This week, President Trump announced plans to introduce new tariffs for selected steel and alumnium goods, using the justification of the Section 232, the national security exemption. The move, set to be implemented next week, was swiftly condemned by a wide range of U.S. trading partners, including Canada, Mexico and South Korea, several of whom are currently negotiating with the U.S. Following past tariff increases, and a very busy trade calendar, the move is likely to amplify volatility in markets, including FX. I look in this post at the looming elements of a busy trade calendar and consider some impacts on growth, inflation and broader policy.
Several factors may amplify the impact of trade friction - the precedent of using the national security exception, the seeming lack of coordination within the administration and with other ongoing trade negotiations. If implemented, the move would likely add to distortions in metal prices, amplify input costs in the United States, and add to uncertainty for businesses in the U.S. supply chains. The additional grit of trade friction may add transactions costs and uncertainty at a time when global trade growth may already start to moderate (2019+)
Increased targeted tariffs and trade restrictions should not be a surprise. After all, President Trump (and Candidate trump) was very insistent that he wanted tariffs, and fair trade. The choice of the largest tariff size (big beautiful tariffs) was more of a surprise, as is the use of the WTO’s national security exemption at a time when members of the national security infrastructure were loath to see a risk - particularly since much of the current products come from Canada. By using this measure, the U.S. is calling into question elements of the WTO regime and more generally the rules based system it helped created.
Several other trade related measures include.
Any tit for Tat is likely to add trade friction and raise questions about any inflection point for global trade. its worth noting that these measures come at a time of robust global trade and demand and that's unlikely to change in the near future. However the pace of global growth is likely to slow in 2019 and especially beyond due to higher rates and cost of capital, the struggles in growing above potential growth. Global trade flows have been strong and relatively resilient to protectionist threats (in part because these threats hadn’t been converted to action). It might be less resilient going into 2019, when global growth is likely to moderate from the current above potential pace.
The move has not only been questioned abroad, but also at home, including by many Republicans especially in the Senate, who fear the price impact on American consumers and businesses reliant on imports (including food processing many manufacturers and even the energy sector). If the U.S. was moving ahead with even its small infrastructure plan, it could have a greater cost uncertainty and impact - however the Senate suggests no vote on infrastructure this year. Corporate outcry could result in some adjustment of the measures, but the general direction in policy seems clear. Expect more targeted measures - and greater price and demand uncertainty.
The move complicates an already contentious set of negotiations between the NAFTA partners, who seem to have made little progress in the last round of talks, not least because the U.S. representative focused on rules of origin was recalled early. The 232 tariffs may well reflect some desire to play hardball in these negotiations, and to deflect from what seems to be a wave of defections from the White House and pressure on those close to the president. Expect Senate hearings on extending TPA authority past July (the measure that allows an up or down vote) to be even more difficult.
My baseline view continues to be a continuation of NAFTA talks into H2. As the U.S. and Mexican elections approach, the risk is that the talks will be put on hold to allow new leaders to play a role. They may shift to a lower profile pace. Meanwhile the ongoing trade frictions add to come concerns I have expressed about the pace of growth going into 2019 and cost dynamics. Tariff imposition could amplify price pressures at a time when demand has been picking up and the labor market is tightening.
Several factors suggest that the rate