The Independent Market Observer

Here We Go Again? Proposed Tariffs on Mexico

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on May 31, 2019 2:08:37 PM

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tariffs on MexicoMuch of the recent market decline has been due to worries that the U.S. and China have been intensifying the trade confrontation, rather than trying to come to a deal. With the recent announcement by President Trump that he intends to impose tariffs on all imports from Mexico, trade risks have risen even further and markets have continued to drop. So, what could this latest round of tariffs mean for investors and for the markets?

Assessing the potential damage

Just as with the China tariffs, the initial impact will be on confidence—and we are seeing exactly that in the markets today. U.S. and global markets are down as investors try to process the potential damage.

From an economic standpoint, with Mexican imports at around $350 billion per year (according to Capital Economics), the initial tariffs would drain about $18 billion from the economy. If the tariffs were to increase to the full 25 percent (as proposed), the cost to the economy would jump to around $90 billion. Prices in the U.S. could rise by about 0.4 percent.

That would be just the direct and immediate damage, of course. Companies, especially in the auto industry, have supply chains integrated around the border and could incur significant costs to redo them. With approximately two-thirds of imports occurring between different factories owned by the same company, the effect could be severe. Exports to Mexico could also be hit if Mexico retaliates. Several states have significant exposure there, with nearly 5 million jobs reported to depend on trade with Mexico. This situation is also likely to threaten the USMCA trade deal, intended to replace NAFTA, which would disrupt trade with Canada as well. The potential damage is very real and will expand over time, just as we are seeing with the China tariffs.

How real is the threat?

But we are not at that point yet. These tariffs may be a negotiating tool, as we have seen before. So, it remains to be seen whether the tariffs as proposed will be enacted. Even if the threat is real, there are other hurdles. The administration’s authority to impose tariffs is not clear, for example, and Congress has refused to endorse previous proposals against Mexico. There is a real possibility this will come to nothing, and markets are aware of that. At the same time, the same assumptions were made about the China tariffs, only to see them persist. Confidence may be slower to recover this time.

The true question

Indeed, confidence is the true question here. After a slow first quarter for consumer spending and business investment, we are seeing signs of a rebound. This rebound could be at risk if confidence drops back, and the tariffs could hit confidence directly. Job growth could be at risk, even as higher prices—from expanded Chinese tariffs, as well as the new tariffs on Mexico—could hit consumer confidence. Business confidence is already down, especially in manufacturing, and could decline further, especially in the auto industry. These declines would pull investment down even more. Hiring, consumer confidence, and business confidence are three of the four key economic indicators we follow, so this is a serious threat.

At this point, the likelihood is that some sort of deal will be cut, and the tariffs will not happen. If they do, though, the risks to the economy will substantially increase on multiple fronts. Other parts of the world will also be negatively affected, which would be another headwind.

Are things different this time?

Is it different for Mexico than for China? It is, a bit, but not in a good way. Although the outlook remains positive, this policy is something that could change that outlook sooner rather than later. I will be watching this situation closely.

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