May 31, 2019 – On Thursday May 30, President Trump unexpectedly announced new tariffs on imports from Mexico, tying the policy to illegal immigration. Specifically, he indicated that on June 10 the administration would begin assessing a 5% tariff on all imports that would gradually increase by 5 percentage points each month until they reach 25% in October, and will remain at 25% until illegal immigrants ceased coming into the United States across the southern border, “at which time the [T]ariffs will be removed.” This potential action only adds more risk to the economy and markets, which led us to recently decrease domestic equity exposure in portfolios earlier in May. Just earlier this week we adjusted portfolios moving some incremental cash into core munis, which we believe will benefit from the risk-off sentiment emanating from ongoing trade tensions.

This move from President Trump was quite a surprise, as his ire on trade issues has recently been sharply focused on China. In May, the administration punted a decision on whether to levy tariffs on automobile imports from the European Union (EU), Japan, and other countries, an indication that it was leery of fighting multiple trade fights at once because of the damage such a fight does to the economy and markets. Trade relations with Mexico had appeared to be in good shape, as both countries were looking forward to implementing the revised NAFTA agreement.  Additionally, although the president has clearly been very focused on illegal immigration problems, he only very recently indicated a plan to use trade policy as a lever to effect change on this separate issue, with little indication the administration was ready to move this quickly. 

If the tariffs are implemented, they could significantly affect the economy and markets. In 2018, the U.S. imported $345 billion worth of goods from Mexico. If trade volumes did not change, a 5% tariff would be a tax hike of $17 billion. If it rose to 25%, it would be a tax bill of $86 billion. All evidence from the recent tariffs on imports from China indicates U.S. consumers and firms are paying the tax, in the form of higher prices for the consumer or lower margins for firms. Importantly for markets, much of the trade with Mexico is a supply chain for the automobile industry that has been built up over the past several decades under NAFTA. These tariffs would hit those auto companies directly and supply chains are not easily moved. There is also the very real possibility of retaliation. The total trade relationship with Mexico is nearly as large as with China so many U.S. exporters would be put at risk (Figure 1).

Figure 1: Bilateral trade with U.S. partners (goods & services)

Bilateral_trade_with_US_partners.png

Data as of May 15, 2019.

Source: Macrobond.

If these tariffs were fully implemented, it would only add to an already-daunting tax bill. Our recent decision to reduce equity exposure is significantly tied to our expectation that the administration is more likely than previously expected to implement a 25% tariff on the full slate of goods from China. Those would amount to a tax hike on U.S. consumers and businesses of roughly $150 billion. A tariff on autos and parts would bring the tax hike up to $200 billion. A 25% tariff on all imports from Mexico would bring the tax hike to nearly $300 billion (Figure 2). To put that in perspective, the December 2017 tax legislation that boosted growth in 2018 was estimated to deliver $260 billion in tax cuts for American households in 2019. The sum total of proposed tariffs would more than wipe that out.

Figure 2: Values of U.S. tariffs proposed and imposed

Values_of_US_Tariffs.png
  1. Solar panels and washing machines
  2. Section 232 steel and aluminum tariffs
  3. 25% tariffs on first $50bn from China
  4. Additional tariffs on $100bn further from China
  5. Section 232 auto tariffs
  6. Tariffs on $200bn further from China (10%)
  7. Tariffs on all remaining imports from China (10%)
  8. Step-up to 25% rate on $200bn from China
  9. Step-up to 25% rate on remaining ~$300bn imports from China
  10. 5% on all imports from Mexico, stepping up by 5% each month until reaching 25%

Data as of May 31, 2019.

Sources: Goldman Sachs and Wilmington Trust Investment Advisors, Inc.

It is important to note that these newly proposed tariffs may never actually be implemented, or at least not progress very far. First, in these early days, it is not clear the administration has the legal authority to implement the tariffs under the same laws used for China and auto tariffs. Second, and probably more significantly, there was immediate pushback from Trump’s own party. Senator Chuck Grassley (R-IA), an important power broker for the party, pushed back immediately and forcefully on Thursday after President Trump made his announcement. If the president does not have the support of his party, he will find it challenging to pursue this course of action. Nonetheless, markets and companies are clearly worried and we expect conditions to further deteriorate before they improve.

Core narrative

The possible implementation of tariffs on all imports from Mexico only add to the economic and market risk that recently contributed to our decision to reduce equity exposure in portfolios. We also recently reallocated some cash to core munis that we expect would benefit this year as trade issues continue to weigh on risk sentiment. Although the proposed tariffs on imports from Mexico may never be implemented, it is clear that the president intends to use tariffs as a tool to pursue his policies, and we do not expect swift resolution of these issues, especially with China. Tariffs are damaging to the economy and markets, leading us to favor a neutral position on equities and our recent higher allocation to core munis. Last, we continue to monitor economic data closely, looking specifically for signals of a recession.  We are not there yet, but we now seem to be headed there faster than expected just a short time ago.

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