Why trade tensions with China may help muni bonds

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Trade tension, sparked by President Trump’s threat to increase tariffs on $200 billion of Chinese imports this Friday, and 25% tariffs on $325 billion of Chinese goods "shortly," may not turn out badly for the municipal bond market.

As the stock market declines on trade worries, high-tax bracket investors may turn to the muni market for a safe haven, according to Steven Jon Kaplan, CEO at True Contrarian Investments LLC. “If the trade tensions lead to especially large losses for U.S. equity indices, then this will probably cause more investors to switch into bonds,” he suggested.

The bond market may lose some investors seeking the safe haven of Treasuries, but if the Federal Reserve is forced to lower interest rates — and traders have moved up expectations of a cut to next spring from summer — it will benefit bonds.

“Although the current Fed policy should be a positive for business leaders’ behavior change coming out of Q1, the trade war and tariffs continue to hang uncertainty over capital investment on a global scale,” said Chief Market Strategist Brett Ewing of First Franklin. “Tariffs or no tariffs, volatility in the bond market is all but guaranteed in the short-run."

If no deal is reached and the 25% tariffs are imposed, he said, "it will raise uncertainty in the equity market. I expect that it will, in turn, increase volatility in stocks and lower interest rates in the bond market. This would create an environment that will provide a short-term upside for municipal bonds."

If a deal is reached and further "tariffs are avoided, I believe that stocks will rally in the short term and that bonds will sell off, including munis,” Ewing said.

To be sure, this week's threats or tariffs may have been posturing on Trump’s part, and a deal with China may be reached. Morgan Stanley research said any increase in tariffs is likely to be temporary “as market weakness would bring the two sides toward a deal that de-escalates tariffs in stages as part of an enforcement mechanism.”

Andrew Schneider, U.S. economist at BNP Paribas Securities, and Joel Alcedo, a data scientist for the firm, agreed that a deal should be reached by midyear. “However, the tweet underscores structural issues that remain thorny and could play as spoilers,” they wrote in a note after one of the president's social media postings. “We think the uncertainty as to the deal's timing, treatment of existing tariffs, and content has likely increased.”

Fed officials, also weighed in on the impact of trade issue. Federal Reserve Bank of Dallas President Robert Kaplan, said, “It is not having a substantial material impact on U.S. GDP growth at this point, but … it is having some chilling effect on [some industries and their] ability to manage their costs and the way they do business."

Speaking on Bloomberg TV, Fed Vice Chair Richard Clarida said, "So far, the trade measures put in place really only had a very modest effect on the economy." He added that if no agreement is reached, the Fed would “certainly take that into account in future policy."

Economic news
Job openings in the U.S. posted their biggest gain in a year, climbing 346,000 in March to 7.49 million, from an upwardly revised 7.14 million in the prior month, the Labor Department reported in its Job Openings and Labor Turnover Survey or JOLTS released Tuesday. The quits rate held at 2.3%.

Late Monday, the Treasury Department reported newly issued Treasury securities held in stripped form increased about $2.653 billion in April to a total of $303.793 billion.

Consumer credit rose $10.3 billion in March, after a revised $15.5 billion gain in February, first reported as a $15.2 billion increase, the Federal Reserve reported. IFR Markets had projected a $17.0 billion increase.

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