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Trump's tariffs and a "beautiful normalisation" of monetary policy

02 March 2018

1. What are the implications of Trump's steel and aluminium tariffs?

Yesterday President Trump announced that he would impose import tariffs of 25% on steel and 10% on aluminium. In his campaign he talked tough on trade and this is an example of his protectionist agenda. Some of his aides appear to have been trying to deter him and the announcement had been delayed. 

Reaction around the world has been predictably averse. China may take retaliatory action on US agricultural products but has done nothing so far. A trade war is not in anyone's interest but the US economy is less dependent on external trade than many. In acting to protect the US steel industry that has lost 50,000 jobs since 2000, he will be penalising manufacturers who use steel and who employ many more. Following these cuts, we cannot assume US production can replace imports so the price rise is likely to be pushed through to the price of consumer goods. Many of Trump's allies in trying to control North Korean nuclear weapons expansion are exporters of steel, therefore he may be harming his own efforts in that direction. Canada is particularly effected and this may have implications for the North America Free Trade Agreement (NAFTA) that Trump is trying to negotiate. He also needs to remember that China is a big buyer of US debt and at a time when US treasury interest is growing it is not a good idea to antagonise one of the biggest holders.

In many ways, he may be shooting himself in the foot. When George W Bush introduced tariffs on steel in 2002 he had to remove them again two years later. Given the global reaction, it will be interesting to see if the action is diluted when he signs the order next week. Market reaction has been broadly negative. US equities moved lower after the announcement and Far Eastern markets have been marked lower too.

On balance, not good news for markets but as long as it does not develop into a global trade war the impact may be limited.


2. Will Jay Powell be able to engineer a "beautiful normalisation" of monetary policy?

Apart from the very first rise in interest rates in 2015, the normalisation of rates under Janet Yellen as head of the US Federal Reserve (Fed) had passed off without much impact on equity markets and no precipitous selloff in bonds. This coincided with improving economic data and corporate earnings. Equity markets made new highs and it all looked like a "beautiful normalisation”.

This had been achieved by carefully flagging rate changes well in advance and the market was expecting three rate rises in 2018. Then, at the end of January, stronger wage data raised the prospect of higher inflation and a steeper rise in interest rates. This coincided with Jerome Powell taking over as Chairman of the Fed. He was seen as a continuation candidate; given the economic numbers, what he is saying is not too different to what Yellen could have said in the circumstances.

The drop in equity markets was Powell's first test. The market had maintained a long period of growth and central bankers appeared to see this as a healthy correction. In testament to congress this week, Powell has stuck to his guns and continues to suggest that the strength in the economy may justify as many as four rate rises this year. A steep fall in equity markets could impact economic sentiment but the correction we have seen so far is judged to be not big enough to do that. Interest rate rises themselves may slow economic growth but this takes time to feed through and the tax changes put through at the end of last year may provide an economic stimulus.

On balance, it is possible for Powell to manage a “beautiful normalisation”. However, as equity markets rise they become more sensitive to interest rate rises and Yellen has to some extent had the easy part, future rate moves may be harder to manage without market disruption.



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