HIGHLIGHTS OF THE WEEK
- Markets have swung from euphoria over tax cuts, to the protectionism pits, as the White House announced imminent tariffs on up to $50 billion in Chinese imports. China has also announced modest retaliatory measures
- It remains to be seen what kind of actions will ultimately be taken. As the scope of steel and aluminum tariffs is continually narrowed, the White House’s bark on tariffs may prove worse than its bite.
- As expected, the FOMC hiked rates 25 basis points, but more importantly, it upgraded its outlook for growth and inflation. The median “dot” now suggests three rate hikes in 2019, up from two in the last forecast. This suggests the Fed will continue to be cautious in the face of fiscal stimulus.
Markets Hurt by Tough Trade Talk
Despite good news on the U.S. economy, the announcement of potential tariffs on Chinese imports dented sentiment and took equities sharply lower on the week. Over the past three months, markets have swung from euphoria over tax cuts, to the protectionism pits, as the White House followed up the announcement of forthcoming steel and aluminum tariffs with a 25% tariff on up to $50 billion in Chinese imports.
As expected, China has announced how it would retaliate, with 15% tariff on U.S. imports of steel pipes, fruit, wine and other products, and 25% on pork and recycled aluminum, all in targeting about $3 billion in U.S. goods. The relatively modest size of the planned retaliation suggests China is willing to pursue dialogue with the U.S. to address trade disputes about the continuous violation of intellectual property rights of U.S. firms that operate in China. It’s not clear when or even if the announced tariffs will come into effect. We have already seen the U.S. walk back the scope of recently announced steel and aluminum tariffs, by exempting more countries, suggesting that this week’s announcement is an opening gambit.
The U.S. does have a leg to stand on, when it comes to China’s trade practices. However, even a just war has collateral damage. Many U.S. companies will be hurt if these tariffs come to pass, even if the actions are short-lived. This localized damage, however, would not deal a body blow to the over $19 trillion U.S. economy, which looks set to grow quite strongly over the next two years.
However, as demonstrated by markets this week, it is the indirect effects of a more adversarial global trade environment and the uncertainty it breeds that could hamper investment and trigger volatility on financial markets. And it is unfortunate that these threats come just as growth in global trade flows has accelerated (see Chart 1).
Now, about that good news. The FOMC hiked rates 25 basis points as expected, but more importantly, it an upgraded its economic outlook. Real GDP growth was lifted 0.2 percentage points in 2018, and 0.3 percentage points in 2019, and the unemployment rate now troughs at 3.6% in 2019, down from 3.9% previously. Core PCE inflation is also now expected to rise a hair above 2% in 2019. A modest inflation overshoot following nearly a decade of below target readings should not come as a terrible surprise. But, it speaks volumes to the bias of the FOMC not to push too hard or too soon against the rising fiscal tide.
That bias was demonstrated in just one additional hike by the end of 2019 as a result of its upgraded outlook. This forecast is consistent with our own view. That said, seven of 15 FOMC members now have four hikes penciled in for 2018, up from four in December, suggesting that it won’t take much to tip the number of hikes expected in 2018 from three to four. For now though, the Fed doesn’t look keen to get too far in front of the expected pickup in economic growth, but is happy to make sure its outlook is realized before increasing the speed of rate hikes. Given the risk that too much fiscal stimulus in a hot economy could result in the Fed raising rates too quickly, and contributing to a recession, this cautious approach is reassuring.
Leslie Preston, Senior Economist | 416-983-7053
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