Three quick near-term macro reflections on the tariff announcement
Dedicated to my Aggie students
Tonight I am in Ohio -- preparing to give a talk on the darkening US and global economic outlook :(
Before leaving Texas, several of my students asked me about putting out some "takes" on the tariff announcement since I would be away. It has long seemed likely that the Administration would go for tariffs. Hence, my November go long short-dated TIPs recommendation, plus real yields were ~2% which in any event would be a healthy real return.
Here are three near-term macro thoughts/reflections.
First, a liquidity event seems to be in the offing. At March FOMC, Chair Powell stated that the Federal Reserve was observing tightness in money markets even as there was no scarcity in bank reserves. I agree. There is evidence of growing pressure in repo markets. More finite private sector balance sheets are having difficulty funding the rapid growth in US government debt; foreign central bank balance sheets are turning to other assets like gold.
Now reflect on tariffs. Tariffs are an unexpected liquidity drain on someone -- foreign producers, US retailers and/or US consumers. Someone will send dollars to Treasury that previously went into their pockets going forward. They probably had a plan for how they would spend those dollars as did the people who expected to receive their dollars. So, post March FOMC we have the Fed forcing the private sector to fund its balance sheet runoff while the Treasury begins its own operation to drain dollars even as the large April 15th liquidity drain unfolds. To me, this is a liquidity concern. Not pausing QT in March was an error made to avoid drawing attention to ongoing Fed balance sheet losses. If the Fed fully exits QT, the Fed's balance sheet begins to drift upwards again due to ongoing losses from excessive pandemic QE.
Second, the motivation of these tariffs does not appear to be largely national security given the broad nature. Revenue and government debt dynamics may also be a significant motivation.
Might one develop a belief that tariffs could be virtuous for government debt because tariffs
- weaken economic growth which will lead to lower interest rates and lower interest rates can reduce the budget deficit and also facilitate terming out the Treasury market;
- if not as much revenue is generated, it still lowers US consumption and thus increases domestic savings;
- produce tax revenue in a manner where initially it is unclear who is footing the bill;
- increase inflation which contributes to favorable government debt dynamics; and
- sets things up nicely (weak economy, lower budget deficit from lower interest expense) for a large tax package in H2 2025 to increase private sector led growth.
If someone believes this works, write up and let's discuss it. It would be good to ensure that what we are doing is more than someone in the Commerce Department wishing to be Treasury Secretary.
Third, announcing Musk's departure from DOGE on "Liberation Day" produced a bounce in Tesla and the S&P-500 which flushed some shorts before the announcement -- cute.
But the yen carry trade unwind may be expected to act as a risk-off amplifier on tariffs. Japan is largest provider of foreign capital to the US -- much of which comes from the private sector. This evening their equity market is down 4%, their bank stocks are down 6%, JGBs are rallying and the yen has strengthened. This, coupled with a repricing in US risk assets is a recipe for the yen carry trade to unwind that hurts US risk assets in ways that extend beyond the direct impact of tariffs.
Time to turn in; wishing M-FAB readers and my students a restful evening and good day tomorrow!