"...we are all limited by our perspective” Siri Hustvedt
Most commentators would likely agree that if there is a specific target nation in mind with reference to US trade measures, it is surely China. Indeed the White House have confirmed a target of USD 100 billion reduction in the US / China trade deficit. However, as Wolfgang Munchau argued in the FT yesterday, Germany and the eurozone are another huge and potentially extremely vulnerable protagonist in any trade war. Munchau points out that Germany, with its current account deficit of 8% - an intentional beggar-thy-neighbour response to the eurozone crisis since 2012 - is very vulnerable to Trump’s threats.
Germany is a large exporter of steel into the US, but it is the threat of escalation by Trump to include tariffs on German cars that would be devastating. "From a strategic point of view, it is utter madness for the EU to have allowed itself to become so dependent on the export of a late-cycle product” [Munchau] and to become so reliant on the US to absorb its current account surpluses. In this context, a trade war with the EU may well be "easy to win”
Against this backdrop it is hardly surprising that Germany have pledged to raise defense spending towards 2% GDP - the NATO target, a target that President Trump has made numerous pointed remarks about (in relation to the US not only being the largest member and contributor, but also being the only nation to maintain the 2% target). This concession is likely to open the conversation, but the next move from either side is likely much more significant.
"Symmetry is overrated” Larry Wall
We have noted several times over recent weeks that our thoughts differ from most commentators on the likely impact of the Trump tariffs. ‘Symmetry and reciprocity’ have been the Trump Administration’s approach to its global trade policy throughout, and our view remains that the US has one of the lowest tariff ratings in the global economy. In this respect I would love to be a fly on the wall at the G20 meeting this week as Finance Ministers that have protectionist or restrictive trade practices towards other G-20 members argue the case against the trade restrictive policies by the US.
We stand by our call that instead of being short-sighted, regressive and economically illiterate, the resulting discussions are more likely to lower global trade tariffs than encourage a trade war. The response from Chinese Premier Li last night that China will further open up and "lower import tariffs” is a case in point. We fully expect further concessions to emerge from across the globe over the coming days / weeks.
"A journey of a thousand miles begins with one step” Lao Tzu
Yesterday also represented a second significant milestone in the Brexit negotiations. The EU and the UK reached an agreement on the remaining divergences on citizens rights and the financial settlement, as well as on the translation into legal text of the December withdrawal agreement. Progress that Michel Barnier suggested opened the way for negotiations on the "future ambitious partnership”, which Mr Davis referred to as "the biggest, most complicated, most effective trade deal ever”.
The Ireland border issue is still lacking a solution. However, there was agreement on the provision of a backstop that fulfills the requisite criteria, and Davis added that the UK was "confident it could come up with a better solution to avoiding a hard border, meaning the backstop need not be engaged” . This point either provided enough clarity, or lack of clarity to keep all sides (including the DUP) happy.
I often read commentaries criticising how long the negotiations are taking and how if relatively minor issues, such as agreeing a transition deal (which essentially constitutes the status quo with the ability to sign trade deals) can take so long, then how can we expect a comprehensive and groundbreaking trade deal. However, perhaps this makes more sense if we look at it from a different perspective. The UK and the EU, and more specifically, Davis Davis and Michel Barnier, must make it be seen that they have worked tirelessly to achieve the best possible deal for their respective sides - agreeing anything in a short time period does not give that impression. Furthermore, in areas of contention or where the negotiating stance is more sensitive, it makes little sense to lay your comprehensive desires on the table too early (for the UK more so than the EU), as they would likely quickly become an unattainable maximum.
"There is no unique picture of reality” Stephen Hawking
Stephen Hawking’s pioneering work on Black Holes, space-time and relativity and his ability to communicate complex theories in simple terms, despite his obvious restrictions in this regard, were nothing short of remarkable. As was, his ability to imagine and intellectually wrestle with interactions of things too large, or too small to observe. The news of his passing yesterday may be an opportunity to reflect on, or imagine things from a different perspective.
- Black holes: Stars that have collapsed under their own gravity, producing gravitational forces so strong that even light can’t escape. The laws of quantum mechanics and general relativity conflict on what happens to the information about the physical state of objects that fall into a black hole - this conflict is known as the information paradox. Later in life, Hawking switched sides deciding that the information is in fact stored on the boundary of the black hole - the event horizon.
