EXPERT VIEW: Tariffs and trade wars – watch for unintended consequences

And so it begins. The United States will impose import tariffs on steel and aluminium, and with depressing inevitability other nations and trading blocs will cry “foul” and reach for the drawer marked “retaliation”, almost certainly leading to a wider and broader trade war.

It is not difficult to imagine how this will pan out for the wider global economy, geopolitics, overall trade flows and even the prices of steel and aluminium.

But – and this may be the sting in the tail – there could be an unexpected and unwanted effect on business for the London Metal Exchange.

To recap, on March 1, US President Donald Trump announced the intended imposition of trade tariffs under Section 232 of current US trade legislation, mandating tariffs of 25% on steel imports and 10% on aluminium imports into the country for an indefinite period.

This should not have come as a complete surprise. Whatever your on Donald Trump – and there are many conflicting views – as a politician he is somewhat unusual in implementing promises made on the campaign trail before being elected. At some stage, he was going to get round to this, given its importance to the so-called ‘Rust Belt’ region of the US and his ‘America First’ policy focus.

It was no surprise, either, that this sparked a wave of responses from Canada, Mexico, Japan, Brazil and, significantly, China.

And the EU, no stranger to protectionism with its decades-long tariffs on aluminium imports, also got in on the act when, on March 7, it warned of potential duties on imports of such commodities as peanut butter and orange juice, as well as steel and industrial products.

The upshot of this is that free trade between the world’s two biggest national economies, the US and China, and the largest trading bloc, the EU, will take a massive hit – if the threatened sanctions are enacted.

In other words, a trade war.

Could it be that, 10 years after the start of the Global Recession, the world will fall into another steep and severe economic downturn? Maybe not, but the likelihood is that global economic growth and activity will be slower than they could have been.

That will affect the usual suspects – data for gross domestic product (GDP), purchasing managers’ intentions, industrial production, consumer and retail prices will be softer than previously modelled, which will have a knock-on effect on the financial markets.

Global equity markets have already weakened, and may well continue to weaken. For example, on March 6, the resignation of Trump’s top economic adviser, Gary Cohn, a proponent of free trade, widely undermined share prices and weakened the dollar.

And LME prices fell on March 7. Indeed, they have been struggling to maintain the strong upward momentum and multi-year highs seen in the first few weeks of 2018. The price of copper has been clinging around the $7,000 per tonne level for some time, while aluminium, which hit its highest price for nearly five years in January at $2,290.50 per tonne, is now languishing at less than $2,100 per tonne.

Of course, in the case of aluminium, there have been other factors at work in recent weeks, such as gyrating spreads in the forward structure, and a plethora of big inventory movements and cancellations, some of which may have been due to pre-Section 232 operations.

The common factor for all metals is, of course, uncertainty. In the case of aluminium, there are the additional worries in the market over what products will be affected by US tariffs and the effect these will have on premiums and physicals.

These are often factors that typically impinge on sentiment in the short to medium term, however. Once the initial excitement fades, metal markets then move on to take account of the continuing fundamentals, such as supply and demand and fresh developments – a strike here, or a closure there.

But for the LME – and this where the sting in the tail may lie for turnover and liquidity – there could be a much longer-term negative caused by tariffs on aluminum, steel and any other metal that could have import duties slapped on it some time in the future.

Ferrous markets are relatively new as LME offerings, and they are a work-in-progress. Steel billet was only launched in 2008, while the newer cash-settled scrap and rebar contracts, which are trading nicely at the moment, are still maturing. More additions to the LME’s suite are being considered for later this year.

Meanwhile, aluminium is the LME’s most-traded contract, and has been for many years. Do not forget, too, that the North American Special Aluminium Alloy Contract (NASAAC) also turns over some respectable volumes.

These turnovers are built on a healthy mix of trade business from producers and consumers, and speculative flows from investment, index funds and systems-based traders.

But the latter speculative component may be affected if the perception and the reality is that steel, aluminium and other products are not really free-markets any more. Duties and tariffs will have to be taken into account when making decisions about where to invest, and these can chop and change on a political whim.

Discretionary money – and there is plenty of it around these days in LME markets – can move very quickly and smoothly to other financial areas and to non-protectionist instruments where this is not a risk.

That could make it harder for the LME to nurture and grow its ferrous sector, because risk-takers are a vital part of futures markets, while maintaining overall base metals business growth on the LME will be more challenging.

Additionally, aluminium is a major constituent in the key commodity basket funds, so any downward re-weighting will lead to less LME spread business during monthly rolls.

All of this may not happen, of course, and it was surely not the intention when Trump signed off on Section 232.

But trade wars are similar to military action. And, as has been observed, these never go as planned.