Energy

Escalating Trade War Signals More Pain For Oil

Farid Hajili Analysis 12 June 2019
Escalating Trade War Signals More Pain For Oil

Trump backed off his proposed trade war with Mexico in the face of intense pressure from business groups and even his own party, but his faith in tariffs remains unbowed. In fact, Trump may have internalized a lesson that presents further risks to the global economy and to oil markets.

“If we didn’t have tariffs, we wouldn’t have made a deal with Mexico,” Trump said on Monday. “We got everything we wanted.”

The proposed 5 percent tariff on Mexico was suspended because Trump said that the Mexican government agreed to a series of demands to tighten up migration through the country. However, press reports suggest that some of the provisions in the deal, such as Mexico agreeing to buy agricultural goods, are a mirage, while others, such as expanding border security, were agreed to months ago.

Leaving those pesky details aside, Trump was triumphant. Indeed, even though the White House saw pushback from business groups and the Republican-controlled U.S. Senate, in Trump’s mind the whole episode seems to have reaffirmed his strategy.

With the U.S.-China trade war unfinished, the U.S. President feels emboldened to take a hardline on Beijing.

“The China deal’s going to work out,” Trump said in an interview on CNBC. “You know why? Because of tariffs. Because right now China is getting absolutely decimated by companies that are leaving China, going to other countries, including our own, because they don’t want to pay the tariffs.”

Moreover, he says that the tariffs to date have been successful. “We’ve never gotten 10 cents from China. Now we’re getting a lot of money from China, and I think that’s one of the reasons the G.D.P. was so high in the first quarter because of the tariffs that we’re taking in from China,” he told reporters on Monday.

All evidence points to the contrary. Global growth concerns have ballooned since the hike in tariffs last month. Recently, finance ministers from G-20 recently met and said that risks from trade and geopolitical tensions were “intensifying.”

“The principal threat stems from continuing trade tensions,” IMF managing director Christine Lagarde said. “To mitigate these risks, I emphasized that the first priority should be to resolve the current trade tensions — including eliminating existing tariffs and avoiding new ones — while we need to continue to work toward the modernization of the international trade system.” The IMF said that the U.S.-China trade war could shave off global GDP By 0.5 percent, or $455 billion, in 2020.

Meanwhile, Trump continues to browbeat the U.S. Federal Reserve into backing off interest rate hikes. While there is little evidence that the Fed has been influenced by the intense pressure, the central bank has in fact backed off more rate hikes and has even opened up the door to reversing course and cutting rates again. Trump may actually force the hand of Fed Chairman Jerome Powell. By engaging in a trade war with China, which a wide range of economists say would slow down global growth, Trump may create the conditions where a rate cut is needed. A loosening of monetary policy would likely then relieve some economic and political pressure on the White House as its pursues its trade war.

Last week, the U.S. Labor Department reported job increases of May of just 75,000, sharply below consensus estimates. A weak jobs report from May would typically sink financial markets, but equities rose on the news as investors viewed the downbeat assessment as increasing the odds of a rate cut from the Fed.

The next flashpoint could come as soon as this month. The U.S. Trade Representative is holding a hearing on June 17 to ask companies about the effects of the next round of tariffs on China – a 25 percent levy on $300 billion worth of imports. Trump said on Monday that he would move forward with the tariffs if Xi declined to meet with him in Japan at the end of June.

The first few waves of tariffs on Chinese goods hit select items. But levies on the remaining $300 billion would have a greater impact on the consumer economy, likely dragging down growth. That, in turn, would drag down crude oil demand at a time when demand was already softening. In May, crude oil posted its worst price slide since the financial crisis, in large part because of the jump in U.S. tariffs on China.

The EIA released its Short-Term Energy Outlook on Tuesday, which included downward revisions to both supply and demand. U.S. shale takes a hit this year because of lower prices, but prices will be lower because demand will be weaker than previously thought. The agency sees demand rising by 1.2 million barrels per day this year, down 200,000 bpd from its previous report.

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