Trade Tensions and Central Bank Policies Causing Global Growth Concerns

Tom Cleveland

The month of May is typically a bad month for stocks, but this year, it is even more so due to one simple fact: “The trade war between the world’s two largest economies is back on.” Yes, Trump the “Tariff Man” is back at being his irascible self, trying to churn the waters over the Pacific, as if ranting and raving was ever going to influence the long-term perspective of Chinese officials, who view his term as President merely a bump in the road on a long-term path to achieve their domestic agenda.

Equity markets do not like uncertainty, a trait that Trump seems to admire, as long as he is the one causing it. Equity markets also like accommodating central bank policies as a rule, the lower the interest rates, the better. Just two months back, analysts at Barclays were confident that economic growth trends would continue unabated through the balance of the year: “The global expansion should continue for the foreseeable future, and we do not see any major economy growing below trend in 2019.”

Fast forward two months to May, and suddenly the trend in our equity markets has reversed, and bond prices, both short and long-term, are “pricing in doomsday”, as depicted in the dual charts below:

SmP and Rates

It is not time to head for the storm bunkers. We are not in as dire a straits as bond yields might be implying in the charts, primarily because central banks the world over, including the Fed, have remained or shifted back to a more accommodating posture. Trade wars will bring anxiety, and weak hands will shift capital to more safe havens, but the end of the world is not near.

The problem for the global economy, however, is more about the strength of the U.S. Dollar. The Fed may have backed off its plan to continue normalization, but it still remains relatively hawkish when compared to its other brethren across the planet. The greenback in a word is stubborn. It has appreciated, when the opposite is needed in order to grease the skids of international commerce.

Nomura’s Charlie McElligott summed it up, as follows: “Global trade is clearly now being dragged into the mud by a ‘vicious spiral’ of not just the actual tariff barriers and the lack of corporate visibility therein, but perhaps most importantly, the ongoing strength in the US Dollar, which further undermines a global economy which is dependent upon trade and financed by US Dollar liquidity.” Another pundit chimed in with: “The dollar shortage story has lingered like stale cigarette smoke, despite the Fed’s efforts to loosen financial conditions.”

As for the current status of monetary policy positions, the following graphic combines two charts to illustrate where policies are tight and lose and to summarize actions over time:

Central bank rates

The U.S. is positioned above other developed economies, and the situation may grow worse since the EU is planning to add more liquidity to the region, while the RBA down under in Australia is widely expected to begin reducing rates in haste. Policymakers appear to be pivoting at just the right time to keep current trends afloat, as depicted in the right half of the pictorial, but the fear is that we might see “déjà vu” all over again as in 2018, when capital rushed to the USD and drove emerging markets to despair.

Once again, the global economy is treading cautiously along a tightrope, balancing   liquidity needs without causing a panic. How long must rates hang low and liquidity expand in order to keep inept politicians from destroying the balance, whether through trade war tensions or geopolitical stressors?

Trade wars have resumed, but what are and will be the impacts?

This report says it all: “Donald Trump, on May 5, suddenly revealed that a trade agreement with China was not imminent after all. To the contrary, the Administration, on May 10, raised its earlier 10 percent tariff on $200 billion of Chinese goods to 25%, and threatened to extend 25% tariffs to the remainder of imports from China by late June (roughly $300 billion of goods). China, of course, retaliated against US exports, announcing reciprocal 25% tariffs on $60 billion of US goods to start June 1. Surprised stock markets fell in response, with the S&P 500 down 4 per cent over the first week of the renewed trade war.”

Yes, financial markets were surprised, a reaction that many analysts have questioned. Why did markets suddenly believe what Trump had claimed, i.e., that the negotiations were going along well, when his White House has established a record of boisterous claims, but has actually been light on deliveries of the goods.

On further inspection, government officials and Trump seem highly conflicted: “On the one hand, Administration officials and apologists defend the high tariffs as a regrettable but temporary expedient, a necessary means to a strategic end, a weapon whereby the consummate deal-maker will force concessions from China and other trading partners. On the other hand, Donald Trump himself looks and talks like someone who would be perfectly satisfied if the tariffs remained in place permanently.”

Trump the “”Tariff Man” also smiles with glee when discussing the amount of money that his Treasury is taking in from his tariffs, and he keeps misrepresenting the impacts, no matter what his advisers tell him, by adamantly proclaiming that China is paying them, when the reality is that the assessments are actually new taxes on Americans.

