The Cost of Drawing Out Trade Wars, Even If They Lift
As with most global military wars of the past, economic engagements exact a toll on the participating countries – and their peers – long after the ceasefire is struck. That is what we need to remember as officials on both sides of the table in the US-China negotiations offer rhetoric that attempts to keep local confidence buoyant. In reality, both governments are trying to walk the fine line whereby local consumers, businesses and investors do not abandon the economy while still resonating a toughness such that their counterparts feel compelled to offer greater concession to make the ultimate compromise.
While both sides have done a fairly decent job of not triggering acute crises in their respective financial systems, there is little doubt that the economic pain is accumulating. On the US side, the slowdown in growth is unmistakable but it is isn’t nearly as severe as some of its counterparts – though the fact that so many large economies are on the cusp of contraction should be very concerning to the single largest as a representative of the global course. Nevertheless, there has been a far more significant drop in US trade health, sentiment measures have slid across the system and the President seems to be concerned enough to call out the Fed regularly for not pursuing negative interest rates – not the most encouraging economic signal. In China, the impact is far more palpable, which is far more concerning than it would be for any other country. There is a well established perception that the Chinese government has greater control over the economy – or at the very least the perception around it. Growth at the lowest levels in decades, manufacturing that is contracting and industrial production that has clearly been throttled is very concerning.
It would be extremely naïve to believe that a trade deal between these two economies would result in a renaissance of growth for either, much less both. Diplomacy can change on a dime, but economic performance alters course over the span of months, if not quarters. The curb on spending and investing intent both through local and foreign interests would take time revive to a productive clip even if market participants were that enthusiastic at the theoretic tipping point (which they won’t be). What’s more, there are many other issues plaguing the global economy and financial system beyond this particularly costly tiff; and a solution here does not compensate for those many other lines of restriction. All of this said, ‘hope’ can fill in for the practical and keep speculative assets buoyant. It is when recognition starts to set in among the masses – and whether it happens before a deal is struck or it dawns that there is not enough lift at the signing – that we will see the greatest market impact set in.
The European Economy
We are due a heavy run of high-level economic updates over the coming week. While I will certainly keep close tabs on the third quarter GDP readings from Japan and Russia – the third and eleventh largest economies respectively – my principal interest will be in the overview we will be given for Europe. There are many Eurozone, European Union and European area economies on the docket scheduled to report last quarter’s performance. Collectively, Europe is either the largest or second largest economy depending on what body you are referencing. That said, there are serious concerns over the health of this juggernaut of influence as warnings from official bodies, both governmental and supranational, have indicated that there is a worrying probability that the region’s expansion stalls. If that were to occur, it is very unlikely that the world will be able to avoid the inherent contagion.
There are quite a few economies on deck whose own growth will matter significantly to the collective including: Norway, Netherlands, Finland and a host of the Eastern bloc. However, my focus will be fixed on two major economies in particular: the United Kingdom and Germany. For the former, there is a lot for which needs to be accounted. The UK is the sixth largest economy in the world (according to the IMF), and it now doubt feels the receding tide that has occurred across the world. That said, the more unique issue of Brexit is exacting its own toll on the country. While the threat of a no-deal divorce from the EU has not been realized owing to two extensions of the Article 50 date, anticipation of the pain that could eventually come to pass is throttling intent nonetheless. The consensus forecast among economists is for the country to have grown 0.4 percent over the third quarter. Such a reading is necessary after the -0.2 percent drop in 2Q. If we continue to head down this course of soft economy, striking a fruitful deal as a best outcome may still leave us on a lackluster path. Anything less could spell a serious problem.
Germany’s health is to some extent the counterpoint to the UK’s performance in the Brexit situation. Yet, as a signal for Europe and the world overall, its health can exert far greater influence for setting our global path. Forecasts for the fourth largest economy in the world anticipate a -0.1 percent contraction. That would secure a technical recession which is defined by the NBER as two consecutive quarters of retrenchment (the previous quarter registered a -0.1 percent reading as well). While there are caveats to such a reading – it would be a mild reduction, it is in seasonally adjusted terms, the government has anticipated it to some extent – there is serious sentimental baggage that comes with the signature of a ‘recession’. Don’t think of these troubling signs as isolated, when they are so widespread.
The Markets are Favoring No Further Fed Rate Cuts Through 2020
There is rare agreement it seems between the capital markets and the Federal Reserve at the moment. Most can readily recollect that world’s largest central bank cut its benchmark interest rate range (by 25 basis points) three consecutive meetings in a row. They may not remember however that the group had believed before each move that no cut was in the cards. Such situations do little to bolster confidence in the institution, which is serious when forward guidance is the principal tool for the developed world’s monetary policy mix. That said, the market was quite certain that easing was necessary owing to a modest flagging of inflation, just a hint of wavering in labor conditions pushing decades’ highs an of course a little stir in volatility in capital markets. After that run of three cuts, though, the market is now pricing in a 96 percent chance that the Fed will hold next month in its final 2019 meeting and a 55 percent probability that they will hold at the current level through December 2020. The FOMC’s own Summary of Economic Projections (SEP) had a hike by end of 2020, but I won’t quibble that optimism. They are generally on the same wave length.
Aside from the atypical convergence of policy authority and market participant views, the outlook is particularly remarkable because it reflect expectations of economic health through the foreseeable future. Clearly the Fed does not expect the US economy to stall, much less contract, otherwise they would offer more cushion through preemptive policy. For the market’s part, their outlook accounts for the GDP component but it also reflects the general complacency around capital markets. There is no shame among speculators such that they expect Fed support whenever ‘risk’ benchmarks like the major US indices start to retreat. There is a not-so-subtle connection between American investors’ assessment of economic health and the performance of the capital markets as they push further record highs. That is in turn an unsustainable connection. Eventually, markets have to ease and its girth is simply far too great for the Fed (or all of the major banks collectively) to offset committed deleveraging. Their weight is based in their ability to encourage enthusiasm among economic participants (consumers, businesses, investors) not shifting all liability onto their own balance sheet.
Therefore, if the market takes another tumble, the natural response will be an assumption that the Fed will put out the fire. When it eventually becomes clear that the central bank is reaching the full extent of its capabilities to keep everything afloat, we will enter into a new, troubling phase whereby recognition of artificial extremes in speculative markets could start a fire sale that overwhelms the complacency and external buffers that have kept the peace for so long.