The Week in Review: April 6, 2018

Trump's China tariffs, March quarter earnings growth and RBA still on hold.

Investment markets and key developments over the past week

  • Share markets had another volatile week – starting down as the US announced details of proposed 25 per cent tariff hikes on $US50 billion of imports from China and as China announced its own plans for same sized tariffs, rebounding as investors came to the view that some sort of negotiated solution was most likely. However, there's been some pressure following Trump's threat of tariffs on an extra $US100 billion of Chinese exports to the US billion. Interestingly though, Japanese and Australian shares held up pretty well on Friday despite Trump's latest trade threat perhaps as the result of investors becoming desensitised to all the trade noise, leaving in place gains for the week. Meanwhile bond yields mostly rose, commodity prices were mixed with oil and iron ore down but metals up. The Australian dollar fell on trade war fears and as the US dollar rose.
  • While the details around the proposed product list totalling $US50 billion of imports from China to be subject to a 25 per cent tariff hike and China's announcement of a planned same size retaliation were not surprising. Trump's ordering the US Trade Representative to “consider” tariffs on an additional $US100 billion of imports to the US in counter retaliation ratchets up the risk of a serious trade war between the two countries if negotiations fail. While tariffs on $US50 billion of imports would have very little impact (amounting to around a 0.4 per cent tariff increase averaged across all US imports which would impact growth and inflation by less than 0.1 per cent) a ratcheting up in the products subject to tariffs will mean a greater economic impact. The additional $US100 billion response if it is adopted by the US Trade Representative will likely also be followed at some point by China announcing another matching tariff hike on imports from the US, running the risk that Trump ups the ante yet again.
  • However, all of these tariff hikes are still just proposals and the latest $US100 billion will have to go through the same 60-day public comment period as the initial $US50 billion. The US tariffs and matching Chinese tariffs will only go into effect if negotiations fail. Both China and the US have indicated their support for negotiations. While America stands to lose less from a trade war than China (because it is less trade exposed and it has a trade surplus) it will still lose. China's proposed tariffs on US soybeans, aircraft, whiskey, wheat etc will hit Trump's supporter base and he would prefer to see the share market going up, not down, particularly the closer we get to the mid-term elections. So, while Trump is upping the stakes and the threat to the global economy if negotiations with China fail our view remains that a negotiated solution is most likely and so the tariffs ultimately won't be implemented or will be much milder if they are. However, negotiations could take months. In the meantime, there will be ongoing noise around the issue – with China and the US potentially announcing an escalation in their proposed tariffs, the US Trade Representative to hold public hearings on the initially proposed tariffs in mid-May and the US Treasury likely to announce its recommended investment restrictions on China in late May which will lead to more tensions. So, it will likely remain a case of no full-blown trade war but no trade peace either. Against this backdrop share market volatility will likely remain high but global growth should remain solid and so the rising trend in shares would likely resume once the trade worries start to settle down (which is likely to be the case ahead of the US mid-term elections later this year).
  • What would be the impact of a full-blown trade war? This is always a bit hard to model reliably - Chinese and US goods flowing to each other could just be swapped for goods coming from countries not subject to tariffs reducing any impact. But modelling by Citigroup of a 10 per cent tariff hike by the US, China and Europe (and bear in mind we are nowhere near that at present) showed a 2 per cent hit to global GDP after one year with Australia seeing a 0.5 per cent hit to GDP reflecting its lower trade exposure compared to many other countries.
  • The US dollar looking interesting. Earlier this year talk that the Bank of Japan and the ECB may be getting closer to an exit from easy money put more downwards pressure on the US dollar. The problem is that the rise in the euro and yen against the US dollar has adversely affected growth indicators like PMIs in Japan and Europe relative to the US and the BoJ and ECB are just following their earlier announced plans regarding easy money with no sign of an early exit. So the US dollar fell too far into February and looks like it's built a base for a rally. This in turn is also likely to weigh on the Australian dollar as US rates rise further relative to Australian rates.

Major global economic events and implications

  • US data remains solid. The March business conditions ISM indexes edged down a bit but remain very strong with continuing strong readings for orders, employment and prices paid. Auto sales rose more than expected in March and employment indicators remained strong. The trade deficit rose further in February (not helped by payments for Olympic broadcasting rights) and trade looks on track to cut 0.7 per cent or so from March quarter GDP growth. The Atlanta Fed's GDPNow has March quarter growth tracking around 2.3 per cent but note that this is around 3 per cent if seasonal weakness in March is allowed for.
  • Eurozone unemployment fell further to 8.5 per cent in February – which is well down from its 2012 peak of 12 per cent. But while the economy is continuing to improve core inflation remains stuck at 1 per cent year on year which will keep the ECB cautious in moving towards the exit from ultra-easy monetary policy.
  • Japanese data was mixed. Unemployment rose slightly to 2.5 per cent in February and household spending slowed, but industrial production rose solidly, wages growth looks to be rising and the March quarter Tankan remained solid.
  • Chinese business conditions PMIs for March were mixed - Up for the official surveys but down according to the Caixin surveys. Put an average through them and they are tracking sideways at a level consistent with continued solid growth.

Australian economic events and implications

  • In Australia, the RBA provided no surprises, leaving rates on hold for a record 20- months in-a-row. The global economy is strong, the RBA does not appear too fussed about recent share market volatility, the risk of a trade war and higher bank funding costs, business conditions and employment growth are strong and the RBA continues to expect a pick-up in growth and inflation. But against this there is uncertainty around the outlook for consumer spending, labour market spare capacity remains high, wages growth remains low (although it may have troughed), inflation remains low and measures by APRA to tighten lending standards have helped cool the Sydney and Melbourne property markets. So, it makes sense to remain on hold. We don't see the RBA commencing a tightening cycle until first half 2019. However, an emerging further tightening in bank lending standards around home borrower income and expenses partly associated with the Banking Royal Commission along with any flow through to higher mortgage rates from still elevated short term bank funding costs could delay this.
  • Economic data was mixed with strong business conditions PMI readings and a stronger than expected rise in February retail sales, but a fall back in building approvals and another decline in home prices led by Sydney and Melbourne. The trade surplus slipped in February but only a bit and looks like it could make a contribution to growth in the March quarter.

Shane Oliver is the Chief Economist at AMP Capital

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