September 2018 Commentary

  • U.S. & China Trade War: Earlier this summer, a 25% tariff was imposed on $50 billion of Chinese goods. Starting September 24th, a 10% tariff was placed on $200 billion of Chinese products entering the United States. This latest round is different since it is not only larger, but the White House has also indicated that it will pursue a higher rate of 25% later this year if progress is not made in trade negotiations with China. This is yet another wave of tariffs that have been placed on Chinese goods this year alone in what appears to be an extremely aggressive negotiation tactic taken by the Trump White House, a tactic of which that has not be well received by Beijing. The Wall Street Journal reported a senior official who advises the Chinese leadership on foreign-policy matters as saying “China is not going to negotiate with a gun pointed to its head.” Beijing has also responded with tariffs of its own, but the total amount has been far less due to the lower amount of goods that China imports from the United States relative to the amount that the United States imports from China. This dispute stems from a report issued by the Trump administration earlier this year that accused China of unfair trade practices - specifically the forcing of American companies to turn over valuable intellectual property in exchange for access to the Chinese market. Moreover, this approach is not unilaterally supported within the White House or the U.S. business community. While this tariff exchange is unfolding, senior level White House officials, such as Treasury Secretary Steve Mnuchin, have continued to pursue trade talks with members of China’s leadership. Additionally, it has been reported that Stephen Schwarzman, Chief Executive of Blackstone Group LP, has played an active role in pushing for further discussions and negotiations between the two countries.

    • Our Takeaways: The president is appearing to use two classic negotiation tactics in this trade “war” - Brinkmanship and Advancing While Negotiating. Regardless of whether the White House’s actions are intentional or coincidental, there will be short and intermediate effects for the economies and markets in both countries. In the short term, the U.S. economy may see a slight uptick from consumer spending if American consumers are in a position to significantly increase their personal consumption on many of the discretionary items that are slated to be affected by the tariffs. If the American consumer is not able to respond in the customary economic fashion to these tariffs, U.S. firms who increased their inventory levels in anticipation of this increased consumption may be stuck with large amounts of unsold inventory. In the intermediate term, American consumers may face higher prices on many goods that either still have to be imported from China or bought from domestic firms at higher prices. This will likely lead to a lower overall consumption from the U.S. economy unless increased revenue at U.S. based firms translates into significant, real improvements to wages of U.S. workers. In China, this will have a dramatically negative effect on firms that were heavily reliant on exporting to the U.S. market. It will take time for these firms to find demand to replace what was lost from other economies or lower cost of production suitably to be able to offer their goods at competitive prices, including the tariff, in the U.S. market. This will also dramatically decrease the amount of dollars flowing into China. The ultimate impact of this change is unclear at this point, but it is generally considered a good thing for the relevance of the U.S. dollar in international business and trade to have large amounts of it end up in the hands of foreign governments and businesses. Nevertheless, the real war has much longer term consequences for the competitiveness of both countries. The root of this tariff tiff – the White House’s allegations of unfair practices around IP conducted and/or supported by the Chinese government – strikes at whether U.S. firms can maintain competitiveness around the world if they are forced to turn over trade secrets just to enter the Chinese market. How this White House is able to reach a resolution, if any, will have long term implications on how the U.S. government and American companies are treated globally.

  • Coffee Bean Price Rout: Coffee bean prices have dropped precipitously this year from $1.50 to $1.40 per pound in late last year to under a dollar per pound. This represents the lowest level since 2006. Yet, due to the strength of the U.S. dollar, local prices for Brazil (one of the largest producers and exporters of coffee beans) have remained relatively stable, encouraging producers to export increasing supplies and further depressing prices. This has significantly impacted the economies of other, smaller coffee producers such as Colombia and Honduras whose currencies have done slightly better relative to the dollar which has resulted in these countries participating in almost 90% of the commodity’s price declines. This has led to calls for protective measures for farmers in these countries as they are no longer able to sell above their cost of production. Market participants expect the price of coffee beans to continue to decline rapidly since Brazilian farmers are harvesting what is expected by many to be a record crop.

