Thursday, August 2nd, 2018
President Trump’s tweets took a predictable turn (at least to us at Clime) last week when he vented on both the manipulation of currencies and interest rates in the same thought bubble, once again targeting unfair trade.
To quote –
“China, the European Union and others have been manipulating their currencies and interest rates lower, while the US is raising rates while the dollar gets stronger with each passing day – taking away our big competitive edge. As usual, not a level playing field …” – Donald J. Trump (@real DonaldTrump) July 20, 2018.
Then he had another go ” …The United States should not be penalised because we are doing so well. Tightening now hurts all that we have done. The US should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals. Debt coming due and we are raising rates – Really? ” – Donald J. Trump (@realDonaldTrump) July 20, 2018.
We wonder why it has taken President Trump so long to state the obvious and attack the true anti-competitive practices adopted by many of the US trade partners. In doing so, he exposes the weak underbelly of the monetary policy settings of the European Union. It is interesting to note that he chose to ignore Japan in his tweets – even though they are the gold medalists in QE practices and interest rate manipulation. We observe that when Trump called out currency manipulation, he combined Europe with China as the culprits.
Who knows or could guess what lies beneath these tweets in the whacky world of President Trumpisms, but the tweets are ominous for 2 reasons.
First, the US President has finally focused on European interest rates settings as the means by which they manipulate the value of the euro to gain trade advantages. In time, we suspect he will happen upon QE as another technique for currency manipulation, even though Europe has promised to slow their currency printing in coming months.
Second, lack of precedent and the unstated rules of governance suggest that the US President should not attempt to influence the US Central Bank in its policy settings – but in the tweet above, he clearly tries to influence and usurp the independence of the Federal Reserve. The President states that the Fed should not be raising interest rates with US government debt increasingly falling due.
As we know, the background to these tweets is the growing trade friction between the US, its allies and friends – compounded by Trump’s desire to engage with Russia. There is also the intransigent US trade deficit and the soon to be obvious (following the massive US tax cuts) growing fiscal deficit and burgeoning US Government debt.
Our first chart shows that the IMF predicts that the current US fiscal policy will take it further into debt, in contrast to the rest of the world.
Figure 1. Change in Government debt-to-GDP ratio, 2018-2023
Source. IMF Forecasts, Haver Analytics, Deutsche Bank Research
Further, whilst over 2018 and 2019 world debt is continuing to grow, most of the increment is created by the US as Trump’s tax cuts take the US fiscal deficit towards $1trillion in 2019.
These tweets concern us and developments must be monitored by investors because they suggest that President Trump intends to pressure the Europeans to unwind their monetary policy to make it consistent with that of the US. Alternatively, he may push for the slowing of the normalisation of US monetary policy (higher cash rates) until Europe catches up with higher interest rates.
Figure 2. Federal Reserve Balance Sheet Assets
Source. Bloomberg, Daintree estimates
However, against the above is the possibility that this is just more of Trump’s hot air diplomacy as he attempts to create chaos and smokescreens while he battles a relentless barrage of personal investigation. These are crazy times and it is comforting – to an extent – that investment markets have been sanguine in response. But are markets too complacent?
Figure 3. Global debt by sector
Source. Institute of International Finance
The stabilisation of bond yields at levels not significantly higher than recent record lows (German, Japanese and Swiss long bond yields) suggests to us that growth assets (equities and property) should remain well supported. While there is no doubt that bond yields are still too low and will rise in coming years, we believe that inflation is well under control. This means that while bond yields will eventually rise above inflation, they do not have far to rise to achieve this.
It is worth remembering that this long growth and low inflation cycle has been created by numerous supporting and unique influences. These influences (subject to a trade war) seem likely to endure for a while yet.
The major ones can be summarised as follows:
1. The emergence of China as the world’s second-largest economy as it sustained growth of around 10%pa over the last 20 years. In the year 2000, China’s GDP was US$1 trillion and by 2020 it will have grown to approximately US$13 trillion. Through this period China has also emerged as the world’s great low-cost manufacturing base. It has exported cheap manufactured goods to the four corners of the globe with many US and European manufacturers relocating their manufacturing bases to China. The burgeoning trade between the world and China has kept inflation of goods in check. We do not see this ending any time soon unless President trump imposes ridiculously high tariffs;
2. The GFC caused massive economic dislocation and pushed up unemployment dramatically across the developed world. The excess supply of labour checked wage growth that would normally flow into inflation. It is only in the last year that the US has reached near full employment with disenchanted workers being drawn back into the working economy. Meanwhile, unemployment across Europe is still around 8% (Germany has near full employment) and so wage pressure is not present; and
3. Another factor checking wages is the relentless advance in technological development which has lowered both the cost and delivery of many goods and services. Rapid IT development, automation and disruption continue apace with it leading to lower prices. Indeed, continuous improvements in extraction and energy production driven by technological developments are driving the world towards sustained excess supply of abundant and clean energy – the very opposite of the assumptions of the “Club of Rome” back in 1972 (which forecast that oil and gas would soon run out). This means that the risk of oil price shocks is diminishing – unless a major Middle East conflict suddenly erupts.
Thus, it is our view that apart from Trump, trade wars and Middle East conflicts, the world economy presents as stable with reasonable growth. While those that control the monetary and fiscal policy levers show a limited capacity to explain their policies, we believe that the emergence of China, followed by India – both massive growth economies – suggests sustained world growth with low inflation.
These underlying influences suggest to us that investors can maintain their investments, appropriately balanced across asset classes, to target returns that are adequate in a low inflation era.
Trump’s tweets need to be monitored but it will be implemented policies that will be much more important.