Here we were, coasting merrily along in the U.S. stock market. Then, all of sudden, the last few days hit!
While I will be sending several opinions on consecutive days, I wanted to start with this one from Giolio Martini, Partner, Director of Strategic Asset Allocation at Lord Abbett.
Will Trade Trauma Trip Up U.S. Growth?
In our view, the effects of recently imposed tariffs likely will not have a significant impact on the current U.S. Gross Domestic Product (GDP) trajectory.
Until recently, financial markets appeared to have settled into a period of relative complacency about global trade, reassured by hopes that continuing U.S.-China discussions would yield some positive results at an indeterminate date in the future. Those hopes were upended on May 10, following the breakdown of negotiations between the two countries, and the subsequent move by the Trump Administration to raise tariffs on $200 billion of U.S. imports from China from 10% to 25%. For its part, China announced on May 13th, its plans to raise duties on certain American imports starting June 1.
Needless to say, the implications of the escalating trade tension have created a great deal of uncertainty around global growth, asset prices, and central bank policy. This is quite apparent in the latest reading of the widely followed Baker, Bloom, and Davis U.S. Economic Policy Uncertainty Index.
Have Tariffs Fueled Market Uncertainty? Certainly.
Baker, Bloom, and Davis U.S. Economic Policy Uncertainty Index (weekly), January 1, 2012–May 13, 2019
Source: Bloomberg and Economic Policy Uncertainty. Data as of May 13, 2019. Index measures policy-related economic uncertainty based on three types of underlying components: newspaper coverage of policy-related economic uncertainty; the number of federal tax code provisions set to expire in future years; and disagreement among economic forecasters as a proxy for uncertainty.
Traders are extrapolating the intensifying tariff war into worsening global economic growth and an increased probability of monetary easing by the U.S. Federal Reserve (Fed). Indeed, based on Bloomberg data, markets are now pricing a greater than 40% chance of more than one 25 basis point easing by the Fed over the next twelve months.
Other developments point to the market’s darkening mood. Major global equity indexes have experienced renewed volatility, including sharp declines on May 13th. Copper prices, a market bellwether for economic growth expectations, have fallen sharply compared to gold prices, a benchmark for systemic market risk. To top it all off, the U.S. three-month/10-year U.S. Treasury yield curve re-inverted on May 13th.
Taking a Step Back
Amid the current volatility, we think the market’s concerns need to be put into context. While fears of global recession are sure to intensify in the short term, it’s worth noting that overall financial conditions, as measured by the Chicago Fed Financial Conditions Index, remain very accommodative, with the index signaling the easiest conditions in more than a decade. And market liquidity, as represented by the U.S. three-Month TED spread, which measures the difference between the interest rate on short-term U.S. government debt and the interest rate on interbank loans, reinforces the notion that financial conditions remain supportive of economic activity.
Moreover, while spikes in uncertainty are never good for financial markets, and there is plenty to worry about beyond trade friction between the United States and China, we believe the increase in tariffs is taking place at a fortuitous juncture. With U.S. GDP very close to potential and inflation consistently undershooting expectations in recent years, we believe that the chance that the unambiguously negative effects of higher tariffs can be absorbed without unhinging expectations about the future paths of the U.S. and global economies is greater than usual. Thus, unless conditions continue deteriorating, we think a buying opportunity among shell-shocked global asset classes should emerge relatively soon.
I hope you find the information in these opinions to be of both value and of interest. As always, we’re here to talk if you would like.