< Back to Trader Blog Articles

The possible implications of broadening tariffs

06744 CC Trader Talk V2

In the face of a high degree of political uncertainty surrounding Brexit and Italy’s current situation within the EU, there is also increased concern relating to the broadening of tariffs on imported goods from China and possibly Mexico by the U.S. administration. Nonetheless, such concern leaves investors with a dilemma of what lies ahead across global economies, assessing the possibility of whether a global recession is imminent or not.

In this regard the Federal Reserve (FED) is assessing the appropriate policy response in terms of this developing trade shock. The question to be posed, is whether the FED will view such shock as a contraction in demand, or otherwise as an adverse supply shock, which could result in an upsurge in consumer prices by a full percentage point.

In line with what happened in 1995, the FED might ignore inflationary risks arising from higher tariffs, and cut policy rates as an insurance against high rescission risks.

In 1995 the FED implemented a correction in monetary policy, by cutting interest rates after a sustained period of tightening. Today, investors are beginning to wonder whether the FED will once again have to ease its stance after raising rates four times in 2018.

It is key to note that there are number of parallels between the current situation and what happened in 1995. The FED justified its three rate reductions at that time by pointing to moderate price pressures. Policy makers today are even more concerned on the low level of inflation, which might result in a possible re-occurrence of the 1995 situation.

Nowadays, markets are viewing the trade war as global demand shock which will eventually reduce the overall output growth. In an attempt to mitigate a future slowdown in growth, interest rates should be reduced.

Until very recently, the FED has given an indication that a situation signifying a slowdown in the overall growth rate, a perception which might trigger policy easing in order to provide an insurance against downside risks to activity. This has been confirmed by Mr. Richard Clarida, the FED’s vice-chairman in a recent interview, whereby he insisted that while taking an initial view through the initial effects of higher tariffs, the FED will ensure that the economy will continue growing.

Mr. Clarida also pointed out that the imposed increases in tariffs should not be underestimated, whereby the underlying effects could prove to be substantial. Academic evidence has indicated that the initial set of tariffs on Chinese imports has had a larger than expected effect on US consumer prices, with little of the impact being absorbed by Chinese exporters or US wholesalers and retailers.

In the absence of outright recession, this action would remove much of the downside risk facing the equity market. In fact, historical evidence demonstrates that following the insurance cut implemented in 1995, the equity market surged upwards in the first six months following such policy undertaking.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

The information provided on this website is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Similarly any views or opinions expressed on this website are not intended and should not be construed as being investment, tax or legal advice or recommendations. Investment advice should always be based on the particular circumstances of the person to whom it is directed, which circumstances have not been taken into consideration by the persons expressing the views or opinions appearing on this website. Calamatta Cuschieri & Co. Ltd. (CC) has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website. You should always take professional investment advice in connection with, or independently research and verify, any information that you find or views or opinions which you read on our website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. CC does not accept liability for losses suffered by persons as a result of information, views or opinions appearing on this website.
This website is owned and operated by Calamatta Cuschieri & Co. Ltd (Co. Reg. No. C13729) of 5th Floor, Valletta Buildings, South Street, Valletta VLT 1103, Malta. CC is licensed to conduct Investment Services in Malta by the Malta Financial Services Authority.