Macro insights

Trump trade policy dominates, Fed announces rate cut, BoE position unchanged

It is with a certain resignation that we observe US President Donald Trump once again plunging the US into heightening trade tensions with China.

The White House announced last Thursday that it would increase tariffs on $300bn of Chinese goods from 1 September. Strangely, this followed the resumption of trade negotiations with the Chinese in Beijing last week, which both sides described as “constructive”. President Trump dismissed the progress as not quick enough. China responded by suspending its commitments to purchase more agricultural products. It also refused to fight downward market pressure on the yuan, allowing it to fall below the psychologically important seven level for the first time since 2008. September’s scheduled trade negotiations may be brought forward to afford an opportunity to offset these proposed increases. We are not convinced they will avert a further rise in tensions. The proposed 10% tariffs could strip a further 0.3 percentage points off Chinese growth and are likely to be followed up with further domestic stimulus - weighted, we believe, towards fiscal measures. The impact on the US could be more troubling: these latest tariffs are likely to be more noticeable in consumer prices, while continuing to undermine business confidence. This would likely result in further easing by the Federal Reserve – we already expect a September cut, but the risks of further cuts beyond September would increase. However, the Fed may struggle to offset the insipid erosion of businesses’ “animal spirits” and while President Trump continues to focus on the Fed, our own view is that the Fed is being set up as a patsy in case trade policy uncertainty kills the current expansion.

Beyond trade tensions, last week saw two key US data releases. The Federal Open Market Committee cut the Fed’s policy rate - the Fed Funds Rate - by 0.25% to 2.00-2.25% for the first time since 2008.

The cut was in line with our views and the majority of analyst expectations, although markets had priced some chance of a slightly greater cut and President Trump was disappointed by the action. Importantly, two voting participants dissented - for the first time since 2016 - arguing policy should be left unchanged with few signs of deceleration in the underlying economy. However, Fed Chair Jerome Powell attributed the decision to an element of risk management and anticipation of downside risks – something that has been crystallised by subsequent trade developments. Friday saw the release of July’s employment report. Headline payrolls appear to have decelerated on a trend basis, but unemployment remained around 50-year lows at 3.7%, broader under-employment fell to a 19-year low and annual earnings growth accelerated to 3.2% - despite another decent rise in labour supply. The labour market shows some signs of softening, but remains broadly healthy. However, it is a backward-looking indicator and the risk to the US economy remains in front of it.

Euro area flash second quarter (Q2) GDP came in line with our expectations at 0.2% quarter-on-quarter (qoq), with the country details showing Spain still resilient (0.5% qoq), France broadly stable (0.2% qoq) and Italian growth flat.

We will get the German number on 14 August and expect 0% qoq, with the manufacturing sector weighing heavily on economic activity. The euro area unemployment rate - a lagging activity indicator - continued to decline in June at 7.5%, the lowest since July 2008. But lower hiring intentions and growth slightly below potential suggest that labour market dynamism is due to fade. Business surveys at the start of Q3 point to additional softness. Together with disappointing inflation - July’s headline Harmonised Index of Consumer Prices was at a 17-month low of 1.1% year-on-year (yoy) due to an energy base effect, and core inflation was at 0.9% yoy – this could push the European Central Bank (ECB) to react at its September meeting. We expect a 10 basis point cut coupled with tiering, and see a higher probability that the ECB will restart quantitative easing. This week attention will focus on German manufacturing orders.

In the UK, the Bank of England (BoE) left policy unchanged at its latest meeting, as we expected.

The Inflation Report, however, detailed a downgrade to the growth outlook, both domestically and internationally – with a resumption of trade tension since its May Report. Governor Mark Carney described how the BoE would navigate international trade tensions and Brexit, but that if both passed benignly the BoE would likely need to tighten monetary policy further ahead. We concur, but risks are obviously rising to the contrary. We pushed back our expectations for the next move from the BoE to a hike in Q4 2020 from Q2. That was before the aforementioned rekindling of trade tension last week. Otherwise, Prime Minister Boris Johnson announced £1.8bn of hospital upgrade spending. This is the latest in a series of announcements of fiscal easing, dubbed “boosterism” by Johnson’s government. It underpins our expectation of an imminent election, which we expect in Q4 this year, probably November. The bigger question is whether the scheduling of such an election comes against a deferral of the Article 50 Brexit deadline, as we on balance expect, or facilitates a no-deal exit by default.          

Japanese Q2 GDP will be released at the end of the week.

We expect a flat reading of around 0% qoq annualised, with downside risks after a 2.2% annualised rise in Q1. An erratic trade contribution during Q1 should weigh on growth this time, with imports rebounding and exports stabilising. Consumption should also rebound, while private investment looks set to remain robust and government spending likely to contribute positively. Finally, the main unknown is inventory, which reached a peak during Golden Week in April and then decelerated due to weak industrial production. We continue to think that the main external risk factors are US/China trade friction and the Chinese economy. Regarding the domestic economy, the main risk is the impact of the consumption tax hike on consumer sentiment.


Upcoming events

US: Services Purchasing Managers’ Index (PMI), ISM non-manufacturing index (Monday), Producer Price Index (Friday)

Euro area: Composite PMI, euro area, French, German, Italian, Spanish Services PMI, German Industrial production (Wednesday), ECB publishes latest Economic Bulletin (Thursday)

UK: Services PMI (Monday), preliminary Q2 GDP, industrial production, manufacturing output, preliminary Q2 business investment, total trade balance (Friday)

China: Trade balance (Thursday), Consumer Price Index (Friday)

Japan: Preliminary Q2 GDP (Friday)

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