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Weekly Hotline





John Dessauer’s market review and update as of Wednesday June 20, 2018.

 President Trump made good on his threat to impose new tariffs on Chinese imports. He announced tariffs on $50 billion worth of Chinese imports effective July 6. In response, the Chinese announced tariffs on $34 billion worth of U.S. exports and promised more. Investors didn’t like that news. Stocks stalled and ended last week in the red.

“While the end game is a compromise trade deal that meets U.S. demands for stronger Chinese protection of intellectual property rights, the road to a trade deal has become very ugly,” said Rajiv Biswas, APAC chief economist at HIS Markit in Singapore. “Both U.S. and Chinese exporters will suffer considerable economic losses while these punitive tariffs are in place, and many Asian countries that are part of the Chinese manufacturing supply chain will also suffer collateral damage in this escalating trade war.”

It could be worse. China is the largest foreign owner of U.S. Treasuries, even after a slight, $5.8 billon drop in April. There have been concerns that China might scale back purchases of U.S. Treasuries in retaliation for U.S. tariffs. Fortunately, China has shown little interest in disrupting financial markets over trade. Instead Beijing is responding in kind with its own tariffs.

“So far, we don’t see any evidence that China is using its Treasuries as part of the trade negotiations. China continues to be a regular and reliable purchaser of Treasuries when its reserve assets are rising, and that remains the case today,” said Zach Pandl, co-head of global FX strategy at Goldman Sachs.

According to The Economist magazine, President Trump has another problem with his trade position. “American trade policy is more protectionist than the president thinks.”

During the G7 meeting in Canada, President Trump stated that the U.S. was being taken advantage of by Canadian and European protectionist policies. Last week I explained that he has a point, especially when it comes to agriculture. European countries have a long history of protecting their farmers from international competition. Canada is also guilty on that score. However, the president assumes the U.S. is innocent and free of nasty protectionist policies. And that is not quite the truth.

According to the World Trade Organization (WTO), on a trade weighted basis, in 2015 America’s tariffs averaged 2.4%, slightly higher than Japan’s at 2.1% but lower than Canada’s at 3.1% and the EU’s at 3.0%. And the U.S. imposes other non-tariff trade barriers such as the “made in America” requirement for many government contracts. New York state requires foreign insurance companies to hold more capital than domestic insurers. Then there is the Jones act that says ships carrying Americans between American ports must be made and registered in the United States. The OECD’s analysis of trade in services found that in 7 out of 22 sectors the U.S. trade restrictions were more severe than others. Only Italy has a worse score on that measure.

The bottom line is that the U.S. is a reasonably open economy, but not the innocent trading partner the president assumes.

In 2011 CNBC began surveying economists, money managers and analysts about the U.S. economic condition and outlook. In the most recent survey the respondents agree with the way President Trump is handling the economy. They see the U.S. growing at nearly a 3% rate this year and next with just a 13.8% chance of recession in the next year. That is the third lowest recession rating in the history of the survey. However, they see the president’s protectionist trade policies as the greatest threat to the economy.

“We finally have an economy that is running ‘hot,’ the culmination of a long recovery, plenty of global liquidity and strengthening fiscal policy. The challenge will be actually achieving a soft landing given the mounting risks due to trade tensions and accumulated global debt levels,” wrote Constance Hunter, KMPG’s chief economist.

The Federal Reserve’s new monetary policy is another source of concern for the economy and financial markets. The Federal Reserve raised short term interest rates by another 0.25% at the June meeting. The respondents to the CNBC survey expect another 0.25% rate hike in September but are divided on whether the Fed will raise again in December. The division is about both the economic need for a December rate hike and concern that the Fed might be overly aggressive, anxious about getting interest rates higher as soon as possible. This is partly the old debate about how quickly interest rates should return to “normal” along with new concerns that low unemployment will lead to higher inflation sooner rather than later.

            The EU’s central bank did not raise interest rates at its latest meeting. That made the interest rate differential more positive for the dollar versus the euro. And, sure enough the dollar has been gaining strength. A stronger dollar makes it more difficult for President Trump to achieve his objective of shrinking the U.S. trade deficit. A stronger dollar makes U.S. exports more expensive for foreign buyers and makes imports cheaper for U.S. consumers. Plus, there is another twist to the combination of trade and U.S. interest rates. Because the dollar dominates global trade U.S. interest rates have a far- reaching impact. That was clear on our recent cruise that started in Palau. Palau uses the U.S. dollar as its currency. Rising U.S. interest rates have a negative effect on the local economy. And Palau is a very small example of the impact from rising U.S. interest rates. Several much larger emerging market economies are feeling the economic heat from rising U.S. interest rates. Higher U.S. interest rates tend to slow the global economy and make it more expensive to finance the purchase of U.S. goods and services.

            Fortunately, the Federal Reserve is not likely to do too much damage raising interest rates. The CNBC survey respondents see the Fed raising short term interest rates to around 3% by the end of next year and ultimately to 3.3%. Economies and markets may struggle to adapt to the change in interest rates, but the U.S. and global economies have grown in the past with interest rates at 4%-5%. 

That explains why the CNBC survey respondents remain fairly optimistic about stocks. They expect the S&P 500 stock index to reach 2,848 by year end, slightly higher than now, and 2,946 by the end of 2019.

Of course, if the trade disputes are resolved peacefully and the Federal Reserve focuses more on economic growth than “normalizing” interest rates, the stock market could easily do better than now expected.

I will have the next market review and update for you one week from today on Wednesday June 27, 2018. 

 All the best,                                                                                                               

John Dessauer                                                                                                            

©June 2018