Global Update: Economic risks rise and markets rallyToday on the blog, Dr. Alex Joiner, chief economist at IFM Investors and esteemed Macrobond user, shares his monthly economic report with us. In short, global trade tensions have been a key focus of global markets, with ongoing risks being interpreted differently by bond and equity markets that both rallied strongly. Faced with subdued inflationary pressures and downside risks to growth, advanced economy central banks have almost unanimously ‘doubled down’ on their dovish tone with markets now pricing in further policy easing.
Global trade tensions remained a key focus of global markets over recent weeks, clouding the outlook for economic growth. However, there has been at least some indication out of the G20 meeting in Osaka that US-China trade tensions will not deteriorate further in the near term. Indeed it was the much-anticipated meeting between the US President Donald Trump and his Chinese counterpart Xi Jinping on the side-lines of the G20 summit in Japan that arguably overshadowed the summit itself. At face value the meeting was fruitful, with the leaders agreeing to restart trade talks after discussions collapsed in May: the US will maintain the recently escalated 25% tariff on US$200bn of Chinese goods but will refrain, for the time being at least, from introducing the 25% tariff threatened on an additional US$300bn of Chinese imports; Trump declared that US companies can sell their products to Huawei but did not remove the company from a trade blacklist; and China will maintain its tariffs on US$110bn of US goods (primarily agricultural) but has agreed to buy “a tremendous amount of food and agricultural products”, according to Trump. Whether the resumption of talks leads to any meaningful developments in the near- to medium-term remains to be seen.
US-China tensions may have eased somewhat but there are still concerns about US measures against Europe and Japan, particularly with regard to motor vehicles. And now the new threat from the US to impose a further US$4bn on food goods in addition to the US$21bn that had already been threatened. This increase was largely in response to the perceived disadvantage of the US aircraft industry due to EU subsidies of its aircraft sector. If trade tensions were not enough, US President Trump castigated European Central Bank (ECB) President Mario Draghi for his dovish shift in June (which contributed to a slide in the euro), claiming Draghi is manipulating the currency as a way to improve competitiveness against the US.
In a less prominent development, tensions between the US and India also escalated in June. India raised tariffs on 28 goods imported from the US. This was in response to the US removing India’s preferential trade status, which exempted approximately US$6bn of Indian goods exports to the US from tariffs. The tariffs New Delhi has put in place are unlikely to have a large impact on trade volumes between the US and India on their own, given they are worth roughly US$240m – less than 1% of the approximately US$33bn of US imports in 2018. Nonetheless, they are indicative of the deteriorating trend of global trade and globalisation more broadly.
This trend is a real concern for central banks which almost unanimously have some reference to downside risks to global growth potentially impacting what are already, for the most part, modest or ‘at trend’ rates of economic growth. And as a consequence, in the absence of any material inflationary pressures, most central banks have also ‘doubled-down’ on their cautious tone and prompted markets to price in further policy easing.
While central banks highlight downside risks, the signal from markets is less clear. Indeed equity and bond markets can’t seem to agree on what the future may hold for the global economy. Equity markets remain well supported, despite a sell off through May which has for the most part retraced. This is particularly true in the US and Australian markets. The former, as measured by the S&P500, ended the fiscal year at a record high and on the latter the S&P/ASX200 was around 2% off its record high. However, bond markets have also continued to rally sharply and yields in advanced economies have plummeted in recent months. This has pushed the quantum of government bonds that have negative yields to a fresh high of US$13.4 trillion.
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It seems unclear whether equity markets believe in a materially better economic outlook or simply have an overwhelming confidence that central banks will provide support in the event a further deterioration in the global economy occurs. And with this confidence in mind, any better news flow with respect to trade talks, should it emerge, creates the risk for an upside surprise in markets. Whereas bond markets view central bank action as a warning and seemingly have a sharper focus on the soft and hard data flows that continue to suggest caution is warranted. For example, the latest global manufacturing PMI was pushed further into contractionary territory in June to 49.4, its lowest level in over six-and-a-half years, and the global services PMI fell 1.1pts in June to 51.6, its lowest level in 33-months. It remains unclear how this market disagreement will resolve itself. It has private sector and central bank observers equally curious. Indeed, Australia’s own central bank governor Philip Lowe noted that “There are investors who think the outlook is sufficiently weak that they expect central banks right around the world to cut interest rates but they are not worried about corporate profits or credit risk”. It seems that markets are pricing in the optimal outcome from policy-makers. This is a pre-emptive easing of monetary conditions to do ‘whatever it takes’ to keep the economic expansion going.
*You can read the full report here.
Macrobond's chief economist, Roger, who usually writes for this blog, is taking his summer holiday. You can expect his weekly market musings back in early September.
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