Teaser: U.S. import tariffs on Chinese goods are beginning to come into force, therefore both the financial markets and the U.S. consumers are preparing for rising inflation – if it happens….
Many things can be said about U.S. President Trump, and one of many could be that he forces both people and countries out of their comfort zones. This includes people in the financial markets, where analysts and economists increasingly need to include Trump’s political agenda in the assessment of the financial markets and the U.S economy. This naturally also includes my own assessments, and for example, the work with our conviction model- the crystal ball. One can call it an extra dimension that gives more spice in the daily work with the financial markets, which at the same time is the jumping-off point in this comment.
The tax reform Trump managed to get approved last year increases the purchasing power to the middle-class households in the United States. Everyone in the financial markets happily participate in the conversation about the increased economic activity, for example, if it sends inflation higher.
On the contrary, is the trade war with China a political agenda that forces economists to assess the effect from Trump’s political initiatives on the economy, including inflation? On the surface, the trade war is based on Trump’s “America First” plan where outsourced jobs should find their way back to the United States. My argument has long been that the jobs may leave China, but it will be to other low-wage Asia countries, and not to the United States. But despite this development, higher inflation caused by the trade war can still find its way to the United States.
Everyone can predict that a 10 pct. higher import tariff on Chinese products can cause higher prices, and thus, inflation in the United States- the same thoughts running through the minds of Trump’s advisors. The new tariffs begin to have an effect during the second half of this year, and I argue that the timing is well-chosen because the potential higher inflation won’t hit consumers on this side of the mid-term elections – an example where the assessment includes the political dimension, rather than base the view on pure macroeconomic elements.
My own best assessment of President Trump is that popularity and voting polls ahead of the mid-term elections are decisive for the political direction chosen by the President – it’s simply what determines Trump’s decisions. Based on that assumption, the tactic is not that bad at all. Trump gets the maximum “America First” election campaign via the trade war action without the Smith family and other consumers being hit by price increases. But on Tuesday the 25th September, the U.S. president held a fire speech in the UN including verbal attacks against the oil-producing Middle East countries because the oil price now plays a trick with the president.
Trump’s challenge is that the higher household incomes created by the tax cuts now are being threatened by higher gasoline and energy prices. As graphic one shows, the oil price has risen quite a lot during the past year, significantly more than the financial markets and central banks had imagined. The chart shows the European Brent oil where the WTI is the American pendant to Brent. The European development could well be the forerunner of further price increases for WTI in the United States, so the pain continues.
All American consumers are prepared for price increases due to higher import tariffs on Chinese products. However, there is a risk that the Smith family and other fellow consumers are not aware of the various reasons why the tax cuts have disappeared from their wallets again.
Graphic two shows the U.S. inflation, where the top curve includes energy and food prices while these two elements are deducted from the lower curve (core inflation). As one can see, the gap between the two curves currently increased and it will grow if the oil price continues to rise. This will be very inconvenient for Trump just before the mid-term elections, and should higher inflation give uncertainty about the president’s popularity, I believe that he strikes a quick deal with China – perhaps Beijing considers this outcome as well.
I argue that the inflation that is expected to origin from the 10 pct. tariff will be much smaller than generally expected. First, because for several years now, it has impressed me how many Chinese companies have been able to counteract price increases through efficiency improvements and cost-cuttings. This will partly be the case again, in addition, the Chinese government has let the renminbi depreciate to help Chinese exporters.
The consequence is that Trump can currently run a trade war against China without affecting U.S. inflation in any big style, though the Christmas shopping might explore price increases because the contracts have been signed a long time ago. Though if Trump chooses to raise the tariffs to 25 pct. for a broad part of the Chinese goods, the story will be very different.
A broad import tariff of 25 pct. will hit hard and push inflation higher, especially concerning consumption in middle-class households. In addition, I expect that the Fed will respond very clearly and continue with rapid rate hikes in 2019. All-in-all, this would seriously put Trump’s popularity under pressure – this I consider as such a strong argument that a broad import tariff of 25 pct. simply won’t be introduced due to the risk for the popularity among Trump’s voters. A natural consequence of this view is that I consider the risk for a new jump in inflation as low.
Should President Trump nevertheless choose this route, I believe that China’s government will take the pain and let Trump’s popularity drop – this scenario may also envisage among Trump’s advisors. Again, this is another reason why Trump won’t send the U.S. inflation on a journey towards new heights next year.
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