When Are Tariffs Going To Bite?

Stocks got a lift at the open yesterday on news that President Trump finally had a telephone conversation with President Xi, but what surprised me at the time was that the announcement came from Chinese state media, noting that it was President Trump who initiated the call. If the call was good news, it seems like our president would have said so first. Regardless, any communication at all is positive after both sides accused the other of violating the tariff truce that was announced three weeks ago.

President Trump did say the conversation “resulted in a very positive conclusion,” and that there should no longer be issues with “Rare Earth products,” but no details were announced other than plans for another meeting between trade officials. China’s version of the call made no mention of rare earth minerals, which is what I think prompted the president’s outreach. China has leverage over us in this standoff because they process 90% of the world’s supply. Last week, US automakers warned the Trump administration that without additional rare earth exports, which China is limiting, auto suppliers, as well as other industries, would not be able to produce critical automotive components. In other news, the president and Elon Musk spent the day engaged in a public display of insults that sent Tesla shares reeling.

It is easy to be distracted by the headlines about phone calls and billionaires “beating each other up”, but investors should be focusing on the leading economic data. Today, markets are trading as though we have nothing but clear skies on the horizon, but the high-frequency economic data suggests otherwise. I think investors have been lulled to sleep because the adverse impacts from tariffs have not shown up yet in the hard data, supporting the view that they will have no impact on the economy. It is too early to come to that conclusion.

The current effective tariff rate on all imports is estimated to be 16-18%. I think most assume that we would see the impact one month after implementation, but businesses stocked up on inventory before the tariffs took effect, which has to be burned through. Additionally, consumers advanced the purchase of goods they feared would increase in price to front-run tariffs. Finally, tariffs are phased in overtime to reach their fully effective rate, due to delays in collection logistics. Based on the tariff revenue collected to date, the effective rate was just 4.5% in April and 6.5% in May. During that time, we were working off pre-tariff inventory and weaker consumer demand. June and July data should be different stories.

When President Trump imposed tariffs of 20-50% on imported washing machines in January 2018, consumers advanced purchases, with sales surging 3.6%. It was not until April of that year that we saw a sharp increase in price for this line item in the Consumer Price Index. Using the same timeline, we should see meaningful price increases show up in June numbers, which will be reported in July. Consumer spending is already starting to roll over. Can the S&P 500 power to new all-time highs in the face of these obvious headwinds? Perhaps it can, but it will be doing so on momentum and not improving economic and market fundamentals.

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