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Global outlook
All About Trade
The long-simmering trade dispute between the US and China has taken an unexpected lurch towards escalation, rather than moderation. Uncertainty was compounded by the threat of adding Mexico to the list of targets. Trade friction unavoidably has cast a shadow over the growth outlook.
The US has now imposed 25% tariffs on US$250b of imports from China, with the threat of the same rate on most of the remainder of about US$300b. To put this in context, world exports are about US$20t and global GDP is US$85t.
The next round of tariffs would involve more pain for the US, as it involves more goods where China dominates global output, making it harder to find alternative producers. This makes us hopeful that the US will want to seek a compromise.
It seems that a lot of work needs to be done if Presidents Donald Trump and Xi Jinping are to reach an agreement at the Osaka G20 summit in late June. Escalation, perhaps with an initial 10% tariff on the remaining US$300b, is looking more likely.
There is also a threat of the US denying China access to its technology, where the impact might be harder to offset. With tariffs, we can assume China will use policy stimulus to balance the hit to demand, but there is no easy fix to barriers to technology transfer, which would be a supply shock rather than a demand shock.
This could bring renewed retaliation from China.
Unlike many of President Trump’s policy initiatives, a harder line towards China has bipartisan support and mirrors a shift in corporate attitudes. This suggests that even if China is trying to “run down the clock” until the 2020 election, a new president might not mean a much less severe approach.
More positively, the US has delayed a decision on tariffs on automobiles, which had prompted a threat of retaliation by the European Union.
A trade war between the world’s two largest economies is bad enough, but to draw in the third and perhaps the fourth (Japan) would be even more harmful.
Globalisation has already stalled over the past decade, with world trade growing no faster than output. Rising trade barriers threaten to reverse the process, with implicit losses to productivity and the efficiency of global production networks.
Latest developments represent a drag on growth rather than an outright threat of recession, but we need to be wary of escalation that could tip the scales.
United States
Tariffs will slow US growth and push inflation higher, but the impact is probably only one or two tenths of a percent in any year. Listed firms, with their global businesses, will suffer more, but the overall impact is unlikely to be enough to send the US$20t economy into recession.
Admittedly, Federal Reserve policy has become far less predictable over the past six months, but for the moment they seem happy to sit and do nothing. This patience seems likely to run well into 2020 and perhaps beyond, unless a swing in the economy forces a policy reaction.
Europe
The European economy is showing some signs of improvement, but the bounce from late 2018 sluggishness is still disappointing. At least Europe is not too exposed to the US-China dispute, although it will be hit if the US imposes tariffs on automobile imports.
The next head of the European Central Bank (ECB) is set to be revealed soon, although his policy options look limited. Growth concerns and sustained low inflation mean that a rate hike by the ECB is not on the agenda, while there seems to be little appetite to returning to the previous policy of balance sheet expansion.
“The long-simmering trade dispute between the US and China has taken an unexpected lurch towards escalation, rather than moderation. This unavoidably casts a shadow over the growth outlook.”
Japan
A positive growth surprise in 1Q2019 GDP – albeit for unsustainable reasons – has reduced pressure to postpone the planned sales tax increase in October (from 8% to 10%). Even though it is a relatively small change, previous moves have seen an out-sized impact on consumer spending. Demographic trends mean that the need for an eventual shift to greater dependence on indirect taxation is unavoidable, even though short-term circumstances can make that difficult.
The lack of policy options is an understandable concern should a sales tax hike, or US tariffs, sends the economy back into recession. The Bank of Japan continues to send a message that it is considering its policy choices, but these look extremely limited.
China
Growth indicators had stabilised – partly in response to an array of policy stimulus measures – before the latest flare-up with the United States. However, with the manufacturing Purchasing Managers’ Index (PMI) dipping back below 50, there will be pressure for more policy support. Exports are less than 20% of Chinese GDP, so measures to offset the damage from US tariffs are feasible but countering lost access to Western technology would be far more difficult.
Emerging Markets
Many emerging markets – especially in Asia – retain significant policy flexibility to respond to difficulties if necessary. Malaysia and the Philippines have already cut rates.
Generally, emerging markets are not showing the sort of imbalances – external deficits, budgetary problems, over-valued exchange rates, severe inflation – that produce vulnerability to external events. Localised problems will always occur, but systemic risk looks low.
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