We know President Trump wants to settle the score with China and many U.S. trading partners by reducing the trade deficit with them. Some goods really cannot be made cheaper in the U.S., hence global trade made sense as it lowered the cost of living not only of many Americans but the rest of the world. That's Globalization 101. But what gives with doing a complete 180 and going head to head with China knowing the odds are stacked up against the U.S. if it bullies China too much?
It is easy to see the lunacy in the president's daily rants on imposing yet another tariff of double-digit proportions on imported Chinese goods. After all, China knows better than to be scared and give in, especially when it is one of the world's largest-growing economies. There may be yet another angle at play. The conspiracy theorist in me, at the risk of giving Trump some credit, cannot help but think there could be another angle to all of this.
In Trump's latest attempt to bully China, Canada, Mexico and Russia, one victim has not been spoken about -- namely, the U.S. Federal Reserve. A few weeks ago as the Chinese yuan was falling, which offset the tariffs imposed on China's goods, Trump decided to have a go at Fed Chairman Jerome Powell and the Fed's strong U.S. dollar policy. The trade war was being lost purely on the back of a higher dollar against the rest of the currencies, especially against the yuan. Its fate with emerging markets is no better, as seen by the latest turmoil in the Turkish lira, Argentinian peso, Brazil real and other similar currencies. To put it simply, Trump wants a weaker U.S. dollar going into the midterm elections, but how to get there?
Robust economic data and higher inflationary prints call for higher interest rate policy. The Fed is just doing its job given the objective to withdraw years of excess stimulus pumped into the system. But could the trade war spat indirectly be a way to coerce the Fed to take its foot off the pedal of its gradual rate increases? After all, the Fed is supposed to be independent and cannot be seen as giving into politicians and their foreign policy objectives.
As the trade wars saga heats up, raw material and construction prices are getting crushed. Base metals are down about 20% from their highs seen in June. Global freight volume indicators are showing some slowdown as well. Global PMIs are not picking up, and as the data comes in we are starting to see lower producer price index (PPI) and consumer price index (CPI) prints.
Are these reasons enough for the Fed to hold off on rate hikes? If it starts to see softer inflationary prints, then it can justify not raising rates, economically speaking. It takes a few months for prices to filter into economic data. After two months of harsh tweets back and forth, the data are starting to appear soft. Emerging markets are off about 20% from their highs with the S&P 500 still holding firm. Asset prices are softer, no doubt.
This could end up being a total win-win for the U.S. The only problem is that investors are not positioned for it. The most consensual trade out there is to be short U.S. treasuries and long the dollar as seen by the latest Commodity Futures Trading Commission (CFTC) spec position reports. Quite extreme, even from a historical perspective.
We all know the U.S. dollar is the only currency where the central bank raising interest rates justifies its higher real yield argument. But if Trump is managing to coerce the Fed or give it enough ammunition to back off on raising rates (taking excess liquidity out of the system), the market better watch out. It could be a nasty sell-off in the dollar and a massive squeeze in government bonds.
After all, Trump cannot ignore what's at stake by really upsetting the Chinese. Maybe this is one big ploy just to give the Fed a reason to keep rates down. Perfect timing into midterm elections, when a lower dollar would help the U.S. economy print better trade surplus and GDP figures and would make it easier for Trump to claim victory on his "Make America Great Again" campaign and take all the credit.