dodge looming trade tariffs on goods from abroad, the trade deficit jumped as a result – sending GDP estimates into tailspin.
Loaded into the closely-watched Atlanta Fed ‘GDPNow’ model, the net exports variable posits the first quarterly contraction in overall U.S. GDP in nearly three years.
While some dismiss the number as a statistical glitch, it’s still alarming for an investment universe that convinced itself the business cycle had died and which has priced most U.S. securities accordingly.
And a problem for those who think tariff distortions will wash out of the mix soon is Trump’s seeming intention to keep ever higher and broader tariffs dangling indefinitely.
MORE THAN IT CAN STAND
Combined with the uncertain impact of slashed Federal government spending and public sector job cuts, even those who consider the Atlanta Fed’s red flag to be a false one also think it’s ominous as a precursor to the real impact of both the tariffs and government cuts.
UBS Global Wealth Management’s U.S. economist Brian Rose described the GDPNow swoon as “noise rather than a signal” – but he added that this week’s planned tariff hikes on Canada, Mexico and China were real cause for concern.
“If implemented, these tariffs would deliver a significant shock that may be more than the economy can withstand at the moment.”
Other relatively bullish Wall Street investment houses are similarly antsy about the recent turn in sentiment.
Morgan Stanley economists on Monday said some of the sudden gloom may be overdone but the uncertain sequencing of U.S. policies was a worry.
Their point was that policies that soften growth and firm inflation – on trade tariffs and immigration curbs – look set to come first and policies that could boost growth, like deregulation, come later or “maybe not at all” in the case of tax cuts.
And it said the spending cuts underway were in areas with “high multipliers”, adding that announced layoffs may reduce federal employment by 31,000 per month through September and a proposed hiring freeze may cut employment by a similar amount.
In a week where markets are now watching the February monthly payrolls report with an element of nervousness, those numbers will resonate.
And with Wall Street in the peculiar position of finding many of its main stock indexes in the red for the year going into March, there is a lingering concern that market turbulence will drain household and business confidence further.
Even for those who think America’s economy can still be a relative winner from all the trade tensions and policy upheavals, there’s a reminder that global economic damage can boomerang on it. Some 41% of overall revenues from the S&P500 firms are sourced overseas, according to Apollo chief economist Torsten Slok.
Today’s key chart
Washington’s freezing of military aid to Ukraine overnight and Europe’s commitment to pick up the tab in support of Ukraine are set to be key drivers of financial markets this week. German and European defence stocks have soared and the euro has risen amid hopes for an economic boost from rapid rearmament.
Today’s events to watch
* U.S. import tariff hikes against Canada, Mexico andChina * New York Federal Reserve President John Williams andRichmond Fed President Thomas Barkin speak * US corporate earnings: Crowdstrike, Target, Best Buy,Autozone, Ross Stores and Progressive
(By Mike Dolan; Editing by Anna Szymanski and Ed Osmond, mike.dolan@thomsonreuters.com)
