Why are interest rates and the U.S. dollar rising? Sure you have traders who are front running the Fed. They are going long interest rate sensitive vehicles in anticipation of the Fed hiking rates. But that’s not the full story.
Protectionism and tariffs are inflationary. That is to say they push prices up. The faster prices move up, the faster the Fed will hike rates in order to counter inflation. In this regard, protectionism and tariffs are bad for the economy. Remember, bull markets don’t die from old age, they are murdered by the Fed.
We’ve had a 9 year bull market run and just as the Fed is tightening, we have a new President who is causing massive inflation through protectionism and tariffs. I’m not saying protectionism and tariffs are bad. You guys know that China has long cheated in their trade dealings at the expense of American jobs. This is not about whether you believe tariffs are good or bad. This is about what is happening in the market right now and knowing what is going on so you can protect yourself.
Some traders, like Jim Cramer, say that the 10 year yield at 3% is nothing and that the U.S. economy has grown when yields are twice this amount. What these traders are not realizing is that the average person has less money than they did the last time the 10 year yield was above 3%. I argue that yields are relative. 11 years ago when the 10 year yield was at 5% right before the Great Recession, consumers were tapping home equity lines to fuel massive consumer spending. Today, we are a nation of renters without home equity lines to borrow against. Energy costs are up 45% over the last 11 years. Health care costs have risen by more than +140% over the last 11 years. 11 years ago the average American worker made $21 per hour. Today, the average American worker makes $26 per hour, that’s an increase of about 25%. If most Americans rent and have no home equity lines to tap and if health care costs have risen by more than +140%, and energy costs are up 45%, while wages are up only 25%, the math says that Americans are actually poorer than they were before the Great Recession. So in an economic environment like that, 3% is a much bigger deal than even 5% was back in 2007.
President Trump said he was going to impose tariffs on $100 billion worth of Chinese exports. Whatever these Chinese goods turn out to be, it’s going to raise prices for consumers which is inflationary and will force the Fed to hike rates faster which will hurt stocks. If the trade war keeps escalating, the economy will slow down faster.
The trade war with China is advancing on three fronts: finished goods, raw materials, and intellectual property. President Trump is fighting back against the Chinese on all three fronts. Tariffs on finished goods will lift prices for consumers causing inflation. Tariffs on raw materials will hit companies that make products out of steel and aluminum. Intellectual property tariffs will hit technology companies which have been the engine of economic growth for many years.
A recent case of intellectual property trade wars was what happened with ZTE and how American companies were banned from selling electronic parts and software to the smartphone maker. China hit back hard by holding up Qualcomm’s acquisition of NXP Semiconductors for anti-trust concerns.
Looking back at history, the stock market has often soared while the Fed is hiking rates; however, it was not during trade wars. It’s the trade wars that make this Fed rate hike cycle more dangerous than the usual rate hike cycle.
The latest trade war news is the revelation that President Trump will tie NAFTA agreements with Mexico on Mexico’s ability to stop the flow of illegal immigrants across the southern border and into the U.S.
Everything we are reading in the news about President Trump’s tariffs may just be opening negotiations with countries and the art of the deal.
May 1, 2018, is the day that steel and aluminum tariffs kick in but we are getting a steady stream of news about how exemptions are being handed out to various companies and countries in exchange for concessions.
So in summary, the Fed hiking rates and the trade war with China are two sides of the same interest rates are rising coin. As tit-for-tat trade tariffs fly back and forth, it’s going to show up as a rapid increase in the PPI and CPI which will make the Fed hike rates faster.