While I was out last week during my son’s spring break, we had a few developments that seem to imply some things may be breaking in the markets.
1. Consumer Breaking? The U Michigan data have become worrying – with both consumer inflation expectation springing up and sentiment falling. That having been said, I have for some time questioned the validity of the data – especially since they went electronic with their data gathering. We got some minor corroboration with the NY Fed 1-year inflation expectations rising to 3.13% (expected 3.1 from 3.0 previously). However, the inflation swaps (market inflation expectations) seem more or less “stable.”
I mentioned this in a prior post, but most of the U Mich data “surprise” is driven by Democrats. (https://www.zerohedge.com/markets/panicking-democrats-send-umich-inflation-expectations-highest-32-years) If you are a Republican, you are probably looking like the “everything is awesome” Lego guy. But if you are Democrat, you have probably lived the last month and a half looking like Beaker from the Muppets. Unlike last month, the Independents are starting to side more with the Democrats.
I also mentioned that “Democrats are people too.” They do make up almost half the US population. I think we need to examine each piece of economic data we get going forward and think about the impacts of the US polarization with respect to that data. With respect to data like sentiment or inflation expectations, Democrats can have an outsized impact. Using “10+%” for inflation or feeling like a “0” for sentiment can drive the reported averages much wider.
Next week’s Retail Sales data will be an interesting data point. I assumed January’s Retail Sales were weather-affected. So we should see a bounce back (which seems to be implied by the consensus). But if Democrats are showing their displeasure and fear by entrenching on spending, we should see that show up in the data. A liberal friend of mine that I visited declined to purchase a NYC pied-a-terre because of a combination of sentiment and equity market fall. Deeds (spending) are worth more than words (survey).
Speaking of deeds, I’m wondering to what extent the equity selling the past few weeks are mostly Democrats. If you thought Trump was going to drive the US into the ground, wouldn’t you sell all your equities and buy something like… gold (which made new all-time highs last week)? The Republicans are probably the ones buying equities on dips. It’s a little unclear how this plays out, with equities at still-lofty levels. The third party to consider is what happens to all the foreigners who hold US assets. Half of the developed world is probably “liberal” as well. I’m wondering if in those countries, having the sovereign wealth fund (or just personal investments) own US securities will be like owning the stocks of cigarette manufacturers, coal plants, or other sin stocks. This mentality change isn’t going to happen overnight, but this tariff process may last YEARS. Sentiment could change over time – especially when an aggressive Trump drives other countries to economic weakness or even recession. People in other countries could find a strong sense of nationalism under duress at any time. For now, people may be thinking tariffs are a “negotiation ploy,” but there may be more Beakers out there when the tariffs stick.
2. Trade Relations Breaking? The responses by the counterparties to tariffs were interesting. There appear to be two schools of thought: (1) fight back (like Canada, EU), or (2) don’t fight back, for now (like Mexico, Brazil). I know that sounds like a Captain Obvious comment, but I was not expecting countries to have such a wide range of responses. I have been impressed at Sheinbaum’s (Mexico’s) ability to get what she wanted out of Trump (so far) with little fanfare. So maybe the softer approach is the way to go. Trump did say ahead-of-time that he would retaliate against any retaliation. So it shouldn’t have been a surprise Trump escalated to 200% tariffs on some EU products. At first, I was surprised at the magnitude of the number. but when I thought about it, AOTBE, a 200% tariff is not that much different than a 100% tariff, or even a 1000% tariff. There aren’t too many products in the world where some country is insisting on producing a product that is more than 2x overpriced (if that). So for most (nonessential) products, even a 25-50% tariff should be enough to get a country’s products a price advantage. There are diminishing effects of raising tariffs above say 50-100%. So maybe if you are already looking at 25+% tariffs, you’ve already taken a bulk of the punishment. If the sliver left for you starts becoming too small, you care less about a further erosion and instead opt for vengeance to get the punishment to stop. Unlike the prior Cosmo Kramer deals, I don’t see a quick exit to the negotiations. When there are two strong opposing viewpoints, sometimes you need to start feeling pain before things get done.
