Macro Overview

Markets were rattled in March as a looming trade war between China and the U.S. enhanced market volatility. The administration announced $60 billion in tariffs for Chinese imports, with a detailed list of products which will be identified by the Commerce Department in April. China threatened to retaliate by imposing tariffs on U.S. imports as well as curbing U.S. Treasury purchases.

Intricate supply chains have evolved between the United States and China over the past twenty years. Some U.S. manufacturers ship U.S. made components to China for final assembly, then ship finished products back into the U.S., thus posing a challenge as to how trade deficits are calculated.

Key economic data released over the past month revealed that key data points were the strongest reported since 1998. The market has become much more dependent on data as it looks for signs of inflation and rising rates. Various analysts view current market volatility primarily driven by non-systemic events and isolated to specific events and individual company news.

A key lending benchmark, the Libor, has been rising steadily. The three-month U.S. dollar Libor rate surpassed 2% in early March, the highest level since 2008. Based in London, the Libor affects U.S. consumer loans, commercial loans, and adjustable rate mortgages.

Rapidly rising mortgage rates are dampening the hopes of families eager to lock in rates before payments start to become too expensive. The continued lack of housing supplies has added a double cost factor to the market, with prices elevating due to tight supplies and rising mortgage rates.

The International Energy Association (IEA) projects that the United States is on track to become the worlds single largest oil producer by 2023. The estimates are based on production growth and supplies generated by U.S. energy producers over the next few years. U.S. daily oil production alone is expected to reach over 12 million barrels per day by 2023, a 20% increase from the current levels of 10 million barrels per day.

Congress reached a $1.3 trillion budget deal that will fund the federal government through September. The extensive 2,232 page bill averts a government shut down and funds special programs for child care, infrastructure, medical research, opioid abuse prevention, and national security.

The IRS audited roughly 0.05% (half of one percent) of the 195,614,161 returns filed for tax year 2016. The number of examinations, also know as audits, was higher in the mid 1990s, when about 1.7% of returns were audited.

Sources: Dept. of Commerce, Bloomberg, congress.gov

Yields Head Higher – Fixed Income Update

Rising global bond yields precipitated a sell off in stocks as the cost to borrow for companies and governments rose. A host of factors are contributing to rates rising including: the ECB, Japan, and Federal Reserve all ending years of stimulus efforts; rising wages; and global economic growth. International bond yields rose in tandem with rising U.S. treasury yields, elevating the 10-year German bund out of negative yields.

As with companies, municipalities may be hit with higher interest rates resulting in saddling state and local government budgets producing increased borrowing costs. Further yet, rising rates may also prevent certain municipalities from taking steps to shore up their underfunded pension plans.

In its January meeting, the Fed did nothing to discourage expectations that it will continue to tighten monetary policy when it meets again in March. The Fed has officially begun to unwind its post financial crisis stimulus process, which entails raising short-term rates and reducing its $4.4 trillion balance sheet.

The Fed is now on track to raise short-term rates three times this year, since it has met its dual mandate of maximum employment with stable inflation. Any additional growth resulting from the recent tax cuts may entice the Fed to raise rates a fourth time this year should it be warranted.

The Treasury Department plans to increase the size of its bond and note auctions by $42 billion in order to meet funding requirements for the government. It also stated that it would only be able to fund government operations through the end of February unless congress raises the debt ceiling.

(Sources: Fed, US Treasury)

Tech & Tariff Influenced Volatility – Equity Update

Technology stocks led volatility in the first quarter, pulling other sectors into trading frenzies. Over 25% of the S&P 500 Index is currently comprised of technology stocks, having added volatility to the index for the first quarter. Trade war rhetoric added to volatility as U.S. companies sensitive to higher import prices on raw materials and certain finished goods experienced pullbacks.

Companies in the technology sector faltered as privacy concerns drove social media shares lower. The technology sector has also became more prone to volatility leading to gyrating valuations. In addition, news of heightened regulatory rules for technology and social media related companies escalated a sell off heading into the second quarter.

Transportation stocks are rising more closely with the rest of the market, an optimistic signal according to the century old Dow Theory.

Sources: Dow Jones, S&P, Bloomberg

The Growing Trade Deficit With China – International Trade Policy

Over the past twenty five years, China has evolved from a heavy equipment and machinery exporter to a prominent leader in technology product exports. Large international conglomerates have established an enormous manufacturing presence throughout China, utilizing its cheap labor and quick turn around times. China’s manufacturing plants are among the most modern in the world, producing large capacities almost entirely for export.

As the world’s appetite for electronic devices has grown, so has China’s ability to manufacture and export these devices. As a product exporter, China is able to manufacture and export finished products worldwide. In addition, China is also an exporter of components, which may be used in the manufacture and assembly of products in other countries, such as the United States. By exporting components in addition to finished products, China is able to hedge against tariff issues and labor costs should they become a factor.

Trade with China has grown tremendously over the past 30 years, from nearly a trade balance in 1985 to a trade deficit of $375 billion in 2017. Imports from China were $506 billion while U.S. exports to China were $130 billion, thus an ensuing trade deficit.

Ironically, China’s purchases of U.S. government debt has helped maintain a low interest rate environment, thus reducing loan rates allowing U.S. consumers to finance more expensive Chinese imports such as big screen TVs, cell phones and computers.

Sources: WTO, IMF, U.S. Dept. of Commerce, FRED

Rates Stabilize In March – Fixed Income Overview

Equity market volatility in March drove assets towards various sectors of the bond market, thus pushing yields slightly lower and various fixed income prices higher.

