MARKETS have been seriously disrupted by the announcement of new trade policies by the Trump Administration in the US.
Trump recently outlined the imposition of global tariffs on steel and aluminium at 25% and 10% respectively. This was an election promise from Trump, but came as a shock to markets, as political rhetoric rarely becomes a reality. Trump is different!
In The Art of the Deal Donald Trump outlines his strategy: He starts from a position of strength and offers an extreme position in his opening salvo, allowing maximum latitude and flexibility during mediation, leading to a more attractive compromise in the final settlement. To understand this negotiating technique is to understand the minimal threat to markets, as has been the case with his domestic policy roll-out.
Trump has decided to use tariffs and trade restrictions as a tool to address the massive trade imbalance, the US currently suffers, with respect to the rest of the world. The President has this option available to him as part of his executive power.
Free-trade agreements negotiated by previous administrations have enabled a massive move away from domestic production/manufacturing and towards off-shoring. This shift has led to an enormous shift in global trade. China, South Korea, Vietnam and Mexico are beneficiaries of this and the trade imbalance with Western Nations, particularly the USA, has become devastating.
The immediate costs of off-shoring has been the loss of domestic industry and thus important manufacturing jobs. This has led to social upheaval, in what is now commonly referred to as the “rust belt” in the US. The impact has been degradation of the working, middle class who are the President’s main constituency.
The other major victim was the current account, with huge trade deficits blowing out, with the new Asian tigers, Mexico etc. The overwhelming advantage has been to the consumer, who has seen massive decreases in prices.
Trump is seeking to reverse this social and economic phenomena by the imposition of tariffs to force trade partners to renegotiate trade deals under a more balanced system. Europe and China have benefited low tariffs for goods exported to the US while retaining higher trade restrictions and tariffs for goods imported from the US. It is this imbalance that Trump seeks to redress. He calls it “reciprocity”, “reciprocal tariffs” or “fair trade”.
Impact on Markets
The shock impact of this new trade policy has been immediate and consequential. Equity markets tanked, with massive losses on global bourses as the fear of a global trade war became a distinct possibility.
Retaliation from Europe and China has been rhetorical. Threats of tariff retaliation must be considered in context, as the Europeans and Chinese are the major beneficiaries, with a huge advantage in terms of trade. This is why a trade war is unlikely.
Overreaction has been sudden and severe, but in reality, the impact is likely to be minimal. Global trade is at record highs and is set to continue. The Baltic Dry Index confirms the healthy state of bulk shipped goods, while the DHL Global Trade Barometer confirms trade is in growth mode, although may be moderated, by short term uncertainty.
The freight and customs industry is uniquely dependent on trade and these are therefore nervous times for industry participants. It is for the above reasons that I suggest the likelihood of global trade wars to be unlikely. The volatility this uncertainty has presented to markets should be short-lived.
Trade-dependent countries such as Australia are the most vulnerable to any trade disruption and must be keenly aware of developments.
The trade prospects of Australia are not as dependent on the US as they once were. Many Australian exports (especially raw materials and minerals) go to the new manufacturing nations such as China, Vietnam and South Korea. This is equally applicable to imports, which come from the new factory nations spreading downside risk. Australia has a strong political and military relationship with the US and have been exempted from the announced tariffs.
Central Bank Influence
The Federal Reserve has taken the opportunity to raise rates for the sixth time in this current cycle with projections for up to three more in 2018. The Fed forecast increased the likelihood of further interest rate rises for 2019/2020. This signals a return to a more normalised monetary policy and a direct result of rising growth prospects and inflationary pressures. This interest rate policy should support the long term prospects of the US dollar.
It is worth noting that the US and UK have advanced into a completely new economic interest rate cycle. Monetary policy in other key jurisdictions remain mired in extremely accommodating and loose policy settings. These include the RBA, ECB, Bank of Japan and RBNZ. This interest rate environment undermines the strength of the currencies. It is therefore easy to assume a depreciation of said currencies against the US dollar and the pound sterling. Cross rate movement will be heavily dependent on the particular country/zone policy, which is directly attributable to individual national growth, inflation and labour markets.
Serious threats surrounding global trade wars have caused significant instability in markets. The impact on equity markets has been far more substantial than currency markets, but as fears subside, normalcy should return. Currency protection is always available through foreign exchange instruments, such as forward contracts, combined with accurate cash flow forecasting.
* Paul Bettany is a foreign exchange partner at Collinson & Co