Since the start of the year the big political event has been Donald Trump’s ‘America First’ trade policies and the potential of a full-scale trade war. This has resulted in China and the US announcing tit-for-tat tariffs on imports. In response to this, the International Monetary Fund’s (IMF) Managing Director, Christine Lagarde, has warned that global trade rules are “in danger of being torn apart” by protectionist forces. She also said that tariffs would “prevent trade from playing its essential role in boosting productivity and spreading new technologies”.
Although fears of a trade war have quite clearly not gone away, the US government appears to be striking a more conciliatory tone on China relations, with Donald Trump saying he was looking to re-join the Trans-Pacific Partnership trade bloc.
A Cold War
The other big political event that has resurfaced is a Cold War. Donald Trump has said that US-Russian relations are as bad as they have ever been, whilst the United Nation’s General Secretary, Antonio Guterres, said that the Cold War was ‘back with a vengeance’. It is too soon to evaluate what the potential long-term economic and social impact will be, but the US has introduced fresh sanctions against Russia, including individual oligarchs and government officials.
The Syrian Civil War is also a political minefield that could spark, at any time, a wider conflict in the region. The US, UK and French coalition that launched an attack on President Assad’s forces, for his use of chemical weapons, was a well-flagged targeted action and should minimise the risk of there being a major escalation in the conflict. For the time being markets are assuming that the coalition’s actions have not substantially heightened the risks of wider regional stability.
Barring any change in the political landscape, the markets are likely to focus their attention on interest rates and the outlook on growth and inflation.
The US economy is continuing to expand, with 103,000 jobs added in March, but this was far lower than the 313,000 added in February. The unemployment rate remains at 4.1%. The data provided markets with some reassurance that the US economy is not yet overheating. However, US inflation, as measured by the Consumer Prices Index (CPI) rose 2.4%, on an annual basis, in March, which is the highest inflation rate in a year.
The Federal Reserve (Fed) is still expecting to increase interest rates three times in 2018. The US labour market is already a bit below what the Fed considers to be full employment. Strong growth over the next six months is likely to cause the Fed to apply the monetary brakes more firmly than it is currently anticipating. The danger for the US economy is the Fed increasing interest rates too quickly, which could have a negative impact not just on the US, but also on the global economy.
One area of concern is the level of US debt. As a result of the tax and spending bill passed by Congress, the Congressional Budget Office, are forecasting that the US budget deficit will rise to just over $1 trillion by 2020. With interest rates at extremely low levels, interest payments will be relatively low, but with interest rates expected to rise, money that could go on infrastructure spending will have to be spent on interest payments.
Donald Trump’s policy to increase infrastructure spending may stoke up inflationary pressure, and if real interest rates rise, it could crowd out private investment. Creating additional demand when there is little spare capacity in the economy is likely to aggravate America’s trade deficit as more imports are sucked into the US economy. The IMF has urged the US to “recalibrate” its fiscal policy, and urged policymakers to stop providing “unnecessary stimulus when economic activity is already pacing up”.
The UK economy is in the process of slowing down, which is reflected in the latest economic data. The National Institute of Economic and Social Research has estimated that the UK’s Gross Domestic Product for January to March has slowed to 0.2% from 0.4% in the previous quarter. The reason for this slowdown is mainly due to the adverse weather conditions, which disrupted all the major sectors.
UK manufacturing output also declined 0.2% in February and was well behind analyst expectations of a 0.2% rise. The fall mirrored similar slowdowns in France, Germany and Italy.
On a more positive note, the year-long squeeze on wages appears to be ending. The Office for National Statistics wage data, for the 3 months to February, revealed that wages rose 2.8%, while inflation, as measured, by CPI, on an annual basis, dropped to 2.5% in March, from 2.7% in February.
The Bank of England Governor, Mark Carney, has said that an interest rate rise is likely in 2018, but any increase will be gradual. If interest rates rise, it will be on the back of a tight labour market and firming earnings growth.
After a period of robust growth, the Eurozone economy has hit an economic soft patch; however, the European Central Bank (ECB) has reassured markets by saying that the recovery is still on-track.
Eurozone Industrial production has declined 0.8% in February from January, which is the third consecutive monthly decline. A Reuters survey of economists had forecast a 0.1% rise. The ECB is still expected to tighten monetary policy by reducing Quantitative Easing.
The political risks of 2018 have the potential to cause problems for the global economy and markets, particularly if a full-scale trade war develops. Looking beyond these risks, markets are expected to focus on the outlook for interest rates, inflation and growth. Year to date, the global economy has been strong, but over the last month there has been some economic data which has been below expectations. This is a concern and should be monitored, but is not unusual in an expanding economy. Overall, the global economy remains in a positive position, with most economies continuing to move in the right direction.