- Inflation: In a cosmological sense ‘Inflation’ describes the exponential expansion of space in the fractions of a second after the Big Bang Singularity - in that sense, it too has been absent for some time.
- Relativity: The premise that the laws of physics are the same for all observers in uniform motion relative to each other
Against the current macroeconomic backdrop, there certainty appears to be something of an information paradox in financial markets (and arguably in both monetary policy and global geopolitics), where conflicting and unresolved arguments (whatever the event horizon) have, in the near term at least, led to a reduction in participation and momentum.
"The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.” Stephen Hawking
The current debate on global trade has placed much focus on both inflation and relativity. At present, numerous countries are lining up to speak with President Trump about why tariffs and protectionism are the wrong path for the global economy (being very clear that if they are not successful then the will apply retaliatory protectionist measures!). The net result for all is likely higher inflation (though not likely exponential) and and lower trade. A resolution is needed in order to keep the ‘universe expanding’ - at least in terms of global GDP.
We have noted on a number of occasions our view that the Trump tariffs are likely designed more to open a dialogue about free and fair trade (in the context of reducing the US current account deficit) globally - and not a short-sighted economically illiterate act, as many have suggested. Our view remains that bringing people to the White House table to discuss trade will ultimately bring down global tariffs and protectionism, not see an escalating trade war. In fact, it is possible that the Trump tariffs ‘collapse under their own gravity’, bringing with them a freer and less protectionist global backdrop. Watch this space.
"The past, like the future, is indefinite and exists only as a spectrum of possibilities” Stephen Hawking
Ultimately, while we are more positive about the backdrop for the global economy going forward, there is little new information in the near term likely to spark financial markets back to life. We continue to favour a shift towards higher inflation in the US (despite recent data such as the Atlanta Fed Nowcast suggesting growth has slowed to 1.9% after hitting 5.4% in early February), and as a result, higher volatility and a higher USD.
The issue, however, is that at the current juncture, inflation is not pressing enough to alter the course of interest rate expectations and thus yield curves or equity valuations. Global economic momentum is slowing, but growth remains strong. Thus, while we are increasingly of the view that the next significant move in the USD is likely up, it may not be particularly imminent. Furthermore, while we retain our long held view of GBP outperformance, in the near term the pace of appreciation is likely modest at best. In terms of GBP appreciation - there is a significant amount of space, but also likely no urgent shortage of time.
"Leaders must aim high, see big, judge widely…” Charles de Gaulle
Last week, the global press commentary was dominated by the US tariff imposition and the negative, regressive (in both senses of the word), and protectionist implications for global trade relations. However, last week we also made the case that there is likely a far bigger positive - if, this leads not to all out trade war, but to a wider global debate about trade and tariffs. In this regard, we also made the point that the US likely has one of the lowest levels of protectionism in the global economy and thus, a global debate is perhaps more likely to see others reducing their tariffs than spurring a "tit-for-tat” levy race (as Juncker oddly claimed the EU was ready for this morning). I for one remain much more optimistic of a positive outcome to the debate on trade than much of the wider media seem at this stage.
For financial markets, the trade debate has likely drawn so much focus due to the disappointing lack of movement and direction in the global macroeconomic backdrop. Last week was a clear example. Given the monetary policy meetings from the RBA, BoC, ECB and BoJ and the February US employment report. With varying degrees of credibility and conviction, all four central banks left policy unchanged and damped expectations of policy normalisation in the near term. At the most dovish end of the spectrum, the Bank of Japan, under the renewed and (perhaps belatedly) validated leadership of Governor Kuroda, reiterate their pledge for … and persistent monetary easing and will likely remain the conscious monetary laggard. In Australia, the RBA remain clear that the lack of inflationary progress rules out any rate movement "for some time” and while Canada (the most hawkish on this small scale) balance expectations of further "cautious” rate hikes with modest wage growth while they assess the "economy’s sensitivity to higher rates”.