Per one critic: “The President’s gleeful belief that his tariffs get China to help fund the US government is outlandish. A tariff is a tax, and US consumers and firms are the ones paying it, not China. (The estimated reduction in U.S. real income is $1.4 billion per month.)” The following chart presents the reality of the situation:

Tariff impacts

Retailers immediately re-priced Chinese imports to reflect the impact of applicable tariffs. If the entire slate of Trump’s tariff threats is imposed, American households are expected to lose on average a total of $750 on an annual basis, well more than any previous reduction in taxes that his revised tax plan was said to have provided. The changes are subtle, but they affect businesses and primarily consumers, who could become upset enough to display their anger at the ballot box in 2020. On the export side, which does get press, farmers are suffering beyond measure. Bail out plans for billions of relief have been passed, but no one has determined where the funding will arise for the program, unless from the tariff inflow.

There is one other possibility, according to Trump economists. As their theory goes, a large drop in demand for Chinese goods should force the Chinese to lower their prices, but research does not support this proposition: “Two new studies by eminent economists examine the 2018 data and find that (1) the Chinese have not, in fact, lowered their prices and, as a result, (2) the full cost of the price increase has been passed through to American households. So, one doesn’t even need Econ 101 – simple common sense gives the right answer in this case.” Americans are paying Trump’s tariff tax.

Will protectionism make America great again, as Trump professes? The words of a critic are enlightening: “Donald Trump appears to have engineered a spectacular example of this generalization: his trade war has hurt almost every segment of the American economy, with very few winners. The losers include not just consumers, but also firms and the workers they employ, whether they are farmers who are losing their export markets or manufacturers who are forced to pay higher input costs. Even the US auto industry, which did not ask for this “protection,” is worse off over all, having to pay more for steel and auto parts.”

What are the consequences of the present situation on the forex market?

On May 23rd, the U.S. Dollar established a new two-year high at 98.35, before pulling back to close below the previous day’s low. In January, the Dollar index started its upward trend, beginning at 95.2, and then gradually ascended to peek above 98 twice in the last 45 days. It sits at 97.9 at this writing. Analysts are claiming that the apparent Double-Top formation is a sign that further appreciation is not in the cards. MACD and RSI indications are signaling a downturn, as well, but the jury is out, as other central banks consider more dovish monetary policy positions.

Theresa May’s resignation as Prime Minister of the UK on last Friday appeared to have already been priced into the market. Sterling continued its third straight week of losing ground, as a result of the uncertainty over Brexit and the possibility of a hard “no deal” divorce from the EU. No less than six contenders are in the running for her spot, with the majority of them espousing a “no deal” outcome as the preferred way to go. EU officials are frustrated by the delays and have never truly wanted the split to be finalized.

It is a given that persistent trade wars will hurt the U.S. economy, but, unfortunately, the rest of the world will suffer more. Reactions in the equity market will dictate which forex pairs will prosper, per this sage advice: “There’s always been a strong correlation between equities and currencies. Traditionally, when stocks perform well and risk appetite is strong euro, sterling, Australian, New Zealand and Canadian dollars will perform the best. These countries are the most vulnerable to global growth so an improved outlook gives investors the confidence to invest in their riskier and more market-sensitive currencies.”

But there is a flip side, as well: “In contrast, when stocks crash, the U.S. dollar and Japanese yen perform the best because they attract the most influx of safe-haven flows. But if stocks go cold because of the trade war, the U.S. dollar could be the ultimate winner.” This bit of wisdom will hold, as long that U.S. economy remains a strong leader and does not slip into a recession. Pessimists in the press will be sure to pick up on this possibility in the weeks and months to follow.

Concluding Remarks

Trade tensions are re-escalating, and investors are anxious over the uncertainty of how this scenario might play out. Trump has shown himself to be unpredictable and one that loves to stir the pot in pursuit of his objectives. Central bankers, however, want to keep an even keel over this ordeal, allowing the economy to heat up if need be, but there is only so much that they can do. Near-zero and negative interest rates and bloated balance sheets do not make for adequate defenses, if and when the next downturn in the business cycle occurs.

And we are at the end of this business cycle, no doubt about that fact. All good things must come to an end, despite the efforts of well-meaning folks to re-write the history books. 2019 seems to be on steady ground, as long as trade issues do not get out of hand, but 2020 is another story. As one pundit put it: “There’s not a lot to like about the setup right now.”

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Tom Cleveland
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