Trump tariffs create uncertainty for state and local government credits

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LOS ANGELES — State and local government budgets and infrastructure projects could be at risk from the tariffs the Trump administration recently imposed on steel and aluminum.

A shift toward protectionist trade policies has negative implications for most state economies, according to S&P Global Ratings.

The rating agency cautioned in its 2018 sector outlook for U.S. states earlier this year that the potential for policy missteps represented a leading risk to its baseline economic forecast for the year.

President Trump’s decision last week to impose import tariffs of 25% on steel and 10% on aluminum is an example of such a risk, said Gabriel Petek, a managing director in S&P’s U.S. States Group.

“It could be considered a policy misstep if the unintended consequence is a trade war or trade barriers,” Petek said.

In the past when the U.S. has turned to tariffs, it has resulted in trading partners responding by enacting their own duties on U.S. exports, said John McKenzie, a partner with law firm Baker & McKenzie LLP and member of the California Council for International Trade.

“The European countries have been explicit about the various products they will target for sanctions, while Korea and Japan have been somewhat less explicit,” McKenzie said.

The proposed tariffs that take effect March 23 prompted retaliatory threats from countries around the globe.

The European Union and China are among those that have said they would retaliate by placing tariffs on U.S. products exported to their countries. Mexico and Canada, which comprise 25% of steel and 45% of aluminum imports to the U.S., were exempted from the metal tariffs. The Trump administration is considering tariffs on $60 billion in Chinese goods, which could further pressure retaliatory measures from China.

Louisiana, Washington and South Carolina are the states with the most economic exposure as a relatively large share of their GDP, ranging from 15% to 21% for the three states, comes from exports, according to S&P. Missouri, Louisiana, Connecticut and Maryland have the highest risk to exposure from price increases on aluminum and steel as those metals represent more than 5% of imports for those states, according to S&P.

S&P’s current forecast for U.S. gross domestic product growth for the year is 2.8%, which is a nice increase from the 2.3% range of GDP for the past several years, Petek said. The boost in GDP that was expected to offer a “dose of fiscal relief to the states” could now fail to materialize, Petek said.

It is not necessarily the metal tariffs, but retaliation from trading partners, particularly Europe, Japan and China that represent the risk to budgetary forecasts, Petek said. If the tariffs led to retaliatory measures the Federal Reserve could raise rates more than most forecasts assume, which would impact retail sales, he said.

“We could witness slower economic growth than most states have assumed in their forecasts,” according to S&P. “Such an outcome could translate to tax revenue growth rates, further squeezing state fiscal margins, which have already been under pressure in recent years.”

The economic and tax revenue implications could force states and localities to reevaluate the forecasts that underpin their key budget assumptions, S&P analysts wrote.

California has a fairly significant stake in the potential fallout if trading partners decide to retaliate because logistics and trade are significant economic drivers for the state, said Jerry Nickelsburg, a senior economist and director of the UCLA Anderson Forecast.

The state is also a destination for manufactured goods from Asia that are then trucked all over the country, he said.

The Anderson Forecast’s economists in their first quarter outlook released last week predicted the U.S. economy would shift from sluggish growth and low inflation to one of accelerating growth and moderate inflation and that California’s economy would continue to outperform the nation's.

“Our assumption is that the tariffs will have enough exemptions to them that their impact will be minor,” Nickelsburg said. “We have the caveat that if there is a full-blown trade war then our forecast will be wrong.”

Slowed U.S. economic growth resulting from shifts in trade policy would most heavily impact local governments dependent on the export industry.

Seattle, Los Angeles, Chicago, Houston and New York together account for roughly 15% of all U.S. exports, according to U.S. Census Bureau data cited in S&P’s report. The impact on credit quality to those cities could be less significant, S&P said, because of their economies are diverse. For smaller cities where export-heavy manufacturing can dwarf other sectors, a shift in the pace of exports creates greater potential for economic disruption and credit deterioration, according to the ratings agency.

Moody’s Investors Service deemed the tariffs a credit negative for the U.S. infrastructure sector in a March 9 report because they are likely to cause steel and aluminum prices to increase, making projects that need those supplies more costly.

Projects that could see cost increases include renewable and fossil fuel power plants, pipelines and liquefied natural gas export facilities, airport terminal construction, transportation projects, and seaports, said Gaurav Purohit, a Moody’s analyst.

The potential for states or local governments that have a lot of projects planned to see downgrades would be specific to the credit, which projects are planned and their dependence on steel, Purohit said.

Ports will experience the greatest impact, because they will be affected on both the expenditure and revenue side, Purohit said.

The Port of New Orleans could be affected the most, because 15% of its imports are steel, Purohit said. Houston and Los Angeles have comparable volumes of steel, he said, but steel represents less than 2% of revenues for those ports, so less of an impact is anticipated.

Moody’s currently has a stable outlook for the port sector, but the tariffs and the potential for a trade war could put that outlook at risk.

“We are expecting both imports and exports to remain at current levels or grow with the health of the economy,” said Kurt Krummenacker, a Moody’s senior vice president/manager. “The ports are on the front line if some sort of expansive trade war develops. We aren’t expecting this to initiate a widespread trade war, but the situation is still developing.”

Kurt Forsgren, an S&P ports analyst, said the agency is monitoring the situation.

“We published our outlook for the sector in January and we cited the potential risks of any trade disputes and tariffs and the unwinding of NAFTA agreements for the sector,” Forsgren said.

Gulf ports including New Orleans, Houston and Mobile, Alabama that are heavily into oil refining and have the largest share of steel and aluminum imports are probably the most impacted, Forsgren said.

“If there is retaliation from trading partners, the risk could spread to other ports,” Forsgren said.

It could stall what has been a really good year for the twin ports of Los Angeles and Long Beach, both of which have seen an increase in port traffic this year, he said. The Los Angeles port processed 725,000 twenty-foot equivalent units in February, the busiest February in the port’s history – and a 16% jump over last February’s number, while the Long Beach port processed 661,790 TEUs, a 32.8% increase over last February, according to officials from each port.

“Yes, we are concerned when anything like this comes up even though steel only represents 2% of our business,” said Phillip Sanfield, a Los Angeles port spokesman.

Gene Seroka, the port’s executive director, has significant concerns of what could happen if there is a trade war, Sanfield said. The Los Angeles port is particularly concerned about the impact on Asia, because that is where the bulk of the port’s cargo comes from, Sanfield said.

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