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"Wisely and slow; they stumble that run fast" - Shakespeare

Peter Warnes  |  09 Mar 2018Text size  Decrease  Increase  |  
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The U.S. Department of Commerce gave the green light on 16 February to proposed tariff increases of 24% on steel and 7.7% on aluminium imports. President Trump had 90 days to review the proposals and decide on the appropriate action. Wasting no time, he took only 13 days (including two weekends) and just for good measure increased the tariffs by 25% and 10% respectively.

Gary Cohn has become the Administration's first tariff casualty. The President's top economic advisor strongly disagreed with the tariff hikes and resigned. To me, his body language in recent weeks suggested he was looking for a way out and the tariff hikes provided the trigger.

It appears the increases are unilateral, although there could be a partial backdown. Canada, a major exporter of both steel and aluminium to the U.S., appears to be the worst affected. This move will certainly have major implications for the ongoing North American Free Trade Agreement (NAFTA) negotiations. In fact, it looks as though NAFTA is Trump's target. As it turns out, while Canada is the largest exporter of steel to the U.S., it is also the largest importer of US steel, with a US$2bn balance in favour of the US. Did anyone in the Trump administration do a check before the shot was fired?

Whether this is the first shot in a global trade war is a moot point. But it has placed the world's trading nations on alert. The protection "for a long time" suggests President Trump is in for the long haul and retaliation in some form, whether financial or trade related, is likely. The direct implications on China, the country with the largest trade surplus with the U.S., of the increased tariffs on steel and aluminium imports are minor. China is the 10th largest steel exporter to the U.S. Not so for allies Canada and South Korea. Secondary, rather than primary retaliatory action is possible should cheap imports of steel and aluminium find their way into other countries from a spill-over effect.

The manufacturing cost base of all products using these two materials will ultimately increase to varying degrees and could put some upward pressure on inflation and bond yields. The knock-on effect in equities markets could be meaningful, should higher bond yields influence risk asset valuations. The performance of U.S. individual 401K's, recently highlighted by the President as being beneficiaries of share market advances, may become unwelcome collateral damage.

An example of direct retaliatory action, say from China, could be the switching of aircraft purchases from Boeing to Airbus. Morningstar's Chicago-based aviation analyst estimates some 20% of all Boeing deliveries over the next decade would normally be bound for Chinese airlines or lessors. He estimates the Chinese market alone accounts for US$1.3bn of Boeing's forecast 2018 operating profits. A switch to Airbus could put 20-25% of Boeing's future deliveries at risk, but it could be more as the Chinese order backlog is tilted toward the more-profitable 737 aircraft.

Indirect action could come in the form of reduced Chinese buying of U.S. treasuries, at a time of elevated supply from government issuance to fund a widening deficit and normalisation of the Federal Reserve's balance sheet. Resultant upward pressure on yields could have unpalatable consequences in financial markets, so closely followed by an adoring President.

Elsewhere, U.S. automakers are in the spotlight as they use significant quantities of steel and aluminium. But, Ford and General Motors use almost entirely U.S. steel and aluminium in their U.S. plants and their component suppliers also source in the U.S. So, the auto industry is not a beneficiary of higher tariffs, as higher input costs would be either absorbed impacting margins or if passed on affecting demand. Longer term the industry could be affected if a trade war caused GDP growth to contract, leading to higher unemployment and slowing auto sales.

President Trump has declared war on the U.S. trade deficit, which widened to US$566bn in 2017, with China's share of the deficit up 8% to US$375bn, representing 66% of the whole. Could a trade deficit reflect strong underlying domestic demand which sucks in imports at a faster rate than exports? Could it reflect demand from an increasing number of people in employment and paying taxes, as is the case with U.S. unemployment near historical lows? Could the U.S. economy satisfy this demand at acceptable prices? While negative net exports (trade deficits) are a drag on GDP growth there are other positive factors at work and the positives outweigh the negatives since the GFC-inspired recession. Demand will tend to seek out cost-efficient supply, unless protectionism intervenes. Heightened protectionism can support inefficiency and reduce productivity (the Trump put) and is not in the best long-term interests of a country.

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

 


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© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is Morningstar's head of equities research.

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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