April 7 – Emotions continued to drive market action overnight, with an initial follow-through selloff followed by a recovery of some sorts toward the morning hours. China continues to talk strong, but it’s stock market collapsed today, aided by a credit rating downgrade by Fitch that puts it in an even weaker position. How we close today will tell us a lot about where we’re at in the current fear cycle. The VIX spiked to 60 overnight, but it is currently near 49, while the dollar index is trading near 103.0. Yields on 10-year Treasuries are trading near 4.05%, while yields on 2-year Treasuries are trading near 3.64%. Crude oil prices are near $60 per barrel, while the grains lean higher.
Fear is a powerful force. Fear of a recession can make a recession happen. That is a risk that the Trump Administration faces as it attempts to restructure the U.S. economy. I choose not to succumb to fear, but I would be naïve to not recognize its risks. Fear is a powerful force that must be respected, but it must not feared. Fear hit the markets like a tidal wave late Wednesday when President Trump outlined his reciprocal tariff plan. The selloff started overseas, where the change in the status quo will be most felt. It then spread to the United States, where it fueled fear among both consumers and corporate heads. We’ve weathered worse crisis than this over the past 250 years, and we will weather this storm as well. Yet, we must also acknowledge that algorithmic traders feed on these emotional markets, taking them further than the fundamentals would justify – in either direction. That fact must acknowledge and respected as well.
We learned a great deal more about the Trump Administration’s strategies over the weekend. Trump cabinet members made the media circuit to do more clarifying. The market was surprised last week by a) the size of some of the tariffs, and b) the fact that many countries received a 10% tariff who had no tariffs of their own, so therefore how could they be reciprocal. The latter was clarified to be a way to keep countries like China from utilizing these tariff-free countries from bypassing U.S. sanctions and tariffs on it by passing goods through them. In theory, the 10% tariffs on these tariff-free countries could be lifted once the larger offenders of tariffs and trade restrictions have actually negotiated those tariffs and restrictions down – preferably to a zero level. The size of the tariffs came from the White House combining three factors in the calculation: 1) the current tariff rate that they charge us, 2) a formula-based value based on measures that the offending country uses to manipulate their currency, and 3) a formula-based value based on non-tariff trade restrictions implemented by that country. Those three things were added together, and then typically cut in half to get the tariff that we would apply to them.
The objective from the start was stated to be to bring countries to the negotiating table to negotiate the tariffs down – preferably to zero. If that works, then we would have a tariff free world that would stimulate widespread economic growth in the absence of inflation. Instead, the markets have focused on fear – fear that negotiations would not take place, but rather that trade wars would escalate. That’s the fear that traders have been pricing into the markets. Again, I would be naïve not to acknowledge that risk, which could happen. But I also would be naïve not to acknowledge what we are seeing happen. More than 50 countries had reached out to the White House by the weekend seeking to negotiate lower tariffs, with many of those nations saying that they would be willing to go down to zero tariffs, while investing in the U.S. economy. That would be a boom for our economy, if it happens.
The fear factor is greatest overseas, where countries have built their economies on a dependency on the revenue coming from these tariffs. Many countries also charge tariffs to protect those industries that cannot produce some goods as cheaply as can other countries. We do that ourselves with the steel and aluminum tariffs, and auto tariffs. President Trump isn’t likely to back down on those – seeing them as national security issues – which will complicate the upcoming negotiations. But the net result should produce economic growth IF Trump is successful in these negotiations. The media will continue to propagate the negative, because that’s what sells. It’s been true through the history of mankind. As such, volatility will likely remain with us as the headlines flow. But the hope is that we see more positive than negative developments this week, allowing a foundation of stability to start to develop.
Crude oil prices plummeted last week from $72.28 on Wednesday to $58.95 overnight on tariff fears, fearing that they would slash demand, among other things. But that also takes prices below the cost of production, which risks slowing output. If I were president, I would be looking to refill the Strategic Petroleum Reserve at these levels. Cheap energy also is a stimulant for the economy. Prices can surely go lower, but there’s risk here for end users of prices going higher if the tariff negotiations work as hoped. Also, note how corn prices refused to go lower despite the strong downdraft created by the above-mentioned fear playing. I would take note of that if I’m an end user.
