The Impact of Tariffs
Welcome to the Real Estate Espresso Podcast. Your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce. On today’s show, we’re talking about the risk to interest rates for real estate investors. Predictions about the current initiatives in the White House range wildly from a Ronald Reagan style outcome, where the short-term disruptions📝 led to a leaner, more efficient government with better financial performance in a period of renewed economic prosperity. However, other predictions point to a Jimmy Carter style disruption that results in stagflation. The arguments can be convincing on both sides.
On Today’s show we’re going to look at the negative implications of retaliations in the trade war that the White House has initiated. We’ll start with interest rates. We tend to think of the Fed as the driving force behind the interest rates that affect real estate investors. But, as we’ve discussed at length on this show, it’s really the market for U.S. Treasuries, and specifically the Ten-Year Treasury that sets the yield on that bond. Most permanent financings are indexed to the yield on the Ten-Year Treasury.
The threat of global tariffs has been met with retaliatory tariffs that have done little to move the White House from trying to influence companies to invest in the US. There are several possible responses. Individual companies that want access to the US market can respond by themselves to the tariffs by opening US manufacturing on US soil, or governments from the affected countries can respond themselves.
Most recently, several countries whose central banks hold large quantities of U.S. Treasuries have been threatening to dump those bonds in the open market. Japan holds $1.1 trillion of U.S. Treasuries and are the largest foreign holders of them. Selling a large quantity of bonds all at once, or even over an extended period of time, would depress the market for these kinds of bonds. Bond prices would fall, which would obviously hurt the seller, but it would also hurt the issuer of these new bonds, specifically the U.S. Treasury. Apart from Japan threatening to dump $1.1 trillion of US Treasuries, China is the second-largest holder with $760 billion, followed by the United Kingdom at $740 billion. In total, there’s $8.5 trillion of US Treasuries that are foreign-owned.
If it’s perceived that there is going to be a run on the bank, so to speak, with multiple foreign investors running for the exits, we could see a collapse in the market for US Treasuries, at least internationally, and a corresponding jump in the yield on those bonds. At the same time, we would also see a drop in the value of the US dollar, which would be a double hit to the holders of those bonds.
Now, I suspect the White House doubts that holders of this debt will dump it en masse, because it would harm them too, as much as they’re retaliating against the White House tariffs. We’re already starting to see a softening stance on the tariffs that were scheduled for April 2nd, possibly included a smaller list of countries and a narrower basket of goods that would be subject. Now Donald Trump, being a real estate investor himself, surely understands the impact of higher interest rates, not just on real estate, but also how higher interest rates can run counter to his entire economic agenda. His aim is to balance the federal budget, and a crisis of confidence in US treasuries would have a negative effect on that agenda.
These public threats are aimed at stimulating changes in behavior without actually costing the US a lot in terms of negative impact. There will certainly be backlash and retaliation, that’s to be expected. So, if you want to understand the impact of tariffs, I would recommend you to look closely at what’s happening in the bond market. It might telegraph more clearly the levers in the negotiation as opposed to reacting to the very next headline in a few hours. I expect you will see further softening of the tariff threats as these negotiations progress.
You have a few domestic companies already making commitments to new US manufacturing, holding up tariffs as the reason. However, the Hyundai announcement of a new steel smelter in Louisiana was not the result of tariffs alone, if at all. The negotiations for that site had been underway for a long time. The abundance of inexpensive natural gas along the US Gulf Coast is a major driving force. Smelting steel is energy-intensive, and the cost of natural gas is much lower in Louisiana than in Korea, driving this decision.
Another major announcement this past week was the Century Aluminum. Truth is, the Century Aluminum smelter project was announced over a year ago with $500 million in green-energy grants from the Department of Energy. That will roughly double the aluminum capacity of the US in a single project. Once again, the tariffs were not the catalyst for the new plant, which will employ about 2,000 people and add about 6,000 in-direct jobs. The first phase of the four-phase project is just kicking off this year.
As real estate investors, we often worry about the impact of a trade war on the budgets we set for our projects. I’ve been saying for some time that these tariffs are not going to stick. They can’t persist without causing undue harm to the US economy. The math doesn’t support the retention of those tariffs. The fact is that negotiations involve leverage, and in an interconnected world, leverage exists in both directions. As you think about that, have an awesome rest of your day. Go make some great things happen.
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