U.S. and Mexico officials failed to reach a deal on tariffs at the conclusion of yesterday's trade talks. Unless negotiators make major progress in the next few days, tariffs on goods coming into the United States from Mexico will be subject to a 5% tariff. Across the board, tariffs on Mexican goods would more than double the dollar value of goods currently subject to tariffs (Figure 1).

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Unlike earlier tariffs with other countries, which were announced several weeks or months in advance, this new round against Mexico could go into effect this Monday, June 10, if a deal is not struck to demonstrate that Mexico is shutting down the path for illegal immigration into the United States. There is a built-in escalation of five percentage points each month until the tariff rate hits 25% on Monday, July 8.1

With each passing hour it appears less likely that there will be a deal in hand by Monday, but the fact that there is little appeal for these tariffs on either side of the aisle suggests Mexican tariffs could be short-lived. This special report puts the issue in context by evaluating the importance of Mexico as a trading partner to the United States and considers potential implications for this new front in the trade war.

Source: Office of the United States Trade Representative, U.S. Department of Commerce and Wells Fargo Securities

By itself, a trade war with Mexico would not plunge the U.S. economy into recession. Still this spat with Mexico is not the only iron in the fire at the moment; cumulative effects add up. Also, Mexico is our second largest export market (Figure 2) and vital to a number of industries, none more so than the auto sector. Comprising roughly a third of all goods coming from Mexico, the auto sector is a key area of vulnerability in any sustained trade dispute with Mexico. For reasons that will become clear in a moment it is likely these figures substantially underestimate the importance of the auto sector. There are also greater risks for border states, which conduct a larger share of trade than the national average, as well as for states that depend on auto manufacturing, as supply chain disruptions could weigh on production and output.

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Numbers to Put the Mexican Trade Relationship in Context

Trade with Mexico is essential to the vitality of the U.S. economy. Of all the goods imported into the United States last year, Mexico was second only to China with a 13.6% share. On the export side, China is less critical, coming in third on the list of export partners with just a 7.2% share of U.S. exports in 2018 (Revisit Figure 2).

By itself, a trade war with Mexico would not plunge the economy into recession. Exports to Mexico comprise only 1.2% of value added in the U.S. economy (Figure 3). The United States exports more to Mexico than to any other country except Canada, but still the share of total U.S. exports is just 15.9%. A big number, but it pales in comparison to the 79.5% share of Mexican exports that went to the United States in 2018. So at least in terms of the bilateral trade relationship, Mexico has more to lose than the United States.

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Source: OECD, United Nations, U.S. Department of Commerce and Wells Fargo Securities

The magnitude of the relationship, however, implies that if tariffs on Mexican goods were to go through, it would mark the biggest escalation yet in the ongoing trade war. If you add up the dollar value of all of the goods currently subject to tariffs, the totals is about $300 billion. The proposed tariffs on Mexico would affect an additional $346 billion of goods coming into the United States. This is more than just a new front; it is a more than doubling of the trade war in one shot (Revisit Figure 1).

 

Integrated Supply Chains

A key reason for the close relationships between the three North American economies are the integrated supply chains that have evolved in a number of key manufacturing industries since NAFTA went into effect in the early 1990s (Figure 4). Those close relationships and integrated supply chains blur the lines in tallying the share of imports. This is particularly true in the auto sector, where in the course of the manufacturing process a vehicle can cross international borders multiple times.

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Consider a pair of vehicles from Honda, the HR-V and the Fit. The versions of these subcompact crossover vehicles for sale in the U.S. market are produced in Guanajuato, Mexico, but they share some chassis and body components with the popular Honda CR-V, which is produced in Ontario, Canada; East Liberty, Ohio and Greensburg, Indiana. Due to the multiple border crossings of parts and components for these vehicles, it is a difficult to dial in the precise impact by country within North American.

Research conducted by American University takes on this thorny issue by considering seven location variables including profit margin, labor and research and development to score specific automobile models and estimate what percent of a given vehicle is made in a given location.2

According to that methodology, the 2018 Honda HR-V is 30% Mexican-made, and 20% U.S. & Canadian-made. The 2018 Honda Fit is 45% Mexican-made and 20% U.S. & Canadian-made.

The point here is that even Mexican-made vehicles can have a significant share of manufacturing activity that occurs within the United States. The inverse is also true. Quintessentially Americanmade vehicles rely on parts production in Mexico. The Ford F-150 is 15% Mexican-made, and 44% of the Chevy Silverado comes from Mexico.

The deep interconnectedness of the auto sector means the supply chain disruptions from tariffs directed against Mexico could cause plenty of harm to U.S. business interests as well. Unlike the Chinese tariffs, which find at least some support among congressional leaders from both parties, the tariffs threatened against Mexico have engendered the rare rebuke of the president's policies from GOP leadership in Congress along with the more predictable pushback from Democratic party leaders. For these reasons, we would anticipate it being difficult for the tariffs against Mexico to have a long shelf life.

 

Conclusion

It may not pay to play the long game on this one. We do not consider ourselves political analysts but there does not seem to be much support for these policies on either side of the aisle. Still, that may not prevent the tariffs from going into effect next week or escalating in subsequent weeks. Should these measures go into effect, and if our analysis about the interconnectedness of the American and Mexican economies is right, the economic pain they will cause, particularly in the auto sector, will likely make this a politically untenable plan in the longer run.

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Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.

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