Jun 4, 201912:39 PMOpen Mic
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Trade war or Game of Thrones?
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Dollar vs. yuan
When tariffs were originally levied, they averaged 10 percent, meaning that they raised the cost of Chinese goods by 10 percent. Not surprisingly, China was able to reduce the value of their currency, the yuan, to the dollar by about the same amount. This currency value change offsets the tariff to some degree. One of the ways they did this was to reduce their interest rates by almost 2.5 percent at a time when the U.S. Federal Reserve was raising rates in 2018.
The problem, of course, is that when tariffs are raised to 25 percent, there is no way the Chinese can devalue their currency by that much, and they aren't really in a position to reduce interest rates further. The gambit, then, is that a further increase in tariffs will be more difficult for them to offset and the result will be their willingness to come to the negotiating table to make a deal.
The Fed has changed course in 2019, indicating that it won’t be raising interest rates until there is more evidence that it needs to. This would come in the form of faster economic growth (not likely given the moderating pace of growth both here in the U.S. and abroad) and higher inflation. On that score, tariffs raise prices, so there’ll likely be higher inflation. Tariffs have the potential to raise inflation by another 0.2 to 0.4 percent, which pushes the current rate just beyond the Fed’s target. However, the Fed will see that as transitory and not likely act upon it.
As of today, the Chinese haven’t come forward — they’ve stepped back. Two weeks ago, they indicated that they want three things: A deal that leaves them with dignity, an exclusion from agreeing to change their laws, and a commitment to not have to buy more goods than their country demands. Unfortunately, the first two won’t come easily.
Stock prices rallied and bond prices sold off on news that a trade deal was nigh. With the recent news of the deal faltering, stocks have declined by over 5 percent and bond prices have rallied, with yields falling by almost 0.2 percent.
This volatility can be expected to continue, as a trade deal won’t come easily. It’s too bad that Twitter didn’t exist during GoT times. Tyrion said it best when he stated, “If you want to conquer the world, you must have dragons.” That would have made for a good tweet. The good news is that no one in the trade game has dragons!
Brian Andrew is CIO of Johnson Financial Group.
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