In the U.S., China and the Eurozone, the idea that lower interest rates alone could heal economic injuries created in trade wars has taken root.
In the short term, it seems to be working. Stocks rebounded from six weeks of carnage this week when central bankers around the world suddenly issued comments supportive of using monetary policy to counter flagging growth.
Whether this central-bank-fueled sugar rush — i.e., the sweet, sweet taste of steady to lower rates, promised specifically in response to the U.S.-China trade war — can continue to support stocks is something we will see in person in coming months.
But you can count on this: If at first cutting rates does not succeed, central bankers will try, try again with even more radical solutions, like quantitative easing.
A Worldwide Effort
Investors received signs of accommodative policy from the European Central Bank on Thursday, when officials said they would keep interest rates unchanged for now. Policy officials also extended the period during which they expected to keep rates on hold from the end of 2019 to at least through the first half of 2020.
Meanwhile, the Federal Reserve in the United States hinted that rate cuts could come as soon as mid-June or mid-July.
We haven’t talked much about the trade war with China lately, but rest assured it will continue to be a major thorn in the sides of investors and policy-makers over the summer and beyond.
This trade war is set to knock at least three-tenths of a percentage point off U.S. GDP growth. This is a significant amount since the current consensus forecast for Q2 is just 1.3%.
To counter this, the Federal Reserve may slash interest rates by as much as 75 basis points through the next nine months to a year. Which means that the pain of tariffs will paradoxically lead to the joy of lower rates.
Make no mistake: Investors are more likely to celebrate the lower rates than to complain about the GDP growth setback.
If this is the plan, it is diabolical and could actually serve the White House’s plans.
Picture this: The worse the trade war gets, the more likely we’ll get lower rates, which is what the president wants going into the 2020 election. So it might make sense to actually prolong the trade dispute.
No wonder President Trump’s stance on trade has hardened in recent weeks, and it has become clear that he will demand a deal with China that resolves structural issues around intellectual property protection and market access. China’s leaders will not agree to major, unilateral changes to industrial policy.
So expect a lasting escalation of the trade war with China over the coming year — even if a truce is announced at the G-20 summit later this month — that ironically serves investors’ interests.
Leading a rebound in tech stocks this week was marketing software giant Salesforce.com (CRM), up 5.5% on Wednesday and Thursday after posting record first-quarter revenue and lifting earnings guidance.
The Nasdaq has borne the bulk of the market decline since the start of May but the strength of CRM as well as CME’s advance to new highs suggest that investors believe enough near-term trouble has been discounted that it’s now time for a recovery. Or at least enough of one to frustrate bears and make their task more psychologically difficult.
The severe selling we saw late last week and Monday, combined with epic low confidence levels in AAII surveys, was at or near major panic levels.
Then came the recovery Tuesday that was the largest in more than three months. This one featured broad participation and shared other genetic qualities with the oversold January rally that kicked off this year’s gains.
These are conditions that tend to serve as medium- to long-term buying opportunities with relatively low risk, though of course there are no guarantees.
The Invesco QQQ ETF (QQQ) has pulled back to its rising 18-month average, which is an oversold condition. It now has potential at least back to the $185 area, which would be a 4.5% advance from the Thursday close.
Another sharp drop in the price of oil put the commodity on track to re-enter bear market territory, down 20% from their April peak. That’s bad for energy producers, but it’s like a tax cut for consumers.
Anxiety about higher tariffs slowing an already weakening global economy has buffeted stocks and other risky assets in the past month and a half. But investors this week essentially figured that the Fed will put a Band-Aid on the recent owies and make the pain of the global economic slowdown go away.
It would be great if that’s the case; I’ll keep an eye out for tooth fairies at the same time.
Federal Reserve Bank of St. Louis President James Bullard said Monday that a lowering of rates “may be warranted soon.” Fed Chairman Jerome Powell said in remarks Tuesday that the central bank is closely monitoring the recent escalation in trade tensions and that it would respond if needed to keep the economy growing steadily.
Who needs superheroes when you’ve got central bankers covering your six?
Let’s look at the tensions a little more closely …
Tariffs Workaround Gains Traction
So about those tariffs on Chinese imports. Turns out that U.S. importers are switching suppliers to avoid them, sprawling out to other countries like Vietnam, Indonesia and Thailand.
And very often, it’s the Chinese manufacturers and distributors themselves behind the new entities, which is pretty amusing.
This is why the impact on final consumer prices still appears limited: Exporters are simply rerouting their goods through these third countries to avoid duties.
Shipments from South Korea, Taiwan and Vietnam have surged, according to Capital Economics data, and the rise in imports from these countries since October has offset about $30 billion of the $75 billion (annualized) fall in Chinese imports over the same period.
The big question is whether this is a genuine shift in production, or whether Chinese firms have simply rerouted their production for minimal processing the onward shipment. The pick-up in China’s exports to Vietnam and Taiwan, at least partly, explains what is happening, the data shows.
Tariffs are effectively a tax on U.S. consumers, which reduces their capacity to buy other things. The hit to real GDP then depends on how much consumers and businesses are paying for those imports from other countries, the CapEcon analysts argue.
- If it’s close to the pre-tariff price of the goods from China, then the real income loss would be minimal.
- If the price is closer to the post-tariff price from China, that implies a significant hit to the real incomes of consumers and businesses.
