Financial markets are being buffeted by President Trump’s tweets on trade. What are the short and long-term implications of this new style of policy making in the US?
Since the summer of last year, investors have had to look at Twitter far more often. President Trump has used this form of social media as a conduit to negotiate on trade with a range of countries. He regards the US trade deficit of over $600 billion as money ‘lost’ to the economy. Economists may talk about the laws of comparative advantage, and ‘growing the size of the cake’, but Mr Trump and his supporters very much see trade as a zero-sum game.
Investors are closely monitoring the tone and tenor of the President’s exchanges with China, Europe and other US trading partners. More hawkish rhetoric was one factor undermining business and investor sentiment during May and June. The recent slide in the Mexican peso shows just how many investors are ready to run for safety, or shoot first and ask questions afterwards. It followed a completely unexpected announcement from Mr Trump: tariffs would be imposed on Mexico unless it made much greater effort to halt immigration from Central America into the US. The peso was trading close to 19 to the US dollar and fell to almost 20. Since then, a further message from the President that he was satisfied with the steps taken by the Mexican government calmed the situation – for the time being!
Why is it difficult to price trade policy decisions into financial markets? It is important to emphasise that the prime audience for the President is the US electorate. His tweets and interviews are part of the long-drawn-out presidential election campaign. The effects on businesses and markets, or on how he is viewed by Congress, are secondary.
Equity prices have rallied on the back of more positive news from Mexico. Also supportive are the strong hints from the US central bank that it will ease interest rates once again, should the slowdown in the US economy become too great this summer. Looking ahead, all eyes are on the G20 summit in Japan later this month, where the heads of important economies meet for discussions. Diplomats are hard at work deciding whether a meeting of Presidents Trump and Xi would advance their interests. The more optimistic observers even hope that a trade deal could be approved.
Sadly, the trade disputes need to be put into context. A strategic rivalry is growing between the US and China. This is broadening out from trade to technology, intellectual property, military and security matters. Even if there is a ceasefire between the US and China, America’s disagreements with Europe could move from the background to the foreground. Mr Trump is very critical of the trade deficit with the European Union in general and Germany in particular. Stepping back from these one-to-one disagreements, there are many signs that the post-war institutional structure of governance is deteriorating.
Preparing for the unpredictable
What is the best way of thinking about the impact on markets of Mr Trump’s trade tactics? Equity markets have rebounded from their lows in May, so continued exposure has made sense for investors. Of course, it is very possible that serious policy errors by the major players create a recession. A full-blown trade war would hurt all parties: 30% of trade in the US and 40% of trade in China contribute to the global supply chain. The easiest way of thinking about this is in terms of the multitude of parts from all over the world that are delivered on time to create a modern smartphone.
A more likely backdrop for financial markets is a ‘muddle through’. Businesses feel buffeted by these trade threats, so confidence is slipping and investment plans are being delayed. Companies are also responding by setting up dual supply chains, moving some factories and other investments from one country, say China, to another, such as Vietnam. Regulatory standards, national champions and favoured company lists are all being used as devices to steer more trade and investment to or from a particular country. The end result is a series of small supply-side shocks. Ultimately, this will create a more muted outlook for company profits and hence share prices. Equity market exposure continues to make sense but with more diversification.
The above article was previously published by Aberdeen Standard Investments on 14th June 2019