How Will the 90-Day Freeze on Tariff Increases Impact the Markets?

According to a press release issued by the United States Trade Representative (USTR) in the middle of September, tariffs of 10 percent on $200 billion of imported Chinese goods went into effect on Sept. 24, 2018. The same tariffs, according to the press release, were set to increase to 25 percent on the same $200 billion in Chinese imports on Jan. 1, 2019.   

However, after talks between the leaders of the United States and China during G20 meetings in Buenos Aires, Argentina, the United States agreed to freeze tariffs at the 10 percent rate for 90 days starting Dec. 1, 2018. If the negotiations don’t lead to long-term settlements, the tariffs will increase to 25 percent on March 1, 2019, according to a White House statement. With this recent announcement, how will markets react in the first quarter of 2019 and beyond?

Along with the negotiations, there seems to be thawing in the icy relations developed during the trade spat. The White House statement also stated that China agreed to buy a substantial variety of American goods, including agricultural products, industrial goods and energy in order to lower the trade deficit America has with China.

The talks during the 90-day negotiations also will address issues raised by the current U.S. Administration, such as China respecting American intellectual property, how to reduce tariffs on both sides, and remediating Chinese cyber-espionage.

Looking at Current Global Economics

According to the Council on Foreign Relations, American exports to China dropped 20 percent since June 2018. However, imports into the United States have increased. As of October 2018 – the first month to reflect the impact of Trump’s 10 percent tariffs, U.S. imports from China were reduced by about $5 billion on an annualized basis..

Per data from the Council on Foreign Relations, non-US imports into China have increased by 18 percent. This is particularly notable because for the 24 months leading up to July 2018, China imported about 22 percent of America’s oil exports, while present Chinese imports of U.S. oil is negligible.

Despite China’s promises to restart importing U.S. oil, Russia is already seeing an increase in exports to China and future opportunities for the former Soviet Union to export one of its well-known commodities are quite favorable.

U.S. trade data from October 2018 showed that there’s more oil production, reducing its deficit in oil production, while there’s an increase in the trade deficit ex-petroleum goods trade. The services surplus has essentially been constant. Brad Setser, a former staff economist at the United States Department of the Treasury, explains that beginning in 2014, imports into the United States have increased by 100 percent because the U.S. dollar has increased in value. Based on data from the U.S. Census Bureau and Haver Analytics, for every two dollars of imports, the United States manufactures one dollar’s worth of goods, not including refined petroleum.

With Americans relying on increased imports and a lack of domestic manufacturing infrastructure, if tariffs move from 10 percent to 25 percent at the end of the 90-day freeze, consumer spending is expected to drop – and this will weigh on the economy going forward.

When it comes to Chinese imports, Setser points out that semiconductors, crude oil and petroleum-related products make up approximately 25 percent of its total imports. With oil prices averaging about $50 per barrel, coupled with the potential for Russia to increase its crude oil exports to China, there’s a question of how much China will need to rely on American petroleum exports during and after the 90-day tariff freeze negotiations.

Will the United States Become a Bond Haven in 2019?

With Italian bond yields rising quickly from 2 percent to 3 percent since the middle of 2018, it begs the question if the United States will become a bond haven. There are many reasons why the United States Bond Market has the potential to became a refuge for many global investors.

According to a 2016 paper from the National Bureau of Economic Research, safety is in the eye of the beholder – in the case of the global markets, it’s the investor. When there are global economic worries, the paper credits a “nowhere else to go” theory for investors that choose U.S. debt versus others. Along with a country’s ability to handle its own debt, the National Bureau of Economic Research found that even if a country’s “fiscal position deteriorates,” its debt is more attractive as long as the country’s fiscal health is in better shape than others, relatively speaking.

Understanding How the United States’ Situation is More Attractive Globally

Since virtually every country uses debt to run the government, they issue bonds in their respective currencies. The returns on bonds are the interest rates offered by the borrowing country to pay the borrower (either the domestic or foreign buyer of the debt). Looking at 10-year bonds is one way to evaluate interest rates among different countries, be it the United States, Italy, China, etc.

Understanding How Yields or Bond Interest Rates are Determined   

With Italian bond rates currently at 3 percent – up from 2 percent in about 6 months during 2018 – this has given many a cause for concern due to the rate of increase. Coupled with the Italian government’s existing debt obligations exceeding its yearly economic output by more than 30 percent, compared to the United States’ debt obligations at about 100 percent of its current economic output, those looking to buy government debt would have a lower risk of not getting paid with the U.S. government issued debt.

When it comes to the global markets determining interest rates, there are two primary factors. The first is how much inflation is expected between purchase and redemption date. This is important because bond buyers want to know how much inflation will impact their investment. The second, and arguably more important, is what are the chances of the issuing government failing to repay its bond or debt obligations in the case of a default.

Understanding the Rise in Italian Bond Rates

While some economies across the world can and do print money to deal with paying off debt, Italy, as part of the European Union, cannot print additional Euros. While inflation is not a major fear for the Italian economy, the recent back and forth between the Italian government and officials from the European Union has raised concerns about excess spending and Italy’s ability to pay for it in the future. The proposal would reduce taxes and increase spending for the public and private sector investment. This is what’s adding to uncertainty about Italy’s ability to service its debt, thus negatively impacting its 10-year bond rates – similar to what eventually happened in Greece.


Used the following PDF from that main site: