This Bird Has Flown

There once was a fellow named Cohn
Who markets thought stood all alone
‘Gainst forces quite set
To keep up the threat
Of tariffs. Now this bird has flown!

Apparently trade friction and tariffs ARE a problem in the market’s eyes. Who’d a thunk it? The announced resignation of President Trump’s chief economic advisor, Gary Cohn, was not well received by markets anywhere as he was seen as the last free trade voice in the White House. S&P futures fell 1% within minutes of the announcement and we have seen that follow through in equity markets around the world. The dollar has been a different story though. While the yen has rallied about 0.35% on its haven status, the euro is little changed, and the dollar has actually shown strength against many key US trade partners amid the escalating rhetoric on trade. For example, CAD has declined 0.45%, MXN is down 0.6% and KRW is lower by 0.5%. Of course, it should be no surprise the renminbi has suffered as well, down 0.15%. Net, the dollar is little changed on the day, at least as measured by the many indices that track it, but there has been some movement.

So what are we to make of all this? Quite frankly I would argue there is no way to know at this time. On the one hand, President Trump campaigned on this specific issue; countless times declaring he would get better deals for the US. Does this mean that he will follow through on these threats and actually impose the tariffs? I am not prepared to answer that question other than to say the probability is clearly non-zero. Will this lead to escalation and retaliation by other nations? Certainly they have made clear they are willing to do that, but a funny thing is given the size of the US trade deficit with the rest of the world, it just might be they have more to lose than the US. Now I’m not advocating for a trade war as history shows those can be quite destructive to all involved, but based on my observations of the President to date, I would not rule out that outcome. There is, however, a more likely thought process to these tariffs; they are the latest salvo in a trade negotiation. In fact, Administration members have been essentially saying that already, for example, pointing to NAFTA and saying if a new agreement is reached that is more to the US liking, tariffs won’t apply to either Mexico or Canada. And when looking at the largest exporters of steel and aluminum to the US, both Canada and Mexico are top of the list, well ahead of China in both cases.

So here’s my broad observation about what is happening in the US right now, at least from the perspective of markets and their investors. There is a significant transition in the tone and language that is emanating from the key power centers in the US: the White House, the Treasury and the Fed. For the past umpteen years, every comment has been carefully considered before being made public, as there was a great fear that speaking forthrightly would unleash market turmoil. Arguably this has been the case since at least the Clinton Administration when the term ‘bond vigilantes’ was invented.

But the current administration is quite different than all we have seen in the past, perhaps since Andrew Jackson in the 1860’s. Forthrightness has become a hallmark of the communication policy, as evidenced by Fed Chair Powell’s testimony, by Treasury Secretary Mnuchin’s comments at Davos, and by the daily commentary from the White House. And markets are having a tantrum because they seem to be losing the control they feel that they had. And in reality, they did have control. Thus the taper tantrum in 2013 was met with the Fed bending over backwards to deny that they would ever stop QE, and the entire concept of the Fed put is based on the idea that if policy changes aren’t met with market approval, a sell-off will result in a change in those policies. But as I have said before, the stock market is not the economy, and despite the fact that President Trump has been bragging about the stock market’s rally, he will drop that discussion in a heartbeat if he has something else to say. I assure you that if this is a negotiating tactic and Canada and Mexico cave on current outstanding issues in NAFTA, that will be the entire discussion, regardless of where equity prices go. I think the rest of the world is having trouble digesting this change as well, as circumspection in announcements has been the norm. It will become ever harder for Draghi or Carney or Merkel or any foreign leader to remain subtle in the face of straightforward comments from the US. Maybe that’s not such a bad thing!

Anyway, we are getting to watch a remarkable turn of events in communication, and I would look for market volatility to continue to rise accordingly. So what is in store for today? As another Nor’Easter bears down on NY, we get our first hint at the payroll data with ADP Payroll (exp 205K) and then Trade Data (-$55.1B). A little later comes Nonfarm Productivity (-0.1%) and Unit Labor Costs (+2.2%) and finally the Fed’s Beige book is released at 2:00. We also hear from Bill Dudley again, as well as Atlanta’s Raphael Bostic. One of the interesting things from yesterday was Governor Lael Brainerd, seen as one of the most dovish Fed members, turned quite bullish on the economy and seemingly hawkish in comments she made. She used the term headwinds turning into tailwinds just like we heard from Chair Powell at his testimony. I remain convinced that the Fed hikes four times this year. I remain convinced that the ECB remains far more dovish than currently anticipated, and I remain convinced that the dollar will end the year higher. For today, I like a modestly firmer dollar by the close.

Good luck