Nevertheless, assuming there is scope for more of the substitution in production that we are seeing show up in the import figures, the impact on final consumer prices could be manageable, particularly beyond the first few months, the analysts conclude.
The newly planned tariffs on Mexico might be a different story, however, since they would cause chaos in the tightly integrated supply chains of the vehicle production sector.
There is much less scope to switch production, at least in the short term, and price rises would be magnified because the tariffs would be applied every time the parts crossed the border.
Potential Damage from a Trade War
Morgan Stanley analysts argued in a thought piece this week that investors are underestimating the risk to the global economy from a trade war, even after U.S. stocks capped the worst month of the year. A recession could begin in as soon as nine months if President Trump pushes to impose 25% tariffs on an additional $300 billion of Chinese imports and China retaliates with its own countermeasures, according to Chetan Ahya, chief economist and global head of economics at Morgan Stanley.
The rift between the Trump administration and China has escalated as each side blames the other for the breakdown in talks. Early in the week, Trump celebrated his trade policies and the recent move to impose tariffs on Mexican goods in response to illegal immigration in a set of new tweets.
Morgan Stanley notes that while stocks have declined, investors are still overlooking the impact the trade war will have on the global macroeconomic outlook. Ahya said growth will suffer as costs increase, customer demand slows and companies reduce capital spending, As the negative effects of the tariffs become more apparent, it may be too late for political action, according to Ahya. Policies to ease the impact are likely to be too reactive and slow to take effect.
Trouble in the Air
By the same token, the Financial Times reported Sunday that renewed global trade tensions have led the airline industry’s top trade body to sharply downgrade its profit forecast for the year, underscoring the mushrooming impact of Trump’s trade war with China.
The International Air Transport Association, which represents 290 airlines that account for more than 80% of all air traffic, on Sunday cut its forecast for the industry’s overall profits this year to $28 billion. That is down from the previous forecast in December of $35.5 billion and would represent a 7% decline from 2018.
“Weakening of global trade is likely to continue as the US-China trade war intensifies,” said Alexandre de Juniac, IATA’s director-general. “This primarily impacts the cargo business, but passenger traffic could also be impacted as tensions rise. Airlines will still turn a profit this year, but there is no easy money to be made.”
Financial markets and business executives were already reeling from the tensions with China that flared up again at the beginning of May, and Trump’s threat last week to impose tariffs on Mexico has exacerbated concerns that global trade is once again coming under pressure.
The FT notes that car manufacturers and other companies with complex international supply chains have come under particular strain in the trade war, but the airline industry would also feel the heat, according to De Juniac. “Aviation needs borders that are open to people and to trade. Nobody wins from trade wars, protectionist policies or isolationist agendas. But everybody benefits from growing connectivity. A more inclusive globalization must be the way forward,” he said.
FedEx on the Skids in China
Now here comes more retaliation. Bloomberg reported that China has targeted FedEx (FDX) in its escalating trade war with the White House, giving a hint of the kind of foreign companies it may blacklist as “unreliable.”
The investigation into FedEx’s “wrongful delivery of packages” was framed by the state news agency as a warning by Beijing after the Trump administration imposed a ban on business with telecom giant Huawei Technologies
A Chinese official said that the government is firmly against the U.S.’s “long-arm” jurisdiction on Huawei, while downplaying concerns that the planned list of unreliable entities will be used to target foreign companies as a retaliation tool in the trade war.
To designate an untrustworthy foreign entity, China will look at whether it discriminates against domestic companies, the state-run Xinhua news agency said Saturday. Bloomberg said other considerations will be violations of market rules, breach of contract, harm caused to Chinese firms and actual or potential threats to national security.
Boeing Faces New Scrutiny
On top of that, Reuters reported that the FAA has a new problem involving Boeing’s grounded 737 MAX, saying that more than 300 of that troubled plane and the prior generation 737 may contain improperly manufactured parts and that the agency will require these parts to be quickly replaced.
When it rains, it pours.
The FAA said up to 148 of the parts known as a leading-edge slat track that were manufactured by a Boeing supplier are affected, covering 179 MAX and 133 NG aircraft worldwide. Slats are movable panels that extend along the wing’s front during takeoffs and landings to provide additional lift. The tracks guide the slats and are built into the wing.
The 737 MAX, Boeing’s best-selling jet, was grounded globally in March following a fatal Ethiopian Airlines crash after a similar Lion Air disaster in Indonesia in October. The two crashes together killed 346 people. Boeing has yet to submit a software upgrade to the FAA as it works to get approval to end the grounding of the 737 MAX.
In its Sunday edition, The New York Times separately revealed that Boeing built deadly assumptions int its 737 Max that blinded testers and safety regulators to a critical late design change.
Boeing in April said the two fatal crashes had cost it at least $1 billion as it abandoned its 2019 financial outlook, halted share buybacks and lowered production. The company’s shares have fallen by nearly 20% since the Ethiopian Airlines crash in March. Some international carriers are skeptical the plane will resume flying by August, as some U.S. airlines have suggested.
Due to their high absolute dollar value, changes in the shares of Boeing have a disproportionate effect on the Dow Jones Industrial Average, which is a price-weighted index. As a result, changes in Boeing can heavily push the benchmark index around at the margins. Look for trouble to continue as this story is far from complete.
Jon D. Markman