Not a trade war but ‘tradepolitik’ is the new normal state of relations between the US and China, Mexico and others — with threats of restrictive trade practices and implementations of those threats waxing and waning like the phases of the moon. That new normal is weighing down on sentiment, as illustrated by the manufacturing PMIs in the chart below. It is starting to dampen growth in the global economy too — but probably not by enough to tip the world into recession.
The impact we have seen to date is more than a mechanical consequence of the tariffs levied by the US and by China. Six months ago, we used our global economic model to argue that it would take a substantial escalation of trade disputes to push most major economies into recession. Specifically, we needed to see not only the US and China raise 25% tariffs on all trade with each other, but the US and the EU, and the EU and China to do likewise. That remains a distant prospect.
What we have seen in business surveys, and indeed in direct measures of world trade, such as that provided by the Netherlands Bureau for Economic Policy Analysis, is largely a consequence of fear rather than fact — it is fear that has pushed world trade below its long-term trend, creating a negative ‘trade gap’ shown in the chart on the right in the panel below. Fear can have direct, macroeconomic consequences. It will tend to produce a reduction in spending by consumers, but particularly by firms in the form of weaker investment. With that hit to spending, world trade will suffer too. The euro area is more damaged by a downturn in world trade than many major economies, with Germany particularly vulnerable. A 1% reduction in world trade below normal levels would hit the German economy twice as hard as it would hit the US economy.
Where do we go from here? If we are right, and the slowdown we have seen to date is largely attributable to fear regarding the actions of US President Donald Trump, then in principle it is within his gift to end it. On the eve of an election year, he will not want to tip the global economy into recession, with all that would imply for US equity prices. He would be quite happy, of course, if the Fed were to respond to the fear he has induced by cutting interest rates — and he has told them as much. But will it? Investors certainly hope so.
Our third chart shows the evolution of the S&P 500 since the beginning of 2018 set against the change in the fed funds rate through 2019 that is implied by a comparison of the December 2019 and December 2018 fed funds futures. For much of last year, we were in a ‘good news is good news’ phase. The S&P 500 drifted higher while investors came to expect a more aggressive policy tightening this year. Then in October 2018 we entered a ‘bad news is bad news’ phase. The S&P 500 reached a low point on 24 December, at which point investors had priced out entirely the prospect of even a single interest rate rise this year. That shift in investor sentiment was supported by soothing words from Fed officials in January, which have pushed us back through the looking glass into a ‘bad news is good news’ world since then — equity prices have recovered their peak because investors believe that the Fed has got President Trump’s back.
In our view we will go back through the looking glass again over the course of the coming year. Growth will slow in the US and elsewhere, but the growth outlook is not as bleak as the markets see it, particularly because the Trump administration will soft-pedal on trade tensions in the run-up to the election in 2020. Moreover, with our forecast showing US inflation close to target next year, we see no strong economic incentive for the Fed to move the policy rate in either direction. Our central forecast for growth is set out in the table below.
The charts in this article have been created using Chartbook on Datastream. The Chartbook was initially created by Fathom Consulting in 2012 and is now a catalogue of approximately 9000 charts, covering over 170 countries, analysing up-to-date macro and financial data. Whether it is a particular topic, country or variable you are interested in charting, the Chartbook has everything you need. The Composite FVI, comprised of readings from all four underlying FVIs, is available for 176 countries in the Fathom Proprietary Indices section of Chartbook. To access Chartbook via Datastream search ‘cbook’.
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