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Trump & Tariffs: Odds favor skirmishes, not all out trade war

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The following report was originally written and published by Michael P. Stritch, CFA, Chief Investment Officer, BMO Wealth Management – U.S. and Yung-Yu Ma, Ph.D, Chief Investment Strategist, BMO Wealth Management – U.S. For more information on BMO Wealth Management, click here.

President Trump kicked off the month of March by announcing import tariffs of 10% on aluminum and 25% on steel. Trade policy, including ongoing NAFTA negotiations, is one of the key risks highlighted in our 2018 Outlook. The U.S. financial markets, as expected, reacted negatively to the initial announcement with the Dow Jones Index falling over 400 points and major aluminum and steel users such as Ford and GM being particularly hard hit. Canada and the EU, the two largest exporters of steel to the United States, came out strongly against the tariffs, with the EU proposing retaliatory actions on certain U.S. goods in response. Notably, the formal justification for the tariffs was “national security,” with President Trump taking to Twitter to proclaim, “If you don’t have steel, you don’t have a country.” We believe that the current developments are unlikely to lead to a trade war characterized by successive rounds of tit-for-tat measures that become increasingly hostile. Rather, in the near term, we expect trade frictions that are unwelcome, but not especially damaging to overall global markets. Nonetheless, there remains an element of uncertainty that could play out in different directions over time.

trump tariffs exhibit 1Our outlook is supported by a series of comments that emerged in the days following the initial release. In other words, the devil is in the details. President Trump indicated that Canada and Mexico will receive an exemption and that other potential carve outs could exist. Additionally, key Republicans such as Paul Ryan came out urging the president to make tariffs “more targeted,” and Commerce Secretary Wilbur Ross stated, “We’re not looking for a trade war. We’re going to have very sensible relations with our allies.” Treasury Secretary Steven Mnuchin added to the moderating voices stating, “We’re going to manage through this so it’s not detrimental.” Then, on March 7th, President Trump tweeted, “China has been asked to develop a plan for the year of a One Billion Dollar reduction in their massive Trade Deficit with the United States. Our relationship with China has been a very good one.” Given an annual trade deficit with China of over $300 billion, finding a way to shave off $1 billion isn’t a particularly big ask. It’s barely a rounding error. Putting it all together, we believe a broad application of the steel and aluminum tariffs, accompanied by an exclusion and exemption process overseen by the Department of Commerce, will be considered a win-win by the administration. This allows President Trump to score a highly publicized victory in the rust belt, an area that significantly contributed to his 2016 election win (see Exhibit #1), while retaining an ability to refine the specific application over time to avoid dire economic consequences.

It’s important not to be too complacent, however, about how trade frictions might develop. First, China is currently under a “Section 301” investigation for intellectual property infringement, and President Trump recently tweeted, “The U.S. is acting swiftly on Intellectual Property theft. We cannot allow this to happen as it has for many years!”. Under Section 301 of America’s Trade Act of 1974, the president can take unilateral measures such as tariffs, fines, M&A restrictions, import quotas, etc. Given that typical loss estimates from Chinese IP infringements reach into the hundreds of billions of dollars per year, this issue is certain to have bigger consequences for trade with China than imports of steel and aluminum. A second concern is that the EU has already indicated it will challenge the recent tariff justification of “national security” at the WTO. If the WTO allows a low bar for national security tariff justifications, this has negative implications for subsequent tariff actions by other countries. If the WTO, however, rules against the United States, then it’s hard to imagine President Trump accepting such a ruling on U.S. national security from an international body. Either way, there’s longer-term potential for weakening the fabric of international trade.

Finally, it’s important to remember that handicapping the different scenarios is particularly challenging with the current administration. When being interviewed on March 4th, Commerce Secretary Wilbur Ross was Zen-like in his framing of the president’s tariff announcement, “Whatever his final decision is, is what will happen. What he has said, he has said. If he says something different, it’ll be something different. If he for some reason should change his mind, then it will change.” And that’s coming from the commerce secretary, who is presumably as close to the issue as anyone.

 

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