The Summer Slumber Continues for Treasuries but Trade Trouble Lurks

Jul 20, 2018

With no economic releases today, the somnolent Treasury market is likely to  continue its slumber into the weekend. The 10yr note is currently off 4/32nds to yield 2.85%, a level it seems quite comfortable at of late. While the lack of volatility has been at generational lows, some data of late points to gathering concern over trade tariffs impacting costs and confidence and that will eventually awaken the Treasury market. On Wednesday, the Fed’s Beige Book relayed concern in this area from many business contacts, and the July Philly Fed Survey details were mixed with the employment index dropping to 16.8 versus 30.4 in June and the future conditions index slipped to 29.0 from 34.8. Perhaps most important was the spread between prices paid versus prices received which increased to 26.6 from 18.6. This brought the 6-month moving average to its highest since Oct 2011. This implies firms are struggling to pass higher costs to end-users  with profit-compression rather than building inflation pressure the result.

 

  Economic News

 

The week ends without any new data to chew on so instead let’s look back at the second day of Fed Chair Jerome Powell’s House testimony and the Fed’s Beige Book summarizing regional economic conditions. In both cases, the impact of trade tariffs garnered significant attention and despite the lack of immediate impact to the $20 trillion U.S. economy there is growing anxiety exhibited by business contacts in the Beige Book and those anxieties were also expressed by Powell.

 

Ten of the Federal Reserve’s 12 districts reported moderate or modest economic growth so far this summer. The one caveat, however, was with manufacturers across the U.S. expressing concern about tariffs, with many reporting higher prices and supply-chain disruptions in the wake of the new trade policies. The report was based on information collected on or before July 9 and showed many businesses expressing uncertainty regarding the impact of trade.

 

For his part, Fed Chair Powell warned about the trade issue in his second day of testimony, this time in front of the House Financial Services Committee. Powell commented that rising world protectionism would over time pose a risk to a U.S. and global expansion that appears largely on track to continue. “If this process leads to a world of higher tariffs on a wide range of goods and services that are traded and those are sustained for a longer period of time, if it results in a more protectionist world, that would be bad for our economy.”  While he refused to criticize the administration’s trade policies he said “the evidence is clear countries that remain open to trade have higher productivity. They have higher incomes.”

 

In the meantime, the administration seems intent on pressing the trade issue. On Thursday, Commerce Secretary Wilbur Ross indicated he would launch an investigation into whether quotas should be used to restrict uranium imports for national security reasons. Much of these imports, however, are from friendly nations with Canada and Australia providing over half of U.S. consumption. Plus, the military is reported to have stockpiles large enough to last decades. Nuclear powered utilities, however, fear such quotas would raise electricity costs for their nuclear fuel.

 

And if that wasn’t enough the administration is continuing to pursue possible tariffs on European autos.  On Wednesday, the president threatened 'tremendous retribution' against the E.U. specifically mentioning auto tariffs, if his upcoming meeting with EU officials doesn’t yield what he considers a fair auto trade deal. The issue of auto tariffs is expected to be high on the agenda of the July 25 White House visit by European Commission President Jean-Claude Juncker.

 

And in the category of now predictable responses, the European Union is preparing a new list of American goods to hit with protective measures in case the Washington meeting next week fails to persuade President Trump not to raise car tariffs. The European Commission briefed EU ambassadors Wednesday on trade relations with the U.S., and said it was working on so-called rebalancing measures that would be ready immediately if the U.S. imposes levies on European car exports.

 

Meanwhile,  auto makers, parts suppliers and dealers are joining forces to push back against the Trump administration’s proposal to apply tariffs of up to 25% on vehicles and components imported into the U.S., contending the administration’s trade policy will backfire and lead to higher prices and lost jobs. The petition asks the administration to back off tariff threats with plans to amplify their message in digital and newspaper advertisements. Look for those ads in your weekend newspaper.

 

The upshot to all this back and forth over trade is to acknowledge it’s likely to get worse before it gets better and as the Beige Book noted, and the Philly Fed Survey verified, costs are increasing with the inability to pass all of it along to consumers thereby constraining profits. That is likely to feed back into reduced business investment and/or confidence. That scenario, if it plays out that way,  will provide a positive backdrop for Treasuries as slowing global growth becomes a more assured reality and flight-to-safety trades into Treasuries gather momentum as the rhetoric and tit-for-tat tariff actions become more heated.

 

 

Market Update  The Case of the Weakening Chinese Currency

 

As the administration is finding out, trade actions almost always are followed by reactions in some form or fashion. In the case of tariffs placed on Chinese imports, Chinese officials have responded in both direct ways, such as retaliatory tariffs on U.S. goods, as well as more stealthy actions such as extended goods quarantines and slow-walking inspections, etc.. Another way they are countering U.S. tariffs is via a weakening in the currency, thereby offsetting some or all of the costs of U.S.-placed tariffs. This action isn’t without other drawbacks, and the currency drop isn’t all official manipulation, but it is most certainly one of the tools being deployed by the Chinese.

 

The Case of the Weakening Chinese Currency

 

 

Agency Indications  Market Rates

 

Market Rates

 

 

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