    • Our Takeaways: Situations such as these are often very interesting to examine because there are so many different factors at play. There are multiple, independent foreign countries, each with their own unique exchange rate to the U.S. dollar all producing the same good. Having a lower exchange rate makes the sale of this good in the U.S. markets more lucrative, but at the same time it makes it more difficult for that particular country to service dollar-denominated debt. Thus, producers in fiscally weaker countries outperform their competitive firms in fiscally stronger countries (Colombia and Honduras). This intricacy is reinforced by the fact that the larger, more market significant producers are located in the fiscally weaker country (Brazil). It has been reported that producers in some of the more affected countries have made overtures to some of the larger coffee purchasers in the United States, such as Starbucks, but it is unclear as to what route could be pursued to help alleviate the situation. Starbucks in particular, after having recently raised prices on its coffee drinks, would have plenty of room to move at the negotiating table, but it is unlikely that this publicly traded company would make significant sacrifices to their profitability windfall at the expense of their shareholders.

  • Hog Price Decline: After seeing sharp declines in mid-2018, hog futures have sharply accelerated back towards price highs witnessed at the end of 2017. Initially, much of this increase was fueled by reports, and cases, of African swine fever in China. China is one of the largest pork producers, and as such, has a large amount of livestock that stand to be affected by this epidemic. It was with this backdrop that prices increased further in the wake of Hurricane Florence's destruction of Eastern North Carolina where much of the state’s hog farms are located. It still remains to be seen what the total impact of the storm will be on the state’s hog production capabilities, but earlier estimates of the total agricultural impact to the state were already in the billions.

    • Our Takeaways: While the impacts from Hurricane Florence were devastating for many in the Carolinas, especially the agricultural community, this development and its impact on the commodity’s price simply served as a bellwether for sentiment among participants in this market. The larger, and potentially more impactful, part of the story is the threat to Chinese production from the African swine fever. The Chinese market alone has outstripped their own ability to produce for the needs of the country making it one of the largest pork importers in the world as well. Further declines in domestic stock in China will lead Chinese consumers in increasing numbers to the global market potentially driving up prices significantly.

  • September’s Federal Reserve Meeting: During the September Federal Open Markets Committee (FOMC) meeting, the committee decided to pursue the widely expected hike of their short-term interest rate target another quarter percentage point, bringing the range to between 2% to 2.25%. Additionally, they raised GDP projections for this year and next year from 2.8% to 3.1% and from 2.4% to 2.5%, respectively. However, they maintained their GDP forecast for the “longer-run” below 2%. They also maintained their rate target forecasts going into 2019 and 2020 which many had suspected they would raise on the back of stronger real and survey economic data.

    • Our Takeaways: This rate hike, as well as the potential of one more this year (likely at the December meeting) have largely already been priced into the market. There has been tangible improvement in the U.S. economy since the ‘08-09 financial crisis, and the Fed’s move to raise the short-term interest rate target has been a warranted, albeit slow, move. The ultimate goal of this exercise, returning the short-term interest rate target range to a suitable enough level from which accommodative policies can be made in the face of the next economic downturn, will almost certainly have the effect of increasing the attractiveness of interest- bearing assets and decrease the attractiveness of “risk” assets (such as stocks) which has drawn criticism most notably from Trump and his administration. The president by his own admission does not necessarily see these efforts as bad, but as a “real estate guy” he knows their collateral effect will be a higher cost of carry for debt instruments such as real estate mortgages. While real estate is not a particular area of concern in today’s market, there are pockets of debt that have risen to the level of concern such as the non-investment grade, or “junk,” bond space. As the Fed continues to plot its course, market participants across a wide variety of asset classes will pay increasingly close attention to what the effects of higher short-term rates will be upon their particular market.


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