The ECB, was perhaps more interesting. Not in the sense that it dropped its reference to increase the size of QE if needed - it maintained its reference to expanding the duration of QE purchases and its commitment to further accommodation if needed. Not in the sense that it continued to avoid the debate over what to do once committed QE purchases end, in September. The ECB was interesting in that Draghi stepped ever so slightly over the standard lines on currency (where he was arguably more explicit on the negative implications of further increases in the value of the EUR) and on trade - where his comments were a clear and direct criticism of US trade policy. Watch this space. The global debate has a long way to play out yet.
"The possibilities are numerous once we decide to act and not react” George Bernard Shaw
Amid the trade debate, it seems that the market’s reaction function to inflation has been moderated. Friday’s US February employment report delivered perhaps the most market friendly outcome, with very strong job gains, more moderate (but at the high end of the recent trend) wage gains, and perhaps most significantly a strong rise in the labour force participation rate. Equities rightly rallied as FX remained steady. Today’s US CPI print for February highlighted that the creep higher in inflation remains intact, with a headline print of 2.2% y/y.
From an FX perspective, we are less convinced that inflation will remain contained in the well-behaved manner of the past year or so. By extension, we are less convinced that the typically USD negative ‘Goldilocks’ backdrop of low rates, low inflation, low volatility - higher equities - will hold true from the USD perspective. We are becoming increasingly positive on the outlook for the USD.
"Where there is no vision, there is no hope” George Washington Carver
That positivity also extends to GBP. This morning, the Chancellor of the Exchequer delivered a positive, upbeat assessment of the current UK economic backdrop. In the first Spring Statement that did not constitute a Budget Statement, Philip Hammond highlighted the current manufacturing expansion - its longest in 50 years - and the significant progress in debt reduction (GBP 108 billion lower than in 2010) - putting the day to day budget into surplus for the first time in recent history. Alongside a modest upgrade to this years’ growth forecast, Hammond committed to a continued, balanced approach to debt reduction that will include a spending review (and likely further public spending rise) in the Autumn Statement later this year.
"What?! ‘The land of the free?’” Know Your Enemy, Rage Against the Machine
This afternoon’s much awaited ECB announcements essentially delivered very little. While the opening statement removed the sentence that the ECB stands ready to increase QE purchases in terms of size and / or duration "if the outlook becomes less favourable”, it was essentially replaced by one committing to the reinvestment of principal payments "for as long as necessary”. Furthermore, in the press conference the significance of the removal of one part of the easing bias was played down further, stressing that the ECB’s "reaction function has not changed”
Perhaps the most interesting addition to the press conference was the reference to protectionist threats and the risks to confidence (and thus both inflation and output) as a result. Draghi was quick to condemn unilateral decisions on trade and highlighted concern about the state of international relations. If you can put tariffs on your allies, "who are your enemies?”
Lastly, Draghi was also clear to point out further confidence in the strength and breadth of the economic momentum. The economy is expected to "grow faster than previously forecast”. However, he also added that the ECB discussed the prospect that potential growth may also be increasing along with current growth, and thus slack is not being reduced. From a rates perspective, this is a disappointing prospect, as is the continued description of underlying inflationary pressure as "subdued”.
In short, whether it was an intentionally targeted at rates or more likely at FX, the press conference was underwhelming from a monetary normalisation perspective. If you subscribe, as we do, to the view that rising inflation, global yields (led by the US) and volatility likely rise through the rest of 2018, it may be prescient for the ECB to remain firmly on hold. However, if this triple whammy causes a marked sell off in risk assets and by extension the the global economy, the ECB may have little firepower to counter the downturn. The ‘Powell Put’ may be deemed to be a way away but, the ‘Draghi Put’ must be weaker.
"There is no friendship in trade” Cornelius Vanderbilt
Following the ECB, markets attention will swing directly back towards the US, and almost seamlessly onto President Trump’s announcement on steel and aluminium tariffs. So far this week the announcements and subsequent paring back of intent of the ‘Trump Tariffs’ have added more to volatility than direction. Clarity may change that. Particularly if, as Draghi suggests, the tariffs imply an enemy!
Volatility is likely to remain elevated in anticipation of the average hourly earnings component of the February US employment report on Friday. While we are clear in the view that inflation will increasingly reveal itself in the US as the year progresses, it is less likely that we get a further extension of wage pressures in Friday’s report. Equities can outperform on any pullback in the inflation print, but it is clear that the US labour market is becoming increasingly tight and wages are unlikely to stay this low indefinitely.