A key leading rate, the Libor, rose the most in 10 years. Debt reliant companies and consumers with variable rate loans tied to the Libor are most susceptible. The three month Libor rate rose to 2.31% at the end of the quarter. The six-month Treasury bill reached a yield of 1.88% in early March, an important yield because that’s exactly what the S&P 500 Index yields. Some income seeking investors may begin to view short-term bonds as an attractive alternative to dividend paying stocks prone to market volatility.

The Federal Reserve decided to raise the Fed Funds rate to a range of 1.5 – 1.75%, on track for another three rate increases this year. Language from the Fed Chief Jerome Powell shed some optimism on economic activity, noting that “the economic outlook has strengthened in recent months”, warranting further increases in the Fed Funds rate.

Sources: Federal Reserve, Bloomberg

New IRS Tax Withholding Tables – Tax Planning

Because of the new tax law provisions this past month, 90% of wage earners will see an increase in their paychecks due to revised withholding rates, according to the administration. The effect of the revisions will be noticeable in early February, or as soon as employers adopt the new withholding tables, which are required to be in place no later than February 15^th.

Withholding tables are used by payroll services and employers to determine how much tax to withhold on employee checks. The new tables reflect the increase in the standard deduction, repeal of personal exemptions and tax rate modifications.

According to the IRS, the new tables should produce more precise tax withholding, thus reducing overpayments that result in excessive tax refunds. The idea is to have just the right amount withheld, not too much and not too little. The IRS is also suggesting that form W-4 be revised to account for changes with itemized deductions, child tax credit, dependent credit, and repeal of dependent exemptions.

The IRS is also updating its withholding calculator on IRS.gov to reflect the new tables https://www.irs.gov/individuals/irs-withholding-calculator. (Source: IRS)

Mortgage Rates Starting To Rise – Mortgage Market Update

Optimism about economic growth has led to higher inflationary expectations, which eventually translate into higher interest rates. Over the past few months, the yield on the 10-year U.S. Treasury has increased from a historical low of 1.35% in 2016 to 2.72% at the end of January. As a gauge for mortgage rates nationally, the increase in the 10-year Treasury has also led to an overall increase in mortgage rates. According to data made available by Freddie Mac, the average rate on a 30-year fixed mortgage loan increased to 4.15% at the end of January. The concern economists have is that as mortgage rates continue to increase, home sales and affordability may begin to falter.

Thirty-year mortgage rates have surged to the highest levels in nearly a year, increasing borrowing costs at a time when the housing market is strengthening and prices have been rising. The 4.15% rate at the end of January was the highest rate since March 2017 and above 4 percent for the first time since May 2017. The average 15-year mortgage rate climbed to 3.62 percent from 3.39 percent.

Even with the recent rise in mortgage rates, rates are still low on a historical basis. As of this past month, the average mortgage rate since 1971 has been 8.16%. Over the past 46 years, mortgage rates have transitioned from the 5% range in the early 70s to over 14% in the late 70s and early 80s, with the 30-year conforming rate hitting a record high of 16.63% in 1981. (Sources: Freddie Mac, Bloomberg, U.S. Treasury)

Lumber Supplies Pose Challenge For Housing – Housing Update

The fierce storms that ravaged Texas and Florida last year, in addition to the horrendous fires in Northern California, have led to a rise in demand for construction materials including lumber. Homebuilders use a multitude of raw and finished materials for the construction of homes, including wiring, plastic tubing, and lumber. The increase in demand has decreased the supply forcing prices higher. Builders are passing along the higher costs to home buyers thus pushing housing prices upward. In addition to the lack of supply contributing to rising prices, a recent imposition of tariffs on Canadian timber is also adding pressure. Less expensive Canadian lumber has been a primary source for builders. Suppliers to homebuilders are essentially running low on levels of lumber all over the country, as lumber prices are on the rise with homebuilders also gearing up for the summer season. Various other factors are also affecting lumber prices nationwide, such as thousands of new homes under construction, and young families eager to purchase a new home before rising rates dampen their chances.(Source: Commerce Department)

Washing Machines & Solar Panels Subject To New Import Tariffs – Trade Policy

Inexpensive imports inundating the U.S. consumer market have become a target for the Trump administration. The Commerce Department has been given the task of identifying imported products where U.S. producers and manufacturers may experience unfair trade characteristics. The low cost of labor overseas has made it nearly impossible for U.S. manufacturers to compete with, especially in labor intensive industries.

Various U.S. manufacturers have been complaining about foreign manufacturers dumping their products in the U.S. in order to gain market share. Dumping is a practice when manufacturers export a product to another country at a price below their costs or below market prices. The U.S. Dept of Commerce monitors such activities and has filed various complaints with the World Trade Organization (WTO) over the practices. The WTO did recognize violations and identified several manufacturers using unfair trade practices.

This past month the Department of Commerce imposed higher tariffs on the imports of washing machines and solar panels manufactured overseas. The bulk of washing machines imported into the United States are from Asian countries including Vietnam, Thailand, and South Korea. The tariff on washing machines will start at 20 percent on the first 1.2 million units, then increase to 50% on every other unit after that. It is expected that the higher cost brought about by the tariffs will be passed along to American consumers by the foreign manufacturers. Solar panels imported into the U.S. will be imposed a 30 percent tariff the first year, dropping to a 15 percent tariff in the fourth. (Sources: Dept. of Commerce, WTO)