The US economy looks fabulous at the moment.
The job market remains solid with unemployment at its lowest in almost two decades. Prior to the year 2000, one has to go back to the Nixon administration to see a jobless rate of less than 4%. The improvement is also broad-based, i.e. by gender, race and so on. This helps fuel consumer confidence, spurring robust spending growth that reached almost 4% in the second quarter of 2018.
The US equity market is soaring. Corporate profits are rising, earnings are surging, and overall market sentiment is positive. The benchmark S&P 500 stock index is scaling new heights by the day. All of this is happening – if some may not have noticed – at a time when a slew of negative macro news on global trade is unfolding.
Whether we like it or not, President Trump is taking most of the credit. His tax cuts are spurring US GDP growth, which this year could possibly fetch 3% on average. His trade barbs with China – his main policy identity to push the trade balance back in the US’ favour – are continuing and are seen by hardcore supporters as proof of the strength of Trump’s administration.
The US dollar has also rebounded since April 2018. The hunt for safe-haven financial assets has caused investors to once again fall in love with the greenback amidst increasing global uncertainties. Again, Trump will hail this development as a glowing testimony of his policy success.
Take a trip to other continents, however, and we will see the opposite. In Asia and other emerging markets, things do not look as fabulous. Their currencies are reeling. The Indian rupee is at an all-time low, whilst the Indonesian rupiah had slumped to its lowest level since the 1997/98 Asian Financial Crisis. And despite the support provided by multiple interest rate hikes in the past few months, rupiah remains under downward pressure. The Turkish lira also succumbed to pressure following the steep imposition of tariffs by the US, whilst the Argentinian peso continued on a downward spiral.
China’s economic news is also widespread. The economy is feeling the heat despite its continued retaliation against the tariffs imposed by Trump’s administration. The country’s headline GDP growth will probably hit a multiple-year low in 2018 as inflation picks up and business sentiment erodes. This, unfortunately, comes at a time when growth is already slowing from the impact of the government’s measures to deleverage the economy. A 6% to 6.5% growth does not look too bad from the global perspective, but for China, that level calls for more fiscal and monetary measures to defend its economy.
Unfortunately, many Asian economies are very much dependent on China. The linkages are not just from trade channels, but also through investments. Once China sneezes, export-dependent economies in Asia would likely start sniffling, if not catch a cold.
Is it likely that these two regions will converge in terms of economic performance in the near term? The intensity of the trade barbs between the US and China is an important determinant to watch. Judging by the steely personalities of the presidents of the two largest economies in the world, it is hard to be too optimistic at this juncture. Still, some have not given up hope. As such, we cannot rule out the possibility that trade hawks will eventually realise that long-term repercussions will not be positive if trade disputes persist. For instance, short-term ‘victory’ may mean long-term pains for the agricultural players in the US and manufacturers in China. Prices will also face upward pressure in both countries.
Secondly, the US Fed is caught between a rock and a hard place. Not continuing its rate-hike plan will risk imbalances that could lead to an overheating economy. And if it is too hot to handle, the downturn of the economy could be severe. Although inflation today remains relatively low by historical standards, surging asset prices are making policymakers uncomfortable. This can be seen from the Fed’s rhetoric in recent times. On the other hand, driving rates up too strongly could risk a sharp downturn. Indeed, shrinking yield gaps (to below 20 basis points in recent days) are already signalling an increasing possibility of a recession in the next one to two years.
Not wanting to sound too pessimistic here, but there are indeed numerous speed bumps ahead. For the US, a more balanced bilateral trade may not equate to an overall improvement in its trade deficit. One reason is that the fiscal stimulus that comes into effect following Trump’s massive tax cuts will lead to a yawning fiscal deficit in the near term. This will eventually be reflected in the country’s current account deficit. And yes, you guessed it right – Trump will not likely see any improvement in the US’ overall trade picture. This leads us to another question: will this situation morph into a currency war, especially if countries wish to keep their exports competitive?
A currency war, if it does materialise, could be more disruptive for the global economy. Businesses will suffer as investments are scaled down due to uncertainties. Swings in capital flows will disrupt global equity and bond markets, leading to further deterioration in business performance. Banks will adopt their standard playbook, i.e. cut financing channels to minimise their risk exposure. We can already guess what would happen next if such a scenario unfolds.
The recent depreciation of the renminbi is a concern. Many think that the Chinese authorities may not have weakened its currency on purpose. Instead, the weakness could be attributed to the market pricing-in the prospects of a weaker near-term macro backdrop due to the trade war. But the Trump administration is already eyeing the renminbi’s path with caution. Any possible hint of currency manipulation will spur another round of disputes between the two countries and spark more volatility in the financial market.
The consolation at the moment is that China is still pledging to stabilise its currency, although it has depreciated markedly against the greenback since mid-April. This is indeed a relief for many regional economies. Indeed, export-dependent Asian economies are banking on the continued stability of the renminbi. Without it, their economies will fumble as well.
There is no doubt that this is again a challenging period for the global economy. Global trade is at a crossroads. And while the US is enjoying a healthy economy, others are scrambling to avert an economic disaster. Remember the punchline that we read in the news recently, i.e. “Trade wars are good, and easy to win”? Let us hope that the next one does not start with the word “currency”.
This article was first published in The Edge Malaysia Weekly on 10 Sep 2018 – 16 Sep 2018.