"The most dangerous negotiation is the one you don’t know you are in” Christopher Voss
Throughout the ‘Road to Brexit’ speeches, many commentators, publications and even MP’s (collectively the ‘usual suspects’) have maintained two points of criticism. Firstly that the UK government has still not provided the exact detail of its targeted Brexit end-state and secondly, that the UK government’s position is not compatible with what the EU has said. Often with ridicule. In this regard the Chancellor’s speech yesterday was refreshingly honest, pertinent, and direct. This is a negotiation.
Ever since the Florence speech from the PM, it has been surprising how these ‘usual suspects’ have taken the EU’s opening negotiating position as immovable red lines - whether that entails the EU maintaining full access to all UK fishing waters, grounding UK planes, or quadrupling the cost of roaming mobile costs. At the same time they are inferring that the UK’s suggestion of negotiating a bespoke trade deal (as Canada, S. Korea, Norway, Switzerland, Turkey have done before) and not trying to squeeze the UK into a deal designed for a completely different purpose, is just hubris parochialism.
Over recent trading sessions much of the sentiment and focus has been driven by the Trump Administration’s move towards fulfilling another election pledge. This time on trade. While some argue that the imposition of tariffs to protect domestic industries or sectors of the economy can be a positive, general consensus argues that, at least on a global scale, the impact is negative for trade, for prices and for economic growth. In fact, trade wars may be good for ‘absolutely nothing (say it again!)’
"… maybe they’d be happy for a while” American Pie, Don McLean
Furthermore, retaliation - apart from facilitating arguably the best headline of the year so far, "Hit the Chevy with a Levy, Tax your Whiskey and Rye” [City AM] - is unlikely to be the best response. Particularly ahead of any legal imposition. But perhaps we are looking at the whole issue from completely the wrong perspective.
It was Oscar Levant who first suggested that "there’s a fine line between genius and insanity”. While the broad response of markets and commentators alike is that the protectionist threats and plans of the Trump Administration are economic madness, we would argue that when viewed from a different perspective (and managed incredibly carefully), one could make a case for this particular strategy coming from the other side of Levant’s fine line - genius (stable or not). With Trump’s rise to America’s top job has come a sharp increase in the focus of financial markets, governments, politicians, strategists and economists on global trade. Withdrawal from TPP, renegotiation of NAFTA and of course the impending Brexit trade negotiations have brought the concept of ‘fair trade’, and what that means to the global economy, to the fore.
Indeed, if we take a step back and start with the fact that - other than city states such as Hong Kong - the US has the lowest tariffs of any other country in the world then it could be argued the protectionist shoe is in fact on the other foot..
In reality it is a little more complex than simply tariffs, as government subsidy and taxation also play a role in what could be viewed as a global level playing field. But if the protectionist actions of Trump lead not to an all-out trade war, but to a global debate on tariffs, everyone would likely benefit. In an ideal world, the best way to narrow the global protectionist gap is not for the US to raise its tariffs, but for China, the EU and other offenders to lower theirs. Just a thought.
"As tedious as a twice told tale” William Shakespeare
While the trade debate will likely continue for a long time to come, the fact that Trump’s protectionist agenda appears to have little or no support from within his own party has calmed markets, and brought their focus of attention back to the events of this week. Chiefly the next monetary policy iterations from the RBA, BoC, ECB and BoJ.
Last night was the RBA, and with slowing housing market pressure, strong exports growth and gradually rising inflation (muted by a higher AUD), monetary policy in Australia remains on hold for the foreseeable future. In Japan, the (albeit late) reappointment of Governor Kuroda has likely mitigated the prospect of near term normalisation - or even something as subtle as a slight steepening of the yield curve under YCC - as Kuroda reiterates that "less stimulus is unthinkable before reaching CPI target”. We maintain the view that Japan will remain a conscious laggard in the process of global monetary normalisation. Indeed, the fact that the unemployment rate fell sharply (and from a commentary perspective, surprisingly quietly) to just 2.4% in January with little or no wage inflation suggests that perhaps it is not just a deflation mindset that the the BoJ will have to overcome.
In Canada, expectations of rate rises this year are considerably firmer, but dependent on continued growth and a smooth evolution of NAFTA. However, the main focus for markets this week will likely be the ECB, and in that regard the central point of the debate is twofold: firstly, on how the current QE purchases will end (whether abruptly, or some form of tapering, and secondly whether the governing council are confident enough in the recovery of growth and inflation to relax the forward guidance linking the length of time between ending asset purchases and raising rates (the current ‘considerable period’ language currently translates as around 6 months).
From our perspective, this week is still a little soon to commit to a monetary tightening (albeit an extremely modest one) into Q4. Despite our growing expectations that there will be a (perhaps significant) repricing of equities and risk assets amid a higher inflation, higher yield, higher volatility global backdrop as the year progresses, the recent evolution of eurozone economic and inflation data has been disappointing. Back to you Mr Trump!
"… or am I part of the disease” Clocks, Coldplay
Yesterday’s second installment of the Fed Governor’s semi-annual monetary policy testimony, this time to the Senate, added to the current debate over the likelihood of 3 or 4 rate hikes in the US this year, with no obvious outlier. Powell did state that there was "no evidence of a decisive move up in wages” despite unemployment being "at or even below the natural rate”, which likely puts greater emphasis on next Friday’s release of the February employment report.
Powell also reiterated the point that the tax bill will "add meaningfully to growth over the next couple of years”, adding that the big question on taxes is how they impact the long term potential growth of the US. (Lower taxes should raise the labour supply and higher investment should boost productivity, both increasing the long run potential growth rate). However, the US tax measures are by no means singularly positive. Powell was clear to point out that the US is "not on a sustainable fiscal path” and the increasingly protectionist stance of the Trump Administration (though this view is likely significantly distorted by the starting point) risks undermining not just the USD, but the long run growth potential that the measures were intended to create.
In financial markets, major economic data continue to underwhelm (more clearly from the eurozone of late), admittedly from relatively high levels, and risk appetite also appears more fragile and less convincing. With the Italian elections and (a not necessarily straightforward) SPD coalition approval vote over coming days, closing levels in equities and risk assets into this weekend are likely of significant importance.
"But Friday never hesitate” Friday I’m in Love, The Cure
I have often thought that there is a window of opportunity for a weekly newspaper dedicated entirely to positive news, or at least focussing on the positive side of any news - Thank Goodness it’s Friday (TGIF), perhaps. On that note, and while it seems the UK’s political volatility is approaching its ‘February VIX moment’, perhaps being a Friday, it may be worth focussing on some positive developments in the UK.
Firstly, after slashing its expectations of expected productivity growth and thus warning of the deficit implications in this financial year as recently as October, the ONS are preparing to significantly hike the forecasts for UK growth ahead of the Spring Statement (which this year will be more of a stock take or progress report). According to the Telegraph, this may result in a boost to the exchequer of an additional GBP 15B at the end of the forecast period (GBP 30B including the November projection), following surging service sector in the past 3 months with profits rising at the fastest pace since November 2015. The ONS may also have to rethink their gloomy revisions to UK productivity.
Secondly, the rapid improvement in the public finances over the past six months means that the UK is now running a current budget surplus, meaning it no longer has to borrow to fund day-to-day spending. This is the first time this balance has been in positive territory since July 2002, following a greater than expected boost to government revenues from the January self assessment tax deadline.
Finally, an ONS report suggesting that the UK’s average ratings for life satisfaction , happiness and feeling that the things done in life are worthwhile, have risen further is very encouraging, considering the current uncertainties. The fact that the temperatures in London are likely to reach a sweltering 9 degrees by the end of next week, even more so.
"I’m really not sure what we’re so scared we’ll miss” Round and round and round, The Cure
Against an increasingly under-confident, if not fully risk averse, financial market, UK PM May will today deliver the final ‘Road to Brexit’ speech entitled ‘The Future Partnership’. Amid heightened political volatility and likely social disunity over the progress of the negotiations, today’s speech is crucial in satisfying the Cabinet, the Conservative Party, the electorate (from both / all sides of the debate) and (to within the margin for negotiation), the EU27.
With expectations from all sides seemingly low, there is a chance that Theresa May surprises on the positive side. TGIF.