It's investors' desire for a trade war that emerged last week in the news of tariff "deals" between the United States and China.
It's OK, it's a 90-day pause, and a higher speed may only bring temporary relief. Investors bought the story of President Donald Trump’s friendly Treasury Secretary Scott Bessent now sitting firmly in the driver’s seat, with the Chinese eagle Peter Peter Navarro being pushed into a broom cabinet somewhere behind the White House, and we can all go back to the bullish day of “Freedom Day.”
I won't buy it.
I think we still have more volatility – not only will the new normal of the brand new U.S. tariffs 10% swing (that's the best case scenario) over the next three months, but also in the coming years, as long-term structural trends continue toward a new global economic paradigm.
Let's start with the direct question. While it is too early to see data inflation now (producer price index, wholesale price scales fell slightly in April), there are many anecdotal warning signs about price increases related to tariffs.
Profit margins have been compressed, and even the largest retailers seem unwilling to take a bigger blow. Wal-Mart announced last week that it is raising prices for goods such as electronics and toys due to Chinese tariff rates, warning that more price increases will be made.
"Thinking about the magnitude of tariffs, even lower rates ... we can't absorb all the pressure," said Doug McMillon, CEO of the retailer. If Walmart thinks the price has to be raised, you can also bet others will.
"Higher real interest rates may … reflect the possibility that inflation may be more turbulent than the crisis period in the 2010s. We may enter a more enduring period more often, possibly longer, supply shocks, daunting challenges to the economy and central banks."
The deadlock is of course the biggest risk here. As Steve Blitz, managing director of TS Lombard, wrote to clients in a report last week: "Even if the moderate recession of the recession is put on hold, given the increased tariffs on the trajectory of larger budget flaws, it seems to ensure higher inflation results. Monetary policy alone cannot reverse the trend, while the deficit shrinks without reversal."
indeed. The financial situation in the United States is the elephant in the room. Even if you assume the U.S. can raise $200 billion to $250 billion from tariffs, that doesn't make sense to offset the $1.8TN deficit.
Aside from that, a new budget bill will be added to debt by $330 million over 10 years, 5.2tn if you think all gimmicky maturities have been permanently extended, if you assume all gimmicky maturities are due. Many tough Republicans rejected the first draft last weekend, but negotiations are underway, and the end result is unlikely to help the U.S. fiscal situation.
The debt problems in the United States are structural and long-term, and they can trigger others. What happens if there is a slowdown or recession that will cause a sharp drop in tax revenue, even if interest rates still rise?
While inflation can temporarily reduce the debt burden, it may also make it more expensive to do business in the United States. As Blitz points out: “In fact, imagine a situation where the Fed helps the dollar strengthen to avoid checking the real interest rate needed to maintain the required inflow, and all of this overwhelms you to stop companies from purchasing foreign capital and labor.”
Trump will undoubtedly try to put pressure on outsourcing companies - he witnessed his "small problems with Tim Cook" last week after Apple announced plans to purchase an iPhone from India. But the rest of the world is not still.
In recent years, China and many other countries have built huge gold reserves in hopes of decoupling and staying away from the dollar. Although gold prices have fallen after the market is rising, I wouldn't be surprised if there is another rise at some point. Discount retailer Costco put new restrictions on Gold Bar sales last week, allowing customers to buy only one instead of two at a time because it can't meet demand.
One of the particularly tricky things at the moment is that you can imagine both supply and demand shocks. Tariffs may disrupt supply when the slowdown adversely affects demand.
Princeton economic historian Harold James said the last supply and demand shock occurred during World War I, and he recently gave a speech on the topic at the Hoover Institution. Supply shocks tend to increase globalization of their consequences (which may support the stock market), while demand shocks are the opposite. When they got together, they didn't say what would happen. Either way, James told me that this shock “promotes government capabilities.”
With its "Liz Truss Moments", the UK has seen what happens when this is lacking. It may be possible in the United States.
rana.foroohar@ft.com