Market Brief: 'Gradual' Tariff Plan Relieves Markets

Currency markets are breathing a sigh of relief after a report suggested that the incoming Trump administration could follow a “gradual” trajectory in ratcheting tariffs higher. According to Bloomberg, officials are considering an approach that would entail raising import taxes by 2 to 5 percent a month on major US trading partners, preserving the president-elect’s negotiating leverage while giving the government time to assess the impact on inflation. The greenback is retreating against many of its major peers, with the euro, Canadian dollar, Australian dollar, and Mexican peso making the biggest advances.

Flaws in the concept’s underlying logic suggest that this retracement may prove difficult to sustain. As the article makes clear, Trump has not yet been apprised of the plans, and could choose to move in an entirely different direction. Loan sharks and credit card companies might consider the proposed pace “gradual”, but a 26-percent per annum increase in tariffs would deliver a severe economic shock by any conventional definition. Inflationary processes are defined by a series of price increases—not one-off moves—and can take months or years to develop, meaning that there is no viable feedback mechanism to tell officials when they reach the point of no return. And currency markets would undoubtedly front-run expected changes as the administration’s end-point plans are clarified, meaning that the financial system would suffer an increase in exchange rate volatility in combination with already-elevated levels of uncertainty.

Treasury yields are slightly lower after wholesale inflation rose by less than expected in December, helping assuage market fears of a rebound in underlying price growth. According to numbers just published by the Bureau of Labor Statistics, the producer price index for final demand climbed 3.3 percent in the year to December, and a measure excluding food and energy was up 3.5 percent. Both measures undershot estimates, but accelerated slightly in year-over-year terms, aligning with a global backdrop in which input cost disinflation appears to be slowing and becoming more volatile—suggesting that central banks could find room for maneuver becoming more limited in the months ahead.

Tomorrow’s consumer price index report could be a significant market mover. Economists polled by the major data providers think core prices—excluding food and energy—rose 0.2 percent in December from a month earlier, but simmering concerns about the incoming administration’s tax and trade agenda could return to a boil if inflation accelerates unexpectedly. Major equity indices, risk-sensitive currencies, and Treasury yields could shift dramatically in the event of a surprise.

From a broader perspective, we think the recent move in long-term yields could be sustained. A record of nominal ten-year US government bond yields going back to 1790* shows the 234-year average sitting around the 4.82-percent mark—remarkably close to this morning’s 4.79-percent level—reflecting a reversal in many of the demographic, technological, geopolitical, and institutional factors that precipitated a sustained decline in interest rates prior to the pandemic. As had been hypothesised a few years ago, it’s possible that we’ve left the post-global financial crisis “new normal”, and are now returning to the “old normal”.

*I've excluded the first three years of government bond issuance, due to exorbitantly-high rates and low volumes.

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