For the week ending May 31
Trade War Opens up on the U.S. Southern Front
Emboldened by solid domestic economic growth, the Administration launched a trade war on our southern border in the form of proposed 5% tariffs on exports coming into the United States from Mexico. The proposed tariffs are a retaliatory move focused on the entry of illegal immigrants into the United States.
The tariffs are scheduled to take effect on June 10, 2019 and rise by 5% per month through October 2019, resulting in a 25% tariff. According to data from the Commerce Department, the U.S. imported $346.5 billion in goods from Mexico in 2018.
The United States is Mexico’s largest trading partner. The total value of Mexican goods and services accounted for approximately 13.6% of total U.S. imports in 2018. The most affected products are auto-related, with vehicles accounting for $93 billion of the total dollar volume. Other items include:
- Electrical machinery ($64 billion)
- Machinery ($63 billion)
- Mineral fuels ($16 billion)
- Optical and medical instruments ($15 billion)
It was reported by several news outlets on Friday that U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin oppose the tariffs on Mexico.
What about China?
Unfriendly rhetoric has emerged between the U.S. and China regarding various trade related topics, following the breakdown in formal negotiations. It is also widely believed that the recent Mexico announcement lowers the probability of a U.S.-China trade deal, but that remains to be seen.
There has been much concern regarding the trade wars that have developed between the U.S. and China. As the graph below illustrates, the flow of goods between any two regions should not be looked at in isolation given the complexity of the global supply chain.
A Snapshot of China and Global Trade
Source: International Monetary Fund (IMF)
While the imposition of tariffs may not significantly affect one specific economy, there are concerns that “less friendly” global trade policies could disrupt supply lines, causing a decline in global exports as a percentage of global GDP, resulting in slower growth and potentially higher inflation.
Trade Wars Roil Financial Markets
Friday’s announcement of tariffs on goods from Mexico added fuel to an already volatile market environment. For the month of May, the S&P 500 declined -6.35% but is up a strong +10.74% on year-to-date basis.
The All Country Word Index ex USA (ACWI ex USA), a comprehensive measure of international equity performance, declined -5.30% in May, but trails the U.S. equity markets on a year-to-date basis, having risen +6.31%.
Conversely, bond prices rose as interest rates declined across the yield curve, both here and abroad. The U.S. 10-year U.S. Treasury bond closed the month to yield -2.13%, down from 2.50% from April month-end.
The decline in bond yields has not been limited to the United States, as noted in the graph below that tracks 10-year bond yields for the U.S. and several other industrialized nations over the last 24 months.
Global 10-Year Bond Yields: Two Years Ending May 31, 2019
Source: FactSet, Inc.
Global bond yields have been on the decline since mid-November 2018. In the U.S., the current yield curve inversion (3-month Treasury bills/10-year Treasury bond yield) is being driven by investors placing a high probability that the Federal Reserve cuts interest rates over the next year. Also, in our opinion, the global risk-off trade and cross border investors seeking a haven in U.S. dollar-denominated securities have been exacerbating the curve inversion.
Uncertainty is a toxic substance for the financial markets and results in volatility.
Economic growth in the U.S. remains expansionary and corporate profitability, although off its peak margin levels, remains strong. Liquidity remains robust but there is no doubt that the trade tensions have clouded capital spending and allocation decisions in corporate boardrooms.
Over the weekend, both China and Mexico have made both indirect and direct statements that at least open the doors for negotiations on the trade front.
Beyond the volatility on the trade front, we remain constructive on the long-term prospects for the financial assets. However, the recent volatility once again underscores the importance of diversification at the asset class and sub-asset class levels.