Economically, everything had been going so well, with most economies expanding, however, there is now a potential dark cloud on the horizon. Although “America First” was a key mantra of Donald Trump’s US Presidential Election campaign, it has taken him over a year to really crank up the volume on trade issues and this represents a major reversal to his more market friendly interventions since taking office.
With the US granting exemptions to the European Union, Mexico, Canada, Australia, Argentina, Brazil and South Korea from the tariffs on steel and aluminium, it is fairly clear that the main focus of the policy is China.
Donald Trump’s concern with China is not just the trade imbalance between the two economies, but the alleged theft of intellectual property by China. China’s exports to the US accounts for about 4% of the Chinese economy, with the trade surplus in goods and services at around 3%. China is a formidable opponent and is growing at 6.5% per annum and, therefore, has some cushion, even if it exports nothing to the US. China is also undertaking massive investment in its “New Silk Road” initiative to broaden trade ties across Eurasia, South East Asia, and the subcontinents of Asia and Africa and has no shortage of trading opportunities. China has the fastest growing consumer economy (in terms of money spent), and, therefore, many American corporations will not want to see their opportunities fade.
Whilst developments of Donald Trump’s protectionist policies appear to be just a bargaining chip, the prospect of a trade war is a serious risk for global markets.
Signs of higher inflation and a record level of US Treasury supply, have led to a rise in bond yields. The US Federal Reserve (Fed) and the Bank of England (BoE) both suggested that their respective interest rates might need to rise more quickly than the markets had previously expected.
One of the big monetary risks comes from the reduction and ultimate reversal of Quantitative Easing. The Fed is already shrinking its balance sheet, with the European Central Bank (ECB), at the start of 2018, halving its monthly bond purchases from €60 billion to €30 billion, and potentially reducing the program to zero later in the year. Even the Bank of Japan has been reducing its purchases of bonds, as yields have stabilised. The BoE and the Swiss National Bank bond purchases are currently on hold.
It is widely projected that the aggregate size of these five central banks will begin to shrink around the turn of 2019.
The global equity markets have not only been impacted due to fears of a trade war, but also two other US events. The first event was the Fed increasing interest rates from 1.5% to 1.75%. It is not the fact that US interest rates have risen that have impacted the markets, it is the comments from the Fed, which were of a more hawkish tone, with monetary policy now expected to tighten at a slightly faster pace. The global equity markets were also impacted negatively by the announcement that Facebook had released unauthorised data and this resulted in downward pressure on the Technology sector.
Despite these concerns, economic data overall, remains positive, with US non-farm payrolls increasing by 313,000 in February 2018, which beat market expectations of 200,000. It is the highest increase in payrolls since July 2016. The US unemployment rate in February held steady at 4.1% for the fifth consecutive month.
Brexit negotiations continue to dominate the news and progress in this area has been a key factor in supporting the Pound. The fact that the Pound has stabilised has meant that inflation, as measured by the Consumer Prices Index (CPI), is creeping back towards the BoE’s 2% inflation target. The CPI, 12 month-rate, was 2.7% in February 2018, down from 3% in January.
The underlying economy is putting in a mixed performance. The UK consumer background remains tough with both Toys “R” Us and Maplin entering administration, however, there are signs that the Pound’s 2016 devaluation, along with growing global demand is beginning to boost exports.
The UK’s year long squeeze on living standards also appears to be nearing an end after figures showed that in December 2017, headline earnings growth had risen 2.8%, 3 months year-on-year, the strongest increase recorded since 2015. The UK unemployment rate in the 3 months to January 2018 was 4.3%, which is a 42 year low.
European Monetary Policy
The ECB has removed from its monetary policy statement, language that said it stands ready to increase its bond purchasing programme if the European Union’s economic outlook deteriorates, which can be viewed as another small step on the path to the normalisation of monetary policy. However, monetary policy remains extremely loose. In Mario Draghi’s (ECB President) statement, bond purchases will continue until at least September 2018, “or beyond if necessary and in any case until the Council sees a sustained adjustment in the path of inflation”. The ECB has also made clear that there has been significant downside risk to a rise in protectionism.
The recent General Election in Italy has illustrated the increasing political risk. No party won an outright majority, which resulted in a hung parliament and a protracted period of negotiations, which could last for months.
Although it is too early to say whether there will be a full-scale trade war, the impact of a trade war could be massive and result in an economic slowdown, together with higher inflation, which would be attributable to the higher import duties. One must never forget that the Great Depression of the 1930s was marked by a severe outbreak of protectionism.