Some Room Left?

By Benjamin Picton of Rabobank

Some Room Left?

President Trump’s tariffs on Canada and Mexico, and an additional 10% tariff on imports from China took effect yesterday. Trump had said on Monday that there was “no room left” for those countries to negotiate on trade, but Commerce Secretary Howard Lutnick walked back the hawkishness late on Tuesday by suggesting that some wiggle room may exist to reduce duties on goods covered by the USMCA trade agreement. Earlier in the week Mexico floated a proposition to apply 25% tariffs to imports from China as a quid-pro-quo for continued US market access. Could we see a united trade front against China on the table as the Trump Administration’s price for watering down duties on Canada and Mexico?

Lutnick said that Trump is considering lowering the 25% tariff rate if USMCA rules are followed, but threw a jab at the USA’s northern neighbours by saying that Canadians “like to cheat”. Similar accusations of foul play have previously been levelled by trade advisor Peter Navarro against Australia, specifically in relation to aluminium exports that were granted exemptions to trade restrictions during the first Trump term through a handshake agreement that Australian exports of aluminium to the USA would be informally restricted.

Canada and China have been swift to retaliate to the new tariff measures, in defiance of the orthodox economic prescription that tariffs are entirely self-defeating. Canadian Prime Minister Trudeau addressed Trump directly, saying that “even though you’re a very smart guy, this is a very dumb thing to do”, a comment that perhaps holds some irony given that Trudeau was in the process of confirming tariff measures of his own when he made it. Trudeau went even further to suggest that President Trump is attempting to crash the Canadian economy as a precursor to annexation(!).

China announced tariffs of 15% on US exports of chicken, wheat, corn and cotton, and 10% tariffs on soybeans, sorghum, beef, fish, fruit, vegetables and dairy. China’s Ministry of Commerce also said that it had added an additional 15 US companies to an export control list, and that additional US firms had been added to the ‘unreliable entity’ list that effectively serves as a sanctions registry for entities perceived to pose a threat to China’s national security.

Early this morning China announced that it is setting its economic growth target for 2025 at 5%, and its CPI inflation target at 2%. The fiscal deficit will widen to around 4% of GDP, which is the largest in over 30 years. The increased fiscal stimulus goes hand-in-hand with a loosening in the monetary policy stance from “prudent” to “moderately loose” – the first time that China had adopted such accommodative policy in 14 years -that was announced in December. By contrast, Donald Trump used his address to Congress yesterday to say that his Administration will aim to balance the Federal budget without giving firm details on how that would be achieved.

The Treasury curve bear-steepened on Tuesday with the 10-year yield rising 8.9bps to 4.25% and the 2-year up 4.1bps to 3.99%. The Canadian sovereign curve shifted even further upwards, while European yields fell at the short end and posted mixed-results further out the term structure.

Of course, despite the hints at détente from Lutnick, further salvos in the developing trade war are likely imminent. Trump used his address to Congress to indicate that reciprocal tariffs and tariffs on agricultural imports will apply from April 2nd:

“whatever they tariff us, we tariff them. Whatever they tax us, we tax them. If they do non-monetary tariffs to keep us out of their market, then we do non-monetary barriers to keep them out of our market. We will take in trillions of dollars and create jobs like we have never seen before.”

Some countries may stand to benefit in the short run from a reshuffling of the global trade deck, but all of this is likely to be bad news for growth in its totality. Speaking in Sydney, RBA Deputy Governor Andrew Hauser (formerly of the Bank of England) noted that there is now a chance that first quarter GDP growth in the USA prints negative. This lines up with the signal from the Atlanta Fed’s GDP nowcast model, which is signalling a contraction of 2.8% in the first quarter, versus a previous forecast of 2.3% expansion as recently as February 26th.

Hauser said:

“if companies and households come to conclude that trade policy uncertainty isn’t ‘classical uncertainty’ (i.e. “carry on until the fog lifts) – but genuine ambiguity- i.e. “anything could happen” – then they may choose to just batten down the hatches, postponing planned spending, particularly on long-term investment, until things become clearer. This sort of watchful waiting is pretty sensible, individually, but for an economy it can be bad news. As The Economist put it recently “tariff uncertainty can be as ruinous as tariffs themselves”.”

This echoes recent comments made by one of our favourite bears, Jeremy Grantham, on Bloomberg’s ‘Merryn Talks Money’ podcast. Grantham paraphrased John Maynard Keynes to point out that animal spirits are incredibly important to economic performance:

“You could line up all your economic stimuli, everything a wonderful plan, but if for whatever reason people become pessimistic, they sat on their money and they did not spend, you’re toast…”

Now that major US stock indices are all in the red year-to-date, the likelihood of creeping pessimism would appear to be growing.

On that theme, the “take Trump seriously, but not literally” meme that had been compressing equity risk premia and sending US stocks into the stratosphere late last year seems to be rolling over in Europe. Growing realisation that Trump means what he says and says what he means on trade sent European stocks sharply lower yesterday, while news that the USA would be halting arms supplies to Ukraine helped to continue the outperformance of European defence names.

European Commission President Ursula von der Leyen announced a new lending instrument to provide EUR 150bn of loans to member states for defense investment. The new facility is expected to improve coordination and quality of expenditure on pan-European priorities (artillery, drones etc). The facility is also expected to help improve inter-operability, create economies of scale for new defence procurement and support a significant step-up in support for Ukraine.

Von der Leyen also announced the activation of an escape clause within the Stability and Growth Pact that will allow for defense spending to increase by 1.5% of GDP without triggering excessive deficit procedures. This relaxation of fiscal rules could be worth up to EUR 650bn over four years. In a similar vein, Germany is set to create a new EUR 500bn fund for defense and infrastructure spending, and to exempt defense spending of more than 1% of GDP from debt-brake rules. 

Fresh from being feted by international leaders after his confrontation with Trump and Vance last week, Ukrainian President Zelenskyy struck a conciliatory tone with the Administration yesterday by saying that he was ready to work under Trump’s “strong leadership” and that it was “time to make things right.” “We are ready to work fast to end the war…and to work with the US to agree a strong final deal.” 

President Zelenskyy appears to recognise that European pledges of support are nice, but it is real production and real firepower that really matters. On that score, the USA is still the only game in town.