Surprise Mexico Tariffs Stoke Market Uncertainty
By Chia-Liang Lian and Kevin J. Ritter, Western Asset Management
June 4, 2019
U.S. President Donald J. Trump announced via Twitter that on June 10, 2019 the U.S. will impose a 5% tariff (with possible increases) on all goods coming into the U.S. from Mexico – until the “illegal migrants” transiting through Mexico into the U.S. are stopped.
This was largely unexpected by investors and political consultants. An already challenging outlook for Mexico – 1Q2019 contraction with ratings downgrades on the horizon – appears to have hit another stumbling block.
The move contrasted with an apparent breakthrough: a deal to lift U.S. tariffs on steel and aluminum imports from Canada and Mexico. For almost a year, steel imports have been subject to 25% tariffs and aluminum to 10% hikes. Retaliatory tariffs have been in place nearly as long.
The deal put the three nations a step closer to finalizing the U.S.-Mexico-Canada Agreement (USMCA) to replace the 25-year-old North American Free Trade Agreement (NAFTA).
But the potential tariffs increased uncertainty for USMCA ratification, which could boost business confidence and avoid potential economic hits to Canada and Mexico.
For Canada, the biggest factor impacting trade has been pipeline capacity for Western Canadian crude oil production. Lifting steel and aluminum tariffs will have only modest stimulative effects.
For Mexico, preserving trade linkages with the U.S. will help sustain economic activity, although growth prospects will continue to be limited by tight monetary policy.
Empirical evidence suggests that U.S. consumers are paying the bulk of Chinese tariff increases. Impacts in the U.S. include higher prices, lower margins for importers/exporters, currency weakness and supply chain shifts.
The magnitude of similar moves toward Mexico will depend greatly on the size and duration of tariffs implemented.
In the U.S./Mexico relationship, goods can cross the border multiple times before completion – in the auto sector in particular. This could make even a relatively small tariff of 5% considerably more disruptive. We suspect the U.S. business community will be forceful, as it was during NAFTA/USMCA negotiations. There is strong bipartisan support for Mexico trade relations.
While Mexico was blindsided by President’s Trump tweet, to Mexico’s credit the response from President Andres Manuel Lopez (AMLO) has been “measured.” This contrasts with the more confrontational approach of former President Peña Nieto. AMLO stated that Mexico plans to press forward with USMCA ratification and expects to address issues with the U.S. via dialogue.
The Mexican response leaves plenty of room for both sides to show flexibility without "losing face.” This dust-up ultimately will likely conclude in negotiation/dialogue/middle-ground.
Asset Prices and Outlook
As expected, Mexican asset prices weakened: the peso fell 3%, Mexico sovereign bonds widened 10 bps, Pemex was 15 bps wider, and most private sector Mexican issuers were 7-10 bps wider.
We expect the Mexican peso’s ride to be bumpy and to favor local rates (given that Mexico’s central bank can be dovish, due to trade frictions or sluggish economic growth). Improvement in core inflation would be welcome.
About Legg Mason, Inc.
Guided by a mission of Investing to Improve Lives™, Legg Mason helps investors globally achieve better financial outcomes by expanding choice across investment strategies, vehicles and investor access through independent investment managers with diverse expertise in equity, fixed income, alternative and liquidity investments. Legg Mason’s assets under management are $747 billion as of Jan. 31, 2019. To learn more, visit our web site, our newsroom, or follow us on LinkedIn, Twitter, or Facebook.
Chia-Liang Lina and Kevin Ritter are Portfolio Managers at Western Asset Management, a subsidiary of Legg Mason. Their opinions are not meant to be viewed as investment advice or a solicitation for investment.
© 2019 Legg Mason Investor Services, LLC. Member FINRA, SIPC. Legg Mason Investor Services, LLC and Western Asset Management are subsidiaries of Legg Mason, Inc.
All investments involve risk, including loss of principal. Equity securities are subject to price fluctuation and possible loss of principal. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors. Additional risks may include those risks associated with investing in foreign securities. Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.