U.S. Trade: Bark Starting to Bite?

This week, President Trump announced plans to introduce new tariffs for selected steel and alumnium goods, using the justification of the Section 232, the national security exemption. The move, set to be implemented next week, was swiftly condemned by a wide range of U.S. trading partners, including Canada, Mexico and South Korea, several of whom are currently negotiating with the U.S.  Following past tariff increases, and a very busy trade calendar, the move is likely to amplify volatility in markets, including FX. I look in this post at the looming elements of a busy trade calendar and consider some impacts on growth, inflation and broader policy. 

Several factors may amplify the impact of trade friction - the precedent of using the national security exception, the seeming lack of coordination within the administration and with other ongoing trade negotiations. If implemented, the move would likely add to distortions in metal prices, amplify input costs in the United States, and add to uncertainty for businesses in the U.S. supply chains. The additional grit of trade friction may add transactions costs and uncertainty at a time when global trade growth may already start to moderate (2019+)

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Increased targeted tariffs and trade restrictions should not be a surprise. After all, President Trump (and Candidate trump) was very insistent that he wanted tariffs, and fair trade.  The choice of the largest tariff size (big beautiful tariffs) was more of a surprise, as is the use of the WTO’s national security exemption at a time when members of the national security infrastructure were loath to see a risk - particularly since much of the current products come from Canada. By using this measure, the U.S. is calling into question elements of the WTO regime and more generally the rules based system it helped created. 
Several other trade related measures include. 

• section 301 which is likely to target China more directly. Concern about Chinese trade is more bipartisan, and arguably more warranted when focus shifts to digital trade and protectionist measures.
• Request for extension of trade promotion authority past July. Expect Congress to look to tie the administration's hand on selected trade agreements. 
• increasingly contentious negotiations with a range of trading partners including the next round of NAFTA talks (see below).  
• CFIUS legislation on national security review of foreign investment in the United States. With several key decisions under consideration. 
• Treasury Foreign currency report (due in April). Several countries seem closer to meeting the requirements, especially in Asia, notably Thailand, South Korea and Taiwan, though notably not China. There isn’t a lot of evidence that the U.S. authorities are that concerned about currency dynamics, but they arguably should be. 
• The latest phase of CPTPP talks and whether there are any more details about the U.S. possibly joining TPP, as mentioned at Davos and more recently by Treasury Secretary Stephen Mnuchin. Given that the U.S. has said little about what would make the deal “better” so far it seems like a distraction and possible deterrence to the deal that the other 11 countries are moving forward on. This week’s move (and previous ones on solar panels and washers) don’t bode well for a re-entry. The example of the NAFTA talks which took several iterations before the U.S. negotiators were reported to have a clear ask and terms of reference suggest this could be a distraction. 

Retaliation is likely to be modest.  Proposed targets are mostly in the agricultural sector including bourbon and grain, products that are likely to provoke concern in congress - or U.S. cultural goods. 

Any tit for Tat is likely to add trade friction and raise questions about any inflection point for global trade. its worth noting that these measures come at a time of robust global trade and demand and that's unlikely to change in the near future. However the pace of global growth is likely to slow  in 2019 and especially beyond due to higher rates and cost of capital, the struggles in growing above potential growth.  Global trade flows have been strong and relatively resilient to protectionist threats (in part because these threats hadn’t been converted to action). It might be less resilient going into 2019, when global growth is likely to moderate from the current above potential pace. 

The move has not only been questioned abroad, but also at home, including by many Republicans especially in the Senate, who fear the price impact on American consumers and businesses reliant on imports (including food processing many manufacturers and even the energy sector). If the U.S. was moving ahead with even its small infrastructure plan, it could have a greater cost uncertainty and impact - however the Senate suggests no vote on infrastructure this year.  Corporate outcry could result in some adjustment of the measures, but the general direction in policy seems clear. Expect more targeted measures - and greater price and demand uncertainty. 

The move complicates an already contentious set of negotiations between the NAFTA partners, who seem to have made little progress in the last round of talks, not least because the U.S. representative focused on rules of origin was recalled early. The 232 tariffs may well reflect some desire to play hardball in these negotiations, and to deflect from what seems to be a wave of defections from the White House and pressure on those close to the president. Expect Senate hearings on extending TPA authority past July (the measure that allows an up or down vote) to be even more difficult. 

My baseline view continues to be a continuation of NAFTA talks into H2. As the U.S. and Mexican elections approach, the risk is that the talks will be put on hold to allow new leaders to play a role. They may shift to a lower profile pace. Meanwhile the ongoing trade frictions add to come concerns I have expressed about the pace of growth going into 2019 and cost dynamics. Tariff imposition could amplify price pressures at a time when demand has been picking up and the labor market is tightening. 

Several factors suggest that the rate of growth of U.S. imports is likely to moderate this year, at least in volume terms. The weakening of the U.S. dollar is likely to increase costs, dampening import incentive. There doesn’t seem likely to be a major food supply shortage. Some of these trends are likely to offset what otherwise would be an increase in imports due to strong growth and rather expansionary fiscal policy.