Tariffs and Mortgage Rates.
Tariffs – Separating Facts from Fiction. Whenever there are huge financial interests at stake, the truth can often be obscured or hijacked. The media does not always do a good job of presenting both sides of a story, which is the case on the tariff issue.
There are huge financial interests to leave our unbalanced trading relationships status quo. This includes the owners of U.S. manufacturing firms who have shifted their production facilities to nations like China to take advantage of their lower wages and their lack of regulations on air or water pollution, which lowers the cost to produce goods. Also, the leader of almost every other nation in the world has been receiving a material economic benefit from the unbalanced trading relationship with the U.S. and has strong motivation to keep the status quo.
The primary beneficiary of a more fair and balanced trading relationship is the American middle class, which does not have a unified voice to counter the narrative of those with strong financial motivation to maintain the status quo of perpetual monthly trade deficits.
What Happens Next? This is the top question in the stock and bond markets today, and the answer to this question will determine which direction interest rates go in the coming months.
The issue of unbalanced trading relationships has been discussed publicly for some time, but there has been very little action by different nations to address these issues, as the status quo was providing valuable monthly economic benefits, so there was no motivation to unilaterally make any changes.
Yesterday’s announcement shook up this status quo and is now forcing the hand of the leaders of every nation trading with the U.S. who each essentially has three choices which they must make relatively quickly:
Do Nothing. Accept the new tariffs as your new reality and accept that you will do less trading with the U.S., and you will receive less economic benefit every month. You can try to find other nations to buy your goods, or you could move your production facilities to the U.S. and not be subject to tariffs. The reduced future profitability from your trading with the U.S. could push your economy into a recession.
Raise your Tariffs with the U.S. This would lead to rounds of escalating tariffs which would eventually get high enough that almost all trade would stop, since the price of your goods would not be competitive. This would likely lead to an economic shock and recession in your country, as you will not be able to find other nations to buy your goods at the same price and quantity you were selling to the U.S.
Lower your Tariffs with the U.S. This would require negotiations with the U.S. where both nations would agree to lower their tariffs and other trade barriers, possibly down to zero for each nation. This would allow each nation’s goods to have the most favorable price possible when competing against goods produced in other nations. This would result in some economic hit to your nation, as you will no longer receive the revenue from the tariffs you were charging on U.S. goods, and your domestic producers will lose some market share to more competitively priced U.S. products, but this is the least economically damaging scenario compared to 1 and 2 above.
Timeline for Next Steps? In my opinion, the leaders of other nations trading with the U.S. will make one of the above choices relatively quickly. We will see some nations try option 3 above and both parties will be motivated to move quickly to reach a mutually fair agreement.
It is likely that some nations will raise their existing tariffs, sparking a full-blown trade war, which will effectively end all of their trading with the U.S. and cause significant economic impact to the nation that was previously enjoying a nice economic benefit with each month’s trade surplus, that now goes to zero.
Impact to Interest Rates. The stock and bond markets will be watching in the coming days which nations go which direction, and then the markets will then attempt to estimate the economic impact to each country and determine if the trade disputes could result in recessions in certain countries. If the markets increase their expected probabilities of recessions in certain countries, this will push down their stock markets, and push up their bond prices, which will push up all bond prices, including U.S. Treasury and MBS bonds. This would then result in lower mortgage rates.
The markets will also be watching how the different resolutions of the trade disputes might impact inflation rates, both short term and long term. Increased short-term rate inflation might be discounted by long-term bond investors, but any increase in long-term inflation rates would push up long-term bond rates, including mortgage rates.
Increased Market Volatility. The uncertainty regarding all the above makes it difficult for the stock and bond markets to predict recessions and inflation directions, and there will be many fast-moving news events happening by the hour or by the day, so the markets will likely remain unusually volatile. A very good strategy in times of increased volatility is to lock rather than float if you are a purchase borrower under contract.
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