Chinese trade war retaliation dominates market concerns

US stock index futures were down this morning on concerns about an escalating trade war between the US and China. Yesterday, the Office of the U.S. Trade Representative published a list of products to target for 25% tariffs. And this morning, the Chinese immediately retaliated with tariffs on $50 billion of US goods.

The Chinese mean business but the White House won’t relent

The Chinese, understanding the political implications, hit the agricultural sector hardest. They also announced additional duties on US aircraft. At a press conference, Vice Finance Minister Zhu Guangyao said there was room for negotiation. But the implication was that an all-out trade war was still a possibility.

The concern has to be that the White House believes its trade policy is good for the markets. For example, when the markets fell on Monday, White House trade policy aide Peter Navarro told CNBC, “Everybody needs to relax.” He said Trump’s trade policy was actually “good for the market.” For good measure, he added: “I teach that stuff. I mean, let’s remember – if anybody knows what goes wrong with these models, it’s the guy who knows how to teach them.”

The market reaction and the economic data

After a decent session yesterday, stock futures have plunged again in response to these events. In the fixed income market, the yield curve has stayed mostly unperturbed. The spread between the 2-year and the 10-year bond remains at 49 basis points. Watch for any further flattening as a sign of impending economic weakness. I see any spread below 50 basis points as worrying regarding the future outlook for the US economy.

Now, after the announcement of Chinese tariff retaliation, the price of a barrel of West Texas Intermediate crude oil for May delivery fell more than a dollar to $62.38. That puts oil  prices at their lowest intraday price since March 20th. I would take this as another signal of potential future economic weakness.

At 9:45 ET, Markit will release the US services and composite PMI data for March. And at 10:00 ET, we get the factory orders and durable goods numbers. None of these numbers are market-moving. I am looking more to the employment market where ADP releases private employment numbers. Friday is the big day though. That’s when we will get the March unemployment data. And that will help guide the Fed.

Yesterday, Lael Brainard gave a speech on how the Fed deals with financial stability concerns. I will have post on this separately. But the big takeaway for me is that the Fed doesn’t use rate policy to deal with those concerns. There are two other Federal Reserve speakers scheduled today. St. Louis Fed President James Bullard is speaking at 9:45 ET and Cleveland Fed President Loretta Mester at 11:00 ET.

My thoughts

With the Chinese retaliating, it does look like we are headed for a trade war now. It is still unclear what near-term economic impact this will have. At the margin, tariffs should raise import prices enough to move the Fed to a fourth rate hike in 2018. And that’s going to be interesting if it does happen. Look at this from CNBC yesterday:

White House trade adviser Peter Navarro on Monday criticized the Federal Reserve, saying he was “puzzled” by the central bank’s forecast for more rate hikes this year.

Navarro said there is no inflation in sight and President Donald Trump’s policies will keep it subdued, suggesting few, if any, more rate hikes are needed.

Fed Chairman Jerome Powell late last month made a strong case for more rate hikes. He said raising rates too slowly would let the economy overheat. Many economists expect the Fed will eventually hike rates four times year but Powell stuck to a forecast of three moves.

Administrations since President Bill Clinton have managed, largely, to avoid criticizing the Fed, but analysts have been expecting this unwritten rule to disappear, knowing the Trump administration doesn’t much care for such conventions.

We will see more of this. And it is going to be negative for markets. As I wrote Monday, Trump’s policy framework assumes a strong executive is all that a dominant US needs to dictate policy. The presumption is that the US economy is, as Navarro put it on CNBC, “as strong as an ox”. And all President Trump needs to do is give favours to those that fall in line and mete out punishment for those that don’t toe the line. This is true domestically and abroad. For his underlings, for US companies, the media and foreign countries alike.

I don’t think this policy framework will work. It is dangerous. “Trump Unchained” means risks are now mounting geopolitically and economically.