Vale 2017/18: part 2


Drew Klease, Principal Economist 

The market calm that pervaded the first half of the 2017/18 financial year proved to be short lived as President Trump launched the global economy towards a trade war in March with his announcements of tariffs on steel and aluminium imports. Since then, threats of trade protectionism have continued to increase with US imposing tariffs on $34 billion of imports from China and potentially on a further $16 billion of imports. But the US has not just been targeting China. After exempting most allies from its steel and aluminium tariffs, President Trump announced that the EU, Canada and Mexico would no longer be exempt due to insufficient progress on trade negotiations. All three countries have responded by placing tit-for-tat tariffs on the US. How worried should we be about the trade war? In our view, the direct impact of the steel and aluminium tariffs and the tariffs on $50 billion of imports from China is likely to be minor, shaving off around 0.2 percentage points from US GDP.

However, should the trade tensions continue to escalate, the impact on the US economy could be substantial. For instance, if the US places a 25% tariff on all Chinese imports (who respond in a tit-for-tat fashion), then our modelling suggests the measures could shave 1.25% from US GDP and cause an 8.5% fall in equity markets. Australia would not be immune, with higher risk premiums and slower growth in China wiping off almost ½ percentage point from Australian GDP. An extension of the trade war to the EU, auto sector or a break-up of NAFTA would lead to an even more dire outlook for the global economy. If the trade war were to spiral out of control, an extreme scenario could be that the US imposes 10% tariffs on all products and trading partners (who retaliated by imposing tariffs on the US). Under this scenario, our modelling suggests the global economy would fall into recession, wiping 6% off the level of US and Australian GDP by the end of 2021 and equities would enter a bear market.

The combination of escalating trade tensions and tightening financial conditions has also seen emerging markets (EM) come under increasing pressure. However, we do not envisage EM economies going into meltdown. There are a few key reasons behind our view. First, commodity exporters are expected to benefit from the recent recovery in commodity prices, particularly for oil. Second, the strong growth in the US underpinned by Trump’s fiscal stimulus is expected to continue to support the manufacturing sector and exports across many emerging markets. Finally, we expect the slowdown in China to be relatively modest, with authorities expected to cushion the slowdown via easier policy settings.

Chinese authorities are already starting to boost liquidity in the economy in response to the recent slowdown by lowering the Reserve Requirement Ratio (RRR) by 50 bps in June, releasing RMB 700 billion of net liquidity to the banks. Further targeted RRR cuts are likely as the PBOC continues to cushion the impact of its clampdown in the shadow-banking sector. While downside risks to the Chinese economy have risen amid escalating trade tensions with the US, Chinese authorities have ample room to stimulate their domestic economy to offset the negative impacts from such an external shock.

While the downside risks to the global economy have risen over recent months, the direct impacts of the tariffs announced to date are small and should not derail the global economic recovery. The solid momentum in the global economy is being driven by the US, where Trump’s fiscal stimulus package is estimated to add 30-40bps to growth in both 2018 and 2019. Furthermore, although there has been some moderation in growth in the euro area during 2018, the economy is not about to roll over. Part of the slowdown has been caused by temporary factors, including poor weather and transitory factors, while ongoing stimulatory policy settings and the recent pull-back in the euro should support growth.

Our central case remains that the solid global growth outlook leads to a further decline in unemployment rates, with tighter labour markets contributing to a gradual pick-up in wage growth and inflation. Investment is expected to remain solid, supporting the longer-term outlook for productivity, while more stimulatory fiscal policy settings will also boost the growth outlook.

Despite remaining constructive on the global outlook, we are cognisant of building downside risks; be they tit-for-tat trade wars that ensnare all US trading partners, the collapse of NAFTA, or deteriorating in public finances in Italy that reignites fears over an EU-breakup. While none of these outcomes are our central case, these downside risks will continue to cast clouds over the longevity of the global economic expansion and contribute to ongoing bouts of volatility in global financial markets.


Table 1: Financial market movements, 28 June – 5 July 2018

Equity index



10-yr government bond



Foreign exchange



S&P 500





-0.7 bps

US Dollar Index (DXY)



Nikkei 225





0.2 bps




FTSE 100





-0.5 bps









-2.0 bps




S&P/ASX 200





-2.0 bps




Source: Bloomberg


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