President Trump’s decision to impose tariffs on US imports of steel and aluminium came as a surprise to the markets, raising the fear of a trade war.
Under Trump’s plans the US will place an additional 25% global tariff on imported steel and a further 10% tariff on aluminium. Trump’s decision to apply a global tariff – as opposed to a targeted one – means the tariff will impact all exporters of aluminium and steel to the US equally. The White House has confirmed that it would grant a 30 day exemption to Canada and Mexico, which we interpret as an effort to gain leverage ahead of the forthcoming NAFTA talks.
The decision to impose tariffs followed the recommendations of a US Commerce Department investigation, ordered by Trump, to consider whether imports of steel and aluminium posed a threat to US national security. The probe was initiated using a seldom used section of the 1962 Trade Act which allows the President to impose import tariffs without needing congressional approval.
Trump’s announcement prompted a strong condemnation from Canada and the European Union (EU). European Commission President, Juncker, expressed his regret warning “we will not sit idly while our industry is hit with unfair measures that put thousands of European jobs at risk.” The response from China has so far been more muted.
Since making his initial announcement, Trump went onto tweet “when a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win”. This is wishful thinking, in our view. History shows that trade wars end up having a negative impact on all protagonists.
The US is the world’s largest importer of steel, over 35 million metric tons in 2017, for use in a wide variety of industries including construction, automobiles, white goods, packaging and general manufacturing. The US’s largest import partners for steel are Canada (17%), Brazil (13%), South Korea (10%), Mexico (9%) and Russia (8%). China accounted for 2.9% of US steel imports in 2017[i].
The US is also a large consumer of aluminium, importing more than 5.7 million metric tons during the first 10 months of 2017. Imports account for around 90% of the total aluminium consumed in the US. Aluminium is a key raw material used in the aerospace, defence, automobile, electrical wiring and food packaging sectors. The US’s largest import partners for aluminium are: Canada (44%), Russia (11%), UAE (10%) and China (10%)[ii].
Trump needs to understand that trade is not a zero-sum game as it is a net contributor to productivity and economic growth. The reason developed countries, like the US, import much of their raw material requirements is because it is more efficient to do so. For example, aluminium smelting is highly energy intensive, requiring a prodigious quantity of electrical energy. Canada, which is fortunate to have access to low-cost hydro-electric power, is able to produce aluminium at a relatively low cost. It is therefore more efficient and cost effective, for the US to import aluminium from its neighbour than producing the metal at higher cost domestically.
President Trump also appears to have underestimated the negative impact tariffs will have on the domestic US economy. On the positive, domestic US steel mills stand to benefit from the proposed tariffs, which are likely to drive an increase in local demand. However, we think it unlikely that these mills will be able to respond fast enough, as they do not have sufficient spare capacity to meet the incremental demand. Lead-times on building new steel plants are lengthy.
As a result, the import tariffs are likely to create an imbalance of supply and demand, driving domestic steel prices higher. Higher steel pricing will act as a drag on profitability in the manufacturing sector, causing these companies to raise prices in an effort to offset the higher material costs. The price rises would ultimately feed through to the retail sector. As a result, Trump’s proposed tariffs amount to an effective tax on the US consumer.
The US working population is also unlikely to benefit from the proposed tariffs. The US manufacturing sector employed a total of 12.5 million people at the end of 2017, with the automotive sector – a major consumer of steel - employing nearly one million workers. In comparison, the US steel industry employed 147,000 people in 2017, equivalent to 0.1% of the total US workforce[iii].
While those working in the steel industry should benefit from greater job security and a potential uplift in remuneration, the positive impact to the economy is likely to be negligible. Rising margin pressure in the manufacturing sector would likely have a negative impact on both the profitability of manufacturing sector, as well as the employment prospects of those employed in it.
Overall, we expect import tariffs to have a negative impact on US economic growth. The rise in prices will also act to stoke inflationary forces in the economy, making it more likely that the Fed would raise rates more quickly than the market currently anticipates.
Our analysis ignores the potential impact from any retaliatory action taken by other countries. The EU has already touted placing an import tariff on several American icons including jeans, bourbon and Harley Davidson motorcycles or as late night US talk show host Stephen Colbert recently put it, “a tax on all men suffering a mid-life crisis”. The impact of Trump’s tariffs, should he decide to proceed, could therefore have far-reaching consequences to the US and global economy.
The implications of Trump’s proposed tariffs are clear, in our view and we can only hope the President takes time to reconsider his proposals. A review of past US tariff decisions does not paint an encouraging picture.
President George W. Bush imposed tariffs on steel imports in 2002 in a similar move to protect the domestic US steel industry. A subsequent 2003 report from the US International Trade Commission found that the majority of firms surveyed reported ‘substantial increases’ in the price of steel following the tariff imposition. In addition:
- 49% of steel consuming companies reported difficulties in sourcing the metal
- 32% of manufacturers that testified suffered delays in production
- Only 19% of firms managed to pass the price increase to their customer
A further report by the CITAC foundation estimated 200,000 US jobs were lost as a result of the 2001 tariffs, with around one in four of the losses occurring in the metal manufacturing, machinery and equipment, and transportation equipment sectors. President Bush reversed the tariffs in 2003.
Tariffs can also have unintended consequences. In 2009, President Obama imposed tariffs on Chinese manufactured tyres. A subsequent report by the Peterson Institute found that Obama’s tariffs did help grow employment in the US tyre industry by 1,200 jobs. However, this came at a cost of an estimated loss of 3,700 jobs in the retail sector. The cost to US consumers was estimated at US$1.1bn, as tyre prices rose sharply following the imposition of tariffs.
Equity market implications
Unless Trump decides to water-down or reverse his decision, we expect the import tariffs to act as a drag on US economic growth. Inflation forecasts would also likely rise, making it more likely that the Federal Reserve will raise rates at a faster pace than the market currently anticipates. While neither revision is likely to change the fundamental outlook for the US and global economy, we expect these negative incremental revisions to weigh on equity market sentiment.
The recent pull-back in equity markets is not unexpected and is something about which we cautioned about in our update on 15th January. High equity valuations, bullish investor sentiment and extreme positioning are not the necessary ingredients for further gains, especially coming off the back of the very strong performance seen in 2017. We expect volatility to remain elevated in the near-term.
We continue to think the market has underestimated the scope for a rise in inflation this year – both in the US and globally. We also think the market has potentially misjudged the Fed’s desire to normalise interest rate policy. That said, rates should likely remain low, in absolute and historical terms. We expect the Fed, along with other central banks, to raise rates at a measured pace.
The main risk to market performance in 2018 is a faster than expected pick-up in inflation, which would likely prompt the Fed, along with other central banks, to tighten at a faster rate than is currently anticipated.
Sectors that normally fare better in an improving growth/rising rate environment include financial stocks, consumer discretionary as well as energy and commodity names. Consumer staple, utilities and other so-called ‘bond-proxy’ stocks are at risk of underperforming when rates rise.
[iii] US Department of Labor, US Geological Survey