Consistent with our expectations back in January, the Trump administration has made trade policy a major focus in this midterm election year. It’s an issue that not only resonates with President Trump’s political base and has animated the president for much of his public life, but can be effectuated (more or less) without Congress. President Trump has been a vocal critic of U.S. trade policy and its growing trade deficit since the 1990s, calling on policymakers to promote fairer, more “reciprocal” trade – a term he often used on the campaign trail and has repeated while in office. And the recent widening in the U.S. trade deficit, to $57 billion (seasonally adjusted annual rate), likely raises the sense of urgency for the administration.
While the Trump administration’s recent tariffs on aluminum and steel have garnered the most attention, we believe the trade actions with the most significant potential economic and market impact – particularly the investigation into China’s use of American intellectual property – have yet to unfold.
What has taken place so far?
In January, the administration announced multiyear tariffs on solar panels and washing machines under Section 201 of the Trade Act of 1974, an area of trade law that allows the president to impose tariffs on certain products in order to “safeguard” domestic industries after they have been deemed “seriously injured” by trade.
In late February, President Trump announced his intention to move forward with indefinite tariffs on aluminum and steel (of 10% and 25%, respectively, with certain notable exemptions, including Canada and Mexico) under Section 232 of the Trade Expansion Act of 1962, an infrequently used area of trade law that gives the president wide latitude to impose tariffs to protect “national security.”
Three key takeaways for investors
Investors should keep these points in mind when considering the recent trade actions:
- While the direct effects of the new tariffs on the U.S. economy are likely to be small, tariffs create winners and losers – and if retaliation escalates, it could have broader implications for U.S. growth and key trade relationships. The magnitude of the tariffs’ impact will vary by industry and by region, but more generally, the metal-consuming industries that are negatively affected by higher input prices make up a larger portion of the U.S. economy than the industries protected. For example, U.S. steel producers in Ohio, Indiana and Pennsylvania will likely benefit from the tariffs, but to the detriment of other industries that are primary consumers of steel, including oil and gas drilling and auto, machinery and appliance manufacturing. Bureau of Economic Analysis data suggest that the U.S. steel industry accounts for around 0.8% of GDP, while industries that use steel as a primary input to their production account for around 3% of GDP in value-added terms. The potential for U.S. trading partners to retaliate against the tariffs with their own actions is an additional risk.
- Despite many market participants’ apparent surprise at the recent actions, they were actually well-telegraphed. The Section 232 process began back in April 2017, when the Commerce Department self-initiated its investigation into steel and aluminum; and in May, solar panel and washing machine companies petitioned the Commerce Department to look at purported unfair practices of trading partners.
- Trade developments that may have the most significant impact – particularly the outcome of the Section 301 investigation into China – are still to come. Section 301 of the Trade Act of 1974 is another area of trade law seldom used in recent history that provides the president wide latitude to impose tariffs and other measures to retaliate against unfair trade practices. We believe the singular focus on China (as opposed to other recent actions, which have been more broad-based) and the wide scope of the investigation into intellectual property theft and forced technological transfer could magnify its impact. While the administration has until August 2018 to make a determination, we expect a decision much sooner. Depending on the investigation’s findings, we could see President Trump imposing widespread tariffs, potentially even on consumer electronics (like phones), and scaling back Chinese investment in the U.S.; indeed, recent media reports indicate that the administration is considering tariffs in the range of $30 billion–$60 billion on a wide variety of Chinese goods. While PIMCO’s base case is that China would have a relatively measured response to these actions, we see a risk that trade tensions escalate depending on the size and scope of the tariffs and restrictions.
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