In all the trade war noise, it is easy to miss just how much global trade conditions have deteriorated in the last few months. If, one year ago, someone would have told investors and businesses that the best-case scenario would be for average US tariffs to quadruple (from 2.5 per cent to over 10 per cent), they would have been considered a “doomsayer”. Adding that markets would cheer on the news, would have probably added disbelief.
Yet here we are, in the midst of a classic game of maximalist demands and then gradual de-escalation. Tariff reductions are more than welcome, of course, as they moderate the probability of an acute economic crisis. We expect more trade deals, however cosmetic in nature, to follow through in the next few weeks, further calming nerves. But unlike equity markets that are used to volatility, the global economy, and especially the global supply chain, are more delicate constructs. The question is “how much damage is already done?”. Will 10 per cent tariffs cause dislocations in the global economy and financial markets?
It may seem that the damage done, thus far, is not significant. Equity markets are used to volatility and they are resilient in high-inflation environments. In terms of corporate confidence, CEO sentiment indicators may be precipitously low, but that doesn’t mean much. Ultimately, if the tariff regime normalises, CEOs will find a way for things to move forward. They will of course have to take a long hard look at their organisations and determine their resilience during what are bound to be turbulent times, but that is more a wake-up call and less of a disaster.
Still, it doesn’t mean that all is well: 10 per cent tariffs from the world’s biggest consumer economy won’t come without repercussions.
A global recession?
Over the short and medium term, the likelihood is that the US and the global economy will still slow down materially, although the probability of a global recession is now lower. Inflation is more of a wildcard, depending on the momentum of the slowdown. If consumers reduce expenditure abruptly causing a demand shock, then prices may not climb. If the growth slowdown is more gradual, we could see inflation picking up in the US. Given the additional pressures from potentially unfunded tax cuts, the long end of the US yield curve could rise, as investors grapple with the effects of an inflation rebound and higher debt issuance. There is little danger that the Dollar would lose its status as the global reserve in the next few years, but the long end of the yield curve (where US mortgages live) could run away if inflation and debt rise.
This particular economic picture does somewhat resemble the 1970s, Much like Mr Trump’s “Liberation Day”, Richard Nixon’s “Shock” of rejecting the gold standard rocked the global economy to its core. It caused persistent inflation along with sluggish growth and fears over the Dollar’s dominance. But there is a key difference: the US Federal Reserve. In the 1970s the Fed succumbed to pressures from the government to keep rates down, further fuelling inflation. Fifty years later, the lesson seems to have been well learned, and the US central bank is firmly standing its ground, preferring (and thus far allowed) to err on the side of caution.
What about the UK? The British economy is one of the most sensitive to shifts in global trade. It is likely to see slower growth on the back of America’s trade war, while some inflationary pressures may persist, both due to supply chain disruptions and also due to stricter immigration rules.
Tariffs will make for a difficult economic environment for everyone, to be sure. But the more they de-escalate, the more the danger of a generalised crisis is removed.
By City AM
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