US announcement of tariffs on Mexican imports rattles markets
In a surprise move, President Trump announced tariffs of 5% on all Mexican goods imports ($347bn in 2018 with the bilateral trade balance at -$82bn or -0.3% of US GDP) effective from June 10th, in order to curtail immigration flows. The US President pledged to increase the tariffs gradually, by 5 pps each month starting from July 1st, to a maximum of 25%, unless the immigration problem is resolved.
Economic implications would be significant should tariffs be implemented, as circa ⅔ of US imports from Mexico are due to intra-company trade. The already vulnerable auto sector could be hit hard if the tariffs are imposed, since Autos & Parts comprise around 27% ($93bn) of total imports. Mexico’s reaction has, so far, been tempered, albeit retaliation measures will be on the agenda.
The Chinese Government issued a white paper, which blames the US Government for backtracking from trade negotiations and that the increase in tariffs was a breach of a preliminary agreement. Overall, the paper reflected no willingness to make any concessions to the US, thus reducing the likelihood for any potential agreement at the G20 summit in June (28-29). As a result, the US could impose additional tariffs (initially 10%) on the remaining Chinese imports ($300bn | total of $550bn, with the bilateral trade balance at -$419bn or -2% of US GDP) that so far had been excluded from levies. Recall that public hearings are scheduled for June 17th, while -- barring conciliatory developments between the two countries -- decisions are likely to be made in early July.
Government bond yields declined sharply across the board to 2 - 3 year lows, with the German 10-year Bund yield (-8.5 bps wow) at an all-time low of -0.20%, as risk aversion prevailed. The ECB meeting on June 6th may include an extension of forward guidance regarding interest rates (current guidance: to remain at zero levels at least until December 2019), on top of TLTRO3 details.
US Treasury bond yields fell across the board (10-year yield down by 9 bps on Friday and by 5 bps on Monday to 2.07%). The UST 2-year yield declined by 14 bps on Friday and -9 bps on Monday to 1.83%, largely reflecting investor expectations that the Fed might need to cut rates should economic and trade tensions persist. Note that 3 - 4 interest rate cuts are fully priced-in up to 2020 (Fed Funds Futures).
Equities recorded strong losses in the past week, ending May deep in the red, as escalating trade tensions weighed on investors’ risk appetite. The MSCI ACWI declined by 1.9% wow (-6.2% May), with Emerging Markets up slightly (+1.2%), albeit after recording large losses in May (-7.5%). US equities (-2.6%) led a decline in developed markets, with energy (-4.4%) and autos (-4.2%) under-performing by a wide margin due to sharp declines in oil and the above-mentioned US/Mexico dispute.
Equity sector valuation metrics (i.e. P/E ratios) have deteriorated sharply as consensus EPS expectations have, so far, remained broadly stable (see page 12). Nevertheless, higher tariffs across the board, if implemented, will result in significantly lower S&P500 2019 and 2020 EPS from their current estimated levels of $167 and $186, respectively.