Updated: May 17
If February was remembered for the somewhat inexplicable falls in equity markets – there was no obvious trigger – March will be remembered for falls that were very much related to one thing – the prospect of a global trade war.
"We may end up with the Chinese equivalent of the Plaza Accord"
To the surprise of many, perhaps even those in his inner circle, US president Donald Trump announced that he would be imposing tariffs on a number of imported goods. Given the goods that were being targeted, steel being a key one, it seemed clear that the object of Trump’s move was China and the large surplus that it enjoys with the US.
Large deficits and surpluses are complicated things and do not necessarily reflect inequity in the way that Trump framed the US deficit with China and others. A deficit in goods and services can simply reflect the fact that there is a surplus on the capital account. China’s goods and services may appeal to Americans but to the Chinese, the US’s assets may be of interest. In simple terms, what goes in must come out. It might also reflect fundamental attributes of the countries involved. Americans, like the Brits, tend to be happy to live beyond their means whereas the Chinese are frugal people who love to save. Are these things that can be solved with import tariffs? Probably not.
That said, the US only has so many assets to sell, so at some point things must change. In other words, the deficit is unsustainable, so action now may not be entirely unjustified. And of course, those Midwestern supporters will be lapping up Trumps words and indeed action.
How things progress from here is hard to say. We may end up with the Chinese equivalent of the Plaza Accord, in which China promises more market-oriented policies on the trade front, requiring a commitment to strengthen its currency.
Elsewhere on the economic front, we started to note the first signs of economic weakness, following nearly two years in which global growth had been progressively strengthening. One of these was the OECD Leading Indicator which had started to turn down towards the end of 2017. The other was the fact that purchasing manager indices (PMIs) around the world had reached such a high level in a historical context that it was likely that they would soon turn down.
Given that unemployment rates are already very low and that trade wars tend to be inflationary not deflationary, it was felt that any growth wobble would not be accompanied by a fall in inflation. Furthermore, we have probably entered the phase of the cycle when growth is as much a potential concern as monetary policy. In other words, we felt there was scope for global growth to disappoint but that central banks would not act because upward inflation pressures remained in place (indeed the US Federal Reserve increased interest rates during the month).
Looking at other economic data, core inflation in February rose in the US and Japan, fell from elevated levels in the UK, and stayed steady in Europe. We would expect the trend of inflation on average rising to continue, given that unemployment is now very low which in turn causes upward pressure on wages to increase.
Elsewhere in financial markets, bond yields in the developed world fell across the board. This perhaps was as much to do with yields having risen so much over the past year or so as it was a flight to safety associated with Trump’s trade manoeuvres. Finally, following months of weakness, the US dollar had a stable month.
Published in Investment Letter, April 2018
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.