The truce in the US-China trade war announced after the G20 talks on Saturday was welcome, but does not appear to pave the way for a more comprehensive trade deal in the foreseeable future. Instead, tariff levels have been frozen, with no deadline set for further progress.
President Donald Trump offered some concessions to China, apparently allowing a resumption of trade with Huawei on its consumer products, while maintaining restrictions on its “strategic” products such as the 5G network system. In return, China has promised to buy more US agricultural products, although the exact amount is unknown.
This outcome was broadly in line with the market’s expectations ahead of the summit.
Because of the removal of the immediate tail risk of much higher tariffs, there may be a relief rally in some asset classes in the coming days. But a more fundamental shift in investor opinion probably requires a more durable settlement of the tariff issues, and greater signs of progress on the more strategic problems concerning intellectual property, IT and China’s industrial policy. It has become clear that these are all thorny and intractable disputes that are unlikely to blow over rapidly.
Trade wars and the markets
The latest flare-up in the tariff wars started with Mr Trump’s aggressive tweets on May 5, following some backtracking on commitments that China had given earlier in the talks. Since this fundamental shift in approach by both sides, global bonds have rallied sharply, with 10-year Treasury yields in the US falling from 2.54 per cent to 2.00 per cent.
The market has also markedly shifted its assessment of monetary policy in a dovish direction. It now expects almost five reductions of 25 basis points each in the Federal Reserve’s policy rate before the end of 2020, while the central bank itself is expecting only a single cut.
Market optimism that the Fed and other central banks are willing to ease monetary policy very aggressively has underpinned equity markets in the face of negative demand shocks throughout the advanced and emerging economies. The US stock market has managed to remain unchanged since the deterioration in US-China relations in early May.
Trade uncertainty has damaged global business confidence, but for now this is being offset by easier monetary conditions. Unlike the situation in the final quarter of 2018, when tariff threats were combined with forward guidance about tighter policy from the Fed and the European Cental Bank, global financial conditions have this time supported risk assets.
According to Goldman Sachs the global financial condition indices tightened by almost 100bp during 2018, but have been broadly unchanged this year. Following the G20, this monetary policy support remains crucial in persuading investors that sluggish global activity growth will not develop into a full blown recession. This seems consistent with the latest global activity data, although growth is clearly below trend in most of the major economies, and has shown little sign of rebounding around midyear.
Nowcasts sluggish as manufacturing slumps
The latest Fulcrum nowcasts for global activity indicate that activity growth is around 3 per cent, which is about 0.7 percentage points below trend (see box). The advanced economies have slowed even more than the emerging economies, which is somewhat hard to explain, given the degree of concern about tariff wars.
The common thread that has driven the global economy has been the slowdown in manufacturing and industrial sectors, with goods production growth declining to about zero this year.
Weakness in the goods sector has been consistent with two factors that may have been connected with higher tariffs. Imports and exports growth have fallen much more than gross domestic product, possibly because of disruptions in global value chains, especially in Asia, causing temporary disruptions in goods supply.
In addition, there has been a continuing slowdown in fixed investment in many economies, which may have been due to declines in business confidence connected to uncertainty about future tariffs. Fortunately, service sectors, consumer confidence and labour markets have so far been entirely unaffected by these developments.
Largest economies out of sync
While subpar global growth has been recorded throughout the first half of 2019, the three largest economies — the US, China and the Euro Area — have not been perfectly synchronised during this period:
- US activity appeared fairly robust in the first few months of the year, but the growth rate has dipped to only 1.5 per cent during May and June;
- The Euro Area began the year close to recession, with Germany apparently being hit by transitory shocks in the auto, chemicals and pharmaceuticals sectors. Germany has remained surprisingly subdued since these transitory shocks started to abate, and there has been only a moderate rebound in the eurozone as a whole, taking activity growth up to 0.7 per cent;
- Chinese activity growth has been very bumpy this year, with industrial activity rising sharply in February, only to subside even more sharply in the spring. Overall, growth has been running at the bottom end of the authorities’ 6-6.5 per cent target range, and is only being held there by progressive easing in fiscal and monetary policy.
With the tariff war now in limbo, markets will be focused on the next significant shift in global activity data. Assuming that the Federal Reserve maintains its recent dovish rhetoric, that move seems more likely to be upwards than towards recession.
Latest nowcasts for the world economy
The global economy has been growing about 0.7 percentage points below trend throughout 2019 and is not improving . . .
The advanced economies have been particularly weak, with growth running about 1.0 percentage points below trend and 2.5 points below the peak rates seen 18 months ago . . .
Each of the three largest economies has slowed sharply since late 2017, when tariff threats started to dominate sentiment . . .
The goods sectors have been much weaker than service sectors, as trade in goods and fixed capital expenditure have dragged down growth in industrial production to around zero . . .