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Economic Insights

President Trump’s plan to impose levies on imported aluminum and steel has fueled concerns about a trade war.

Global trade has joined inflation and interest rates as major concerns for financial markets. On March 8, U.S. president Donald Trump unveiled a final plan to impose tariffs of 25% on steel imports and 10% on aluminum imports, with certain exceptions for our NAFTA trading partners, Mexico and Canada. Trump’s announcement followed a report from the U.S. Department of Commerce recommending several options. For many observers, the decision to impose the levies became a foregone conclusion following the resignation of White House economic adviser Gary Cohn, on March 6, who was strongly opposed to the move.

After Trump first announced the tariff plan on March 1, global stock markets tumbled, reflecting a larger concern of a potential trade war. Major U.S. trade partners affected most by the tariffs might impose their own punitive levies in retaliation, sparking back-and-forth actions likely to hurt whichever economies are involved. Already, the European Union is preparing to apply a 25% levy targeted at a range of products sourced from key states that supported Trump in the 2016 election.

The news comes just as global trade appears to be regaining its footing. Giulio Martini, Lord Abbett’s Director of Strategic Asset Allocation, notes positive developments in global trade flows since mid-2016. But “if serious trade disputes develop, the improvement that has taken place would be put into question,” he says.

Trump’s tariff plan is the latest sign of his administration’s desire to reconsider long-standing efforts to further integrate global economies. During the 2016 election campaign, for example, then-candidate Trump vowed to withdraw from the Trans-Pacific Partnership, a trade deal involving the United States and 11 other countries signed by his predecessor, President Obama. Within days of taking office in January 2017, Trump fulfilled that promise.

NAFTA Effects
However, another major pact appeared to inform Trump’s current trade calculus. In August 2017, as outlined in a Lord Abbett Economic Brief, the Trump administration and the Office of the United States Trade Representative (USTR), led by Ambassador Robert Lighthizer, opened up the trilateral North American Free Trade Agreement (NAFTA) for renegotiation. The White House threatened to withdraw the United States from the agreement if “a better deal” for U.S. companies and U.S. workers was not reached. Trump had used the specter of tariffs as a negotiating tactic to push Mexico and Canada to accept his demands, saying in a recent tweet, “Tariffs on steel and aluminum will only come off if [a] new and fair NAFTA agreement is signed.”

Unsurprisingly, the other NAFTA signatories, who are among the top steel exporters to, and importers from, the United States, did not receive the tariff news well. The Canadian foreign minister, Chrystia Freeland, vowed to “take responsive measures to defend its trade interests and workers” in the event restrictions are imposed on Canadian steel and aluminum products.

While markets appeared relieved that the March 8 announcement contained carve-outs for Canada and Mexico, the exemptions are contingent on the completion of the NAFTA re-do. With NAFTA renegotiations well underway, Ambassador Lighthizer released a statement on March 5 at the closing of the seventh round of talks. “In spite of this hard work, we have not made the progress that many hoped in this round…to complete NAFTA 2.0; we will need agreement on roughly 30 chapters. So far, after seven months, we have completed just six.” Time is of the essence during this process. On July 1, Mexico will hold a presidential election. Canada will hold elections in October, and the United States has midterm congressional elections on the docket in November. Ambassador Lighthizer is pushing to resolve the outstanding issues sooner rather than later in order to “maintain the possibility of having [NAFTA] considered by the current [U.S.] Congress.” 

More broadly, low visibility regarding NAFTA renegotiations is affecting U.S. industries unrelated to steel or aluminum. Mexican buyers in the agriculture industry are turning to Brazil for their corn imports, which would hurt a U.S. industry already struggling with low grain prices. Importers from Mexico purchased a total of more than 583,000 metric tonnes of Brazilian corn last year, a 970% increase from 2016, according to Mexico’s Agrifood and Fishery Information Service. In a Reuters exclusive report, one of Mexico’s top grains merchants cited the practicality and profitability of buying from Brazil, or Argentina, given the possibility of tariffs and uncertainty surrounding NAFTA.

Rising Uncertainty
The initial tariff announcement on March 1 brought on a fresh bout of uncertainty in global markets amid already heightened concerns about inflation. If foreign steel and aluminum makers choose to pass on the higher costs of production to U.S. manufacturers, the market may see even more inflation-related volatility.

Should trade tensions ratchet higher, and if other nations counter with their own punitive measures, the global economy stands to suffer.

“In a trade dispute, each party believes they will come out ahead; but in the swirl of retaliation, consumers lose, companies lose, and economies lose,” Martini says.

While the international community awaits further updates from the United States, Europe and China will be preparing measured responses in the event of a decision threatening their trade interests.

Historically, trade wars have never been “good” or “easily won,” as Trump recently asserted. The last major U.S. effort to invoke substantial, broad-based tariffs was the passage of the Smoot-Hawley Tariff Act in 1930.1 That legislation raised import duties on more than 20,000 agricultural and industrial goods. Foreign governments retaliated, and U.S. exports to Europe fell by two-thirds between 1929 and 1932, exacerbating an already historic U.S. economic downturn.

The stakes remain high this time around, as global economies are even more deeply linked to one another. To that end, Lord Abbett’s economic experts will continue to carefully monitor current and future developments to assess any adverse effects on global growth and their potential implications for major asset classes. 

Reported by John George, Lord Abbett Product Consultant

 

1Smoot-Hawley Tariff Act, formally the United States Tariff Act of 1930, also called Hawley-Smoot Tariff Act, was a piece of U.S. legislation (signed into law June 17, 1930) that raised import duties to protect American businesses and farmers, adding considerable strain to the international economic climate of the Great Depression.

 

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