The Week in Review: March 9, 2018
If it's obvious, it's obviously wrong.
Investment markets and key developments over the past week
Despite a bit of volatility around the US tariff issue and the Italian election, share markets bounced back over the last week, particularly in Europe and Japan.
Bond yields were little changed globally but rose a bit in Australia. Commodity prices mostly fell not helped by a small rise in the $US. Despite this, the $A rose slightly as trade war fears receded a bit.
The noise and fear around the global economy and financial markets initially ramped up another notch over the last week with initial negative market reactions to a messy election outcome in Italy and news that President Trump's chief economic adviser Gary Cohn was resigning adding to fears of a trade war. However, to borrow a great quote from Joe Granville it was another case of “if it's obvious, it's obviously wrong”, as things turned out to not be as bad as they first appeared.
First, the risks around a full-blown trade war kicked off by Trump's tariffs on aluminium and steel imports have receded a bit. Yes they have been confirmed at 10 per cent and 25 per cent respectively and Gary Cohn will be missed as a voice of economic reason in the White House, but there is reason for optimism that a global trade war will not occur.
- The tariffs will cover less than 2 per cent of US imports. It's a far cry from over 20,000 imported goods being hit by an average 19 per cent tariff hike under the Smoot-Hawley Act of 1930.
- Canada and Mexico are exempted conditional on reaching a new NAFTA agreement with scope for other allies to be exempted too on the basis of national security, which has the potential to reduce the risk of retaliation.
- The potential exemptions indicate that Trump has listened to criticism of his initial plan. So another case of Trump's bark being worse than his bite. As a business negotiator he was well known for coming in with an extreme position to use as a bargaining chip and its likely he is doing the same here.
- Trump won't want to go too far on tariffs as the resultant price increases won't go down well with his supporters.
- Other countries are likely to be cautious in retaliating and China in particular may want to enhance an image as the “good guy” in supporting free trade.
- It's also worth repeating that the direct impact on Australia in relation to steel and aluminium exports to the US is trivial as less than 0.02 per cent of GDP is directly affected, so the real risk would come if there was a full-blown trade war affecting key markets for our raw materials in China and Asia generally. But as noted there is reason to see this as unlikely.
Of course, this is not the end of the matter as Trump has warned of more tariffs coming. China looks like being a key focus of this given a US review of China's alleged theft of US intellectual property and a request that China cut its trade surplus with the US by $US100bn (revised up from $1USbn in a tweet by Trump who must have been channelling Dr Evil only to realise $US1bn is not much). So, while there may not be a full-on trade war, there may be no peace on the trade front either.
Second, the messy Italian election outcome is not great for Italy, but its unlikely to threaten the Euro. Basically, there are now three major blocs in the Italian lower house: the right wing coalition dominated by the far right Northern League with Forza Italia (FI) and Brothers of Italy; the Five Star Movement (5SM); and the centre left dominated by the Democratic Party (PD). None of these blocs are near a majority and after parliament first sits on March 23 it could take months to resolve and may require a new election (not that most parties want that). A Democratic Party/Forza Italia grand coalition is not possible as neither party did well enough. Barring a worst-case coalition between 5SM and the Northern League, which given their huge political differences is unlikely, it will be the Democratic Party that will decide who forms government and given its pro-Euro and left of centre bias its more likely to lean in the direction of 5SM but only if it remains supportive of Italy remaining in the Euro. So, while the final outcome may not be great for Italy in terms of keeping the budget under control and reforming the economy, there is unlikely to be a short-term threat to the Euro. 5SM is no longer advocating an exit from the Euro and the Northern League has backed away from it too (which given 57 per cent of Italians support the Euro is why they and 5SM were able to do well in the first place). And it's unlikely that a new election would change this. This and the German Social Democrat Party's solid support for a coalition with Angela Merkel leaves Germany on track to work with France on further strengthening the Eurozone.
And finally, this is all occurring against a global backdrop of strong economic growth, strong profit growth and still relatively easy monetary conditions. So, while the issues around US inflation and the Fed, Trump, trade and Italy, etc, will likely continue to contribute to volatility this year the broad backdrop for share markets remains positive.
There was also good news regarding North Korea, with Trump to meet Kim Jong Un before May. Whether it comes to anything remains to be seen as we have seen this happen several times over the decades. Or maybe its development of nuclear weapons was all just negotiating ploy. At least it will be “quiet” on this front for a while yet.
Major global economic events and implications
US economic data remains strong – both in terms of non-manufacturing conditions and jobs data. A deterioration in the trade deficit will act as a constraint on growth though (and along with a rising trade surplus in China) provide an ongoing impetus to President Trump on the tariff front.
The ECB made no changes to monetary policy, but it did relax its easing bias by removing its commitment to increase quantitative easing if needed, but made no other changes leaving QE on track to continue at €30bn a month out to September (after which its likely to be phased down to end in December) and a reiteration that rate hikes are only expected to come “well past” the end of QE which probably means around mid-next year. So no real surprises here.
As expected the Bank of Japan left monetary policy on hold and with inflation running well below target Governor Kuroda has indicated that “powerful monetary easing” is going to continue for a while yet. Japanese economic data was mixed with an upwards revision to December quarter GDP growth and strong growth in household spending but a fall in the Economy Watchers' measure of corporate conditions.
China softens growth target (a bit). Chinese Premier Le Keqiang's Work Report to the National People's Congress set the growth target at “around 6.5 per cent” and the inflation target at 3 per cent. Both are the same as last year, but the growth target omitted last year's reference to "higher if possible" suggesting a greater focus on reducing pollution and financial risks and greater tolerance for slower growth. There was no sign of slower growth in trade data though with export growth (averaging January and February to remove Lunar New Year holiday distortions) running at 28 per cent year on year and import growth running at 22 per cent. Meanwhile, money supply and credit growth showed little evidence of deleveraging with both up more than expected. CPI inflation bounced to 2.9 per cent year on year, but this was mainly driven by higher food prices and may partly be due to Lunar New Year holiday distortions.
Australian economic events and implications
In Australia, the RBA provided no surprises leaving rates on hold for the 19th month a row, and is likely to remain on hold for a while yet. The global economy looks good, business conditions are strong, non-mining business investment and infrastructure spending are increasing, further export growth is expected, jobs growth is strong and the RBA still expects to see stronger economic growth and inflation. But against this, uncertainty around consumer spending remains high, wages growth remains low, inflation remains low, the $A is arguably too high, and the cooling Sydney and Melbourne property markets have provided a bit more flexibility for the RBA. All of this supports the case to leave rates on hold.
And data released over the past week doesn't do anything to move the dial on the rates front. Building approvals bounced 17 per cent in January but this was after a 20 per cent fall the previous month. Exports bounced back relative to imports in January but against this March quarter retail sales are off to a very weak start. The economy is on track to keep growing but is likely to come in just below 3 per cent this year, below the RBA's expectation for 3.25 per cent growth. Which in turn points to lower inflation and wages growth than the RBA is allowing for. As a result, we have pushed our expectation for when the RBA will start raising rates from late this year into early next year.
Shane Oliver is the Chief Economist at AMP Capital
Want access to our latest research and new buy ideas?
Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.Sign up for free
Join the Conversation...
There are comments posted so far.