January 29 – Money continues to shift from the tech sector to other stocks this morning. The VIX is trading near 17, while the dollar index is trading near 108.2. Yields on 10-year Treasuries are trading near 4.52%, while yields on 2-year Treasuries are trading near 4.19%. Crude oil prices modestly weaker again, while the grain and oilseed sector is mostly higher, with corn prices trading near recent highs.
We’ll get an updated monetary policy statement from the Federal Reserve at 2 p.m. ET, followed 30 minutes later by a press conference with Fed Chair Jerome Powell, which will likely be the primary focus of Wall Street. Powell’s objective today is likely to be as boring as possible. By that I mean that his intention would be to not make any notable headlines. He sought to reset market expectations at the last meeting – to break the perception that we were in a long steady rate cutting cycle. Now he likely wants to sit where we’re at to see how the Trump Administration policies play out. He raised tariff concerns at the last meeting, leading to fears of how they could hurt the economy. He’ll probably play that down at this meeting. He will likely take questions regarding the Fed’s future plans to reshape its balance sheet, but he probably will not provide the clarity desired at this meeting.
The Fed’s objective in September was to start moving its benchmark interest rate down toward its perceived level of “neutral.” Neutral is the interest rate that is neither considered stimulative nor restrictive toward the economy. Many economists believed back in September that neutral was below 3.0% - perhaps near 2.75%. Now they’re coalescing around estimates that it may be in the mid-3% range. My belief has been that it is near current levels, if not a bit higher, particularly when you add in the Trump effect of lower taxes and deregulation – both of which are stimulative in nature. Tariffs continue to be something that economists struggle with. Yes, they increase the costs of the producer to sell to the consumer, or in this case the exporter to sell to the importer. The assumption is that the producer passes along those costs to the consumer. In many cases that’s true, where there’s little to no competition, but that’s not true if policy stimulates the development of more competition. Furthermore, the current strong dollar increases our buying power when purchasing imported goods, offsetting much of the implemented tariff.
The larger threat of the tariff is that the producer retaliates by raising tariffs on what it purchases from the consumer in the way of raw commodities for doing its producing. That can become a vicious cycle that leads to global inflationary issues. But one can’t just assume that will happen. Certainly it will in some cases, but we should look at what happened in Colombia (my apologies for misspelling it yesterday) over the weekend. Trump threatened tariffs, and the president of Colombia threatened to match those tariffs. Business leaders in Colombia quickly connected with their president, convincing him that Colombia could not afford to engage in this tariff war – they could not afford to lose the business that it does with U.S. customers. Colombia’s president quickly backed down and accepted the migrants being returned to the country. Getting back to the Federal Reserve, I don’t believe that policymakers on the Federal Open Market Committee know how this will all play out. Which tariffs are set high to drive policy, such as what as done with Colombia, in a way that they are never applied; or applied at a lower negotiated level. How many tariffs are fully intended to be implemented long term? How many of these will see retaliatory tariffs put in place, and how many will be absorbed, either by the producer, or by the strong dollar?
We may get some clarity this weekend. The current sense from the Trump Administration is that it will apply 25% tariffs on Canada and Mexico on Saturday, and 10% on China, if they do not do their part to stop the flow of illegal migration and drug flow across the U.S. southern and northern borders. Trump may put the 10% tariffs on China regardless, but I still expect Canada and Mexico to move quickly toward some type of agreement regarding these issues. Those agreements may not be reached by Saturday. They may not be well publicized when they do occur, to give their leaders political cover at home. Commodity producers and traders in the States will remain quite nervous until such agreements are in place. But in the end, I do not believe that the economies of Canada or Mexico can afford a tariff war, which is the same conclusion that Colombia came to last weekend. As I said, they may not come to that realization in time to avoid the initialization of a trade war, and that may lead to market volatility going into the weekend, as well as coming out of it. Currently, the markets are showing surprising calm, suggesting that they believe that both Canada and Mexico will make the needed policy changes before Saturday. Money continues to flow into the grain and oilseed sector after being the punching bag of the commodity sector in recent years. Fundamentally, it’s difficult to justify the move in the soybean complex unless you think that a trade agreement with China is going to save U.S. export demand. Global supplies of major exporters outside of the United States are relatively tight for both corn and wheat, which leaves the market more susceptible to shortages in the future.
