Perspective: Morning Commentary for February 3

Perspective: Morning Commentary

Arlan Suderman

Chief Commodities Economist

February 3 – The markets sold off overnight as the Trump tariff war began, but many of the markets are well off their lows this morning, with some near session highs, and even a few positive markets. It’s taking time to sort out the winners and losers in this trade war, which is largely the focus of the markets today, even as Wall Street keeps its eyes on key labor data coming out later this week, including the monthly jobs report. The VIX is trading near 19 this morning on the elevated nerves created by the tariffs, while the dollar index is trading notably higher near 109.2, after peaking overnight near 109.9. Yields on 10-year Treasuries are trading near 4.51%, while yields on 2-year Treasuries are trading near 4.24%. Crude oil prices rise on the prospect of lower imports due to the tariffs, while the grain and oilseed markets were mostly lower, but generally well off their session lows.

President Trump followed through with his threat on Saturday evening. He signed a declaration placing 25% tariffs on goods coming from Canada and Mexico, and 10% on China. One noted exception was that Canadian crude oil will only be taxed at a 10% rate. Many Midwest refineries are designed to utilize Canadian heavy crude oil, which pretty much dictates that they continue to do so in the absence of economic alternatives. Canada immediately released a long list of retaliatory tariffs at the same 25% rate, while Mexico is expected to do so today. China just indicated that it would file a grievance with the World trade Organization. Europe is bracing for the expected tariffs to be levied against it. Keep in mind that these tariffs are applied on imports. Everything that we import from Canada, Mexico and China is impacted. None of them can afford this to continue for long. What we export is primarily only impacted if it is included in the retaliatory tariffs from the importing nation. Canada’s retaliatory list is fairly inclusive, while we have yet to see Mexico’s list. Reuters previously reported that Mexico’s list would be shorter, and that it would be at tariff rates of 5%, 10% and 20%. But all of that may have changed.

The currency markets tend to see strength for the currency or currencies of those nations’ expected to fare the best in these tariff wars, while the currencies of the countries that are expected to see the greatest pain to their economies tend to move lower. As such, we saw significant selling today of the Canadian dollar and the Mexican peso. China’s markets are closed for the Lunar New Year holiday, but its offshore yuan saw a selloff. Yet, all three currencies were already well off their lows this morning, even as the U.S. dollar pulled back from its spike high of overnight trade. The strength of the dollar increases U.S. buying power overseas, helping to offset the cost of the tariffs. On the other hand, weak currencies for Canada, Mexico and China increase the pain for those countries when they implement retaliatory tariffs on imports, while helping to sustain exports of products with tariffs.

I find China’s approach to the Trump tariffs to be interesting. Thus far, China has not announced retaliatory tariffs. Instead, it has said that it will file a complaint with the World Trade Organization. That could take years to settle – certainly many months. To me, that’s an indication that China doesn’t want to escalate the trade war – that it cannot afford to do so. But it also provides another piece of evidence for me that we may be moving closer to a trade agreement with China. Keep in mind that China collects tariffs on nearly everything that it imports, and it has done so for a very long time. We’re just moving closer to matching what they’ve been doing. China imports a great deal of commodities, ranging from soybeans to crude oil to iron ore. But it also exports a tremendous volume of consumer goods, having built an economy around those exports. U.S. commodities flowing to China are expensive to buy due to our strong dollar, but China might find it advantageous to buy our more expensive commodities in exchange for more favorable tariff treatment on the larger sector of consumer goods coming here. China’s reaction thus far keeps that door open.

The Ag markets are trying to sort out the impact of the tariffs. The biggest concern would be the possibility of losing our ethanol exports to Canada, or our pork, corn, soybeans, soymeal, wheat, etc. exports to Mexico. Mexico imports more than half the pork that it consumes, with the bulk of that coming from the United States. We export 25 – 30% of the pork that we produce each year, with 40% of those shipments going south into Mexico. Mexico imports roughly 925 million bushels of U.S. corn per year, and that continues to rise. It’s our second largest importer of soybeans as well, in addition to soymeal, wheat and other products. This will certainly be inflationary for Mexico, which its economy cannot afford at this time. I continue to anticipate an agreement to reduce these tariff rates with Canada and Mexico, but it may take longer than I thought now that Trump is also focusing on the trade imbalance factor. U.S. spring wheat prices rallied this morning on the idea that we’ll see slower flow out of Canada, while U.S. oats prices surged. The big question to answer will be whether Mexico retaliates by putting notable tariffs on the Ag commodities that it imports, and the impact that has on shipments to the south.

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