Donald Trump signed a proclamation to place tariffs on steel and aluminum on Thursday in the first concrete step in his quest to reduce the bulging US trade deficit. The resulting steps as well as fallout will be a driving force for markets in the weeks/months ahead.
Major decisions on retaliation, exemptions and strategy are coming. Here are five areas to watch.
1. The Timeline
Trump’s declaration exempted Canada and Mexico but put all other countries on the clock. They have 15 days to convince the US administration not to tax their steel imports. Trump singled out Australia as it could be spared, indicating defense procurement may be a factor in decision. Exemptions from Trump’s tariffs will have FX implications, but if such reprieves multiply, then it bodes well for risk trades at the expense of the yen.
2. Who Replaces Cohn
The first casualty of the trade war was White House economic advisor Gary Cohn, who resigned Tuesday of the tariffs. Expect Trump to name his replacement in the week ahead. Who he chooses could help signal his agenda into the November mid-term elections and beyond. Cohn made a push for Shahira Knight, widely considered as a moderating voice. Another possibility is former Reagan economist Larry Kudlow whom Wall Street would support. Nonetheless, trade hawk Peter Navarro is also angling for the job, and choosing him would signal that these tariffs are here to stay. Worthy of note, Navarro is especially critical of the trade relationship with Canada.
The EU has taken an aggressive stance towards US aluminum and steel tariffs, which raises the possibility it will retaliate rather than aim for an exemption. China will certainly not be granted an exemption – it wait until the 15-day period runs out to see if Trump acts. Alternatively, Beijing may pre-announce retaliatory measures in the hopes of getting the White House to back down. Countries can also file a complaint against the US at the World Trade Organization, to which the US will appeal on the argument that is protecting national security. The entire process could take 1-2 years, during which, complaints, lawsuits and trade barriers will dominate world trade.
Uncertainty is high and many trade partners will be affected but action is assured. And if action comes, the next big question will be how the US reacts.
Mexico and Canada got a reprieve Thursday but the timeline is indefinite. The idea of a 30-day exemption for Mexico and Canada was floated, suggesting the US is growing impatient with the progress of NAFTA talks. The Mexican Presidential election in July also means talks need a quick finish or they will go on hiatus. Trump said Thursday he was optimistic about a deal but there has been no progress on the thorny parts of a deal. Ultimately, aside from saying things like “NAFTA is the worst trade deal ever”, Trump is reluctant to address any specific problems with the Agreement, leaving him a window to carve out a deal that’s largely the same while declaring victory.
5. The Trade Deficit
A headline that was ignored this week was a surge in the US trade deficit to a nine-year high. It’s rising because of a strengthening US demand and a tax plan that’s added further stimulus to an economy already near full capacity. In all-likelihood it will continue to rise. As it does, it will infuriate and embarrass the President and he’s likely to unveil further haphazard ways to fight it. That means this story isn’t going to go away as long as Trump is in the White House.
Usually the story goes like this: As long as the world economy is growing in synch, the US trade deficit will move towards 3% of GDP, the budget deficit towards 4% of GDP and the US dollar would have little choice but to pull lower. At least that’s what the chart shows.