The stock market continues to fall as the US President’s trade war rhetoric deepens. Is the heady party that has seen stock markets boom since Trump came into power turning into a nasty hangover?
Trump, is his bite as bad as his bark?
For me it always was a puzzle. President Trump came into the White House with the promise of tax cuts, an unfunded fiscal stimulus, and with an anti-globalization agenda. And stock markets boomed. It was as if the markets were saying: “Let’s ignore all the bad stuff, and only focus on the good.”
The economy needs balance – share buybacks can be good things, tax cuts can be good things, fiscal stimuluses can be good things, but only if the conditions are right. If unemployment is sky high, there is a chronic lack of demand, then tax cuts and a fiscal boost can be precisely what the economy needs.
These were indeed the conditions of a few years ago, but not now. US unemployment is at 4.1 per cent – it has been five per cent or lower since the summer of 2015. The timing is all wrong.
If you stimulate the economy when unemployment is low, you get inflation, and a need for higher interest rates. That is basic economic theory. If this does not happen this time around, an awful lot of economic text books will need to go in the bin.
The US Federal Reserve increased interest rates to the 1.5 - 1.75 per cent range earlier this month. The markets now expect rates to be in the 2.75 - 3 per cent band by the end of next year. That means five more hikes in rates to follow (assuming rates go up in 0.25 percentage point chunks) between now and the end of the decade.
An interest rate of 2.75 per cent is still low by past standards, but there is a risk that the overleveraged US economy will struggle at those rates, US auto loans and student loans in-particular look vulnerable.
But Jerome Powell, the new chair at the FED, portrays all the veneer of a man in a relaxed mood. The FED is projecting that unemployment will fall to 3.6 per cent by the end of the decade, its lowest level in around 60 years, while inflation averages 2.1 per cent in 2019 and
These are the kind of numbers that the US President may like, and we know that in Ancient Rome, the Emperor’s advisors told him what he wanted to hear. I am not comparing Mr Trump with Caligula or Nero, for one thing I am not sure he has a horse to make a senator, and fiddle to play should Capitol Hill burn.
But I do have my suspicions about the FED projections.
The Bank of England
Meanwhile, things seem to be getting slowly more hawkish at the UK’s central bank, with two members of the MPC recently voting for a rate hike.
But these words, stated by Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics, worry me: “The MPC has never raised interest rates when equity prices have been down year-over-year.”
A year ago, the FTSE 100 stood at 7,293, as I write it is at 6,921.
The Dow Jones is now roughly 12 per cent down from the peak seen earlier this year, the S&P 500 is 7 per cent down, the FTSE 100, 11 per cent down, and the NASDAQ composite is down 7 per cent – although the NASDAQ story is more complicated than that. The index peaked in January, fell sharply, then hit a new all time high earlier this month and has fallen since then. The fortunes of the NASDAQ have been distorted with what has been happening at Facebook and Alphabet (down 12 per cent in the last two weeks).
The global economy remains strong – although the latest flash purchasing managers indexes suggest it is slowing – both in the US and euro area.
But it is the potential downside of what might happen thanks to the Trump tax cuts and now a possible trade war that worries me.
Of course, one thing that may mitigate against the Trump tax cuts is that as they largely benefit the rich we may see a rise in US savings, thus transferring debt from the private to public sector, but having a neutral effect on the economy.
But the risk of trade wars is more serious still.
His threat to slap tariffs on an ever-reducing number of steel importers – not Canada, not Mexico, not the US allies in Europe, not certain Latin American countries – does rather nullify their impact. If the tariff only effects China, then only 10 per cent of China’s exports to the US are steel and account for just 0.25 per cent of China’s GDP.
It is just that this may not be the end of it. Mr Trump now wants to punish China for the way it ignores US intellectual property. Well China does, but then so did the US once, when it was an emerging economy in the late 19th century.
The bigger risk relates to Chinese retaliation.
Mr Trump says trade wars are good and easily winnable. Truth is, nothing with the word ‘war’ in it is good – and by the way, international trade is a great tool for promoting peace – but the result of a trade war would be less international trade, lower global output, higher inflation and higher interest rates.
The only real hope is that technology starts bringing the benefit it is supposed to and leads to surging productivity. Unless that happens, I see trouble.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.