Calm vs chaos

Principal Economist's View

 

Global equity markets took another hit over the week. The S&P 500 dropped 3.8%, with broad-based weakness seen across the market. The fall was not due to the move by the US Federal Reserve to raise rates by 25 basis points to 1.50-1.75% on Wednesday. The transition to the new Fed Chair Powell has been smooth and orderly, with the Federal Reserve continuing on a steady path towards higher rates.

Rather, the market disruption has been sparked by the White House. Technology stocks underperformed after investigations unveiled that Cambridge Analytica, a firm that assisted President Trump in the 2016 elections, obtained unauthorised access to 50 million Facebook accounts in order to target voters in the campaign. Facebook shares plummeted 10% over the week and other tech stocks also came under pressure.

While the fallout from this scandal was contained to tech stocks, the decision by Trump to impose 25% tariffs on up to US$60 billion of Chinese imports sparked broad-based weakness across the S&P 500. The new measures follow Trump’s decision to impose tariffs on steel and aluminium a few weeks ago and are intended to penalise China for stealing American companies’ intellectual property. Trump has also proposed to pursue China’s discriminatory technology licensing practices at the WTO and to place investment restrictions by China in “industries or technologies deemed important to the United States.”          

Repeating a trend of this President, precise details of the tariffs are yet to be revealed. What we do know is that the President has instructed the US Trade Representative Robert Lighthizer to publish a list of products and the new tariff rates that will apply within 15 days. A testimony by Lighthizer to the Senate Finance Committee on Thursday suggests that the tariffs will be applied to a raft of products that China is focussing on expanding under its 2025 plan: advanced information technology; automated machine tools and robotics; aerospace and aeronautics equipment; maritime equipment and high-tech shipping; new-energy vehicles; modern rail transport equipment; agricultural equipment; and new materials, biopharma and advanced medical products.

How many consumer products will face a tariff remains unclear at this stage. Officials suggest the unreleased US Trade Representative report covers 1,300 product lines, many more than noted by Lighthizer’s testimony. However, Lighthizer suggested that some consumer products will be exempt, noting that “there are a few consumer items that should not be on there, and they are not on there.” It appears that the US approach is to apply tariffs on consumer goods that can be easily sourced from other countries, with Lighthizer explaining the tactic: for example, something that you get from China and a lot of other people, if you put a tariff on that, the effect on US consumers would be minimized. That’s kind of the idea of this.”

Following the publication of this list, there will be a 30-day period for public consultation before a final decision is made. While there is potential for this consultation period to follow the same route as the steel and aluminium tariffs with widespread exemptions, the White House appears intent on blocking trade in key targeted areas, while minimising the damage to consumers. 

China has responded to President Trump’s protectionism, proposing a list of 128 US products for potential tariff retaliation. These include a 15% tariff on US wine, apple and ethanol imports and a 25% tariff on pork and aluminium scrap. However, at this stage, China appears to be taking a measured approach, clearly not wishing to escalate the situation.  

What is the likely macroeconomic impact of these proposals? Although it is hard to be precise given the lack of details, some simple back-of-the-envelope analysis is instructive. Assuming a 25% tariff on $60 billion of Chinese goods imports could lead to an eventual 0.5% lift in US import prices ($60 billion represents just 2% of total US imports). Based on pass-through of import prices to consumer prices, the tariff hikes are likely to boost inflation by around 10 bps in 2018 and 2019.  In terms of the growth impact, our modelling of the proposals in NiGEM (with retaliation by China) suggests the tariffs would shave off around 10bps from US real GDP growth over the next 18 months.

With the growth impact of the protectionist policies limited, we continue to expect the US economy will expand at an above trend pace of the coming two years. Inflation will continue to pick-up, boosted in part by the introduction of tariffs, but also firmer wage growth. Under this scenario, we expect the US Federal Reserve will remain calm, continuing to gradually lift interest rates. Our baseline view remains for a further two hikes this year and another two hikes next year. This is in line with the FOMC’s median projection for this year, but below the three hikes that the Fed now expects to deliver in 2019. Either way, while the Fed is likely to keep on a steady course, they will no doubt be hoping the chaotic trade tensions don’t escalate to a trade war. Rising inflationary pressures and deteriorating growth prospects are an unenviable combination for any central bank.   

Table 1: Financial market movements, 15 – 22 March 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,643.7

-3.8%

US

2.82%

-0.4 bps

US Dollar Index (DXY)

89.86

-0.3%

Nikkei 225

21,592.0

-1.0%

Japan

0.04%

-0.8 bps

USD-JPY

105.28

-1.0%

FTSE 100

6,952.6

-2.6%

UK

1.44%

0.2 bps

GBP-USD

1.410

1.1%

DAX

12,100.1

-2.0%

Germany

0.53%

-4.7 bps

EUR-USD

1.230

0.0%

S&P/ASX 200

5,937.2

0.3%

Australia

2.70%

-0.2 bps

AUD-USD

0.769

-1.3%

Source: Bloomberg

 

To read the full report, including the Economic update by region, click here.

 

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