Third-quarter earnings season isn’t doing much to cheer stock-market investors, but results from U.S. manufacturers might offer some relief to bond investors worried that the Trump administration’s tariffs on imported goods could stoke inflation.
On Tuesday, Caterpillar Inc.
CAT, +0.27%
United Technologies Corp.
UTX, +0.15%
and 3M Co.
MMM, +0.52%
reported tariffs were squeezing their bottom line, also citing the strong dollar
DXY, -0.15%
and trade fears. All three companies addressed the potential for price increases to allay investors’ concerns of tariff-related costs, yet their earnings reports also drew Wall Street’s attention to the problem of firms unable to raise prices in the face of wage growth that has yet returned to pre-recession levels.
“While consumer wage growth has accelerated in recent months, companies are likely to bear the brunt of the tariff impact for the time being with limited ability to pass on rising costs without damaging sales, and that should serve to temper somewhat broader inflationary pressures,” said Tom Garretson, portfolio strategist at RBC Wealth Management.
Inflation is the enemy of bond investors because it erodes the value of future income streams. By definition, tariffs spur price pressures by raising the cost of imports even if more protectionist trade policies ultimately weighs on growth. But bond buyers have little to fear if companies can’t offset the impact of import levies by raising prices on consumers.
There’s plenty of evidence companies are feeling heat from rising supply costs. The IHS October purchasing manufacturer’s index report, for example, said input cost inflation was at its highest since 2013, citing the growing burden of import levies on pressured supply chains.
And the Richmond Federal Reserve’s manufacturing survey for October saw the largest spread between prices paid and prices received by firms, a gauge of companies ability to insulate themselves from higher costs, since 1993.
This could explain in part why inflation has struggled to push higher. The increase in the consumer price index over the past 12 months slowed to 2.3% in September, after hitting a six-year high of 2.9% in July.
Treasury yields, which move in the opposite direction of bond prices, have taken a breather after a sharp rise. The benchmark 10-year note yield
TMUBMUSD10Y, -1.05%
trades at 3.072%, below the seven-year intraday high of 3.261% hit earlier this month, according to Tradeweb data.
In addition, analysts say companies’ earnings will ultimately suffer if they aren’t able to pass higher costs from tariffs on to consumers.
“When combined with trade tensions and the dollar’s strength, our apprehension turns to business, and by extension, consumer confidence,” wrote Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.
Weaker earnings, in turn, could compel management to embark on layoffs and other ways to pursue cost savings. And against a backdrop of rising interest rates, the inability to hike prices and boost revenues could also force companies to row back on capital investment.
“A typical late-cycle development is for flagging earnings to drive cost-cutting initiatives (i.e. capping wages, hiring freezes, etc.) which reduces consumers’ willingness to spend,” said Lyngen.
That could slow the U.S. economy and hold back inflation indirectly, even if by most measures growth hasn’t lost much steam. Data released Friday showed third-quarter GDP clocked in at a solid 3.5% annualized pace, slightly above the 3.4% forecast from economists polled by MarketWatch and slowing from a 4.2% pace in the second quarter.
But it could be too early for investors to draw clear conclusions. After all, President Donald Trump’s tariffs on metal imports and Chinese goods only kicked in a few months ago, said David Norris, head of U.S. credit at TwentyFour Asset Management.
In addition, the most recent update of the Federal Reserve’s Beige Book, a collection of anecdotes from business executives, said retailers in some areas of the country were starting to push forward with price hikes to deal with tariffs.
Still, tariffs could undercut the climb in bond yields through other ways.
Stocks have struggled to claw back their losses amid concerns of tepid global growth partly due to a trade war between U.S. and China. The S&P 500
SPX, -0.75%
and the Dow Jones Industrial Average
DJIA, -0.53%
were briefly down for the year after an equity rout on Wednesday.
With the willingness to take on more risk for higher returns starting to wane, haven assets, including Treasurys, could draw inflows, pushing bond yields lower.
See: Here are the early signs China’s stock-market woes are starting to infect the rest of the world
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Source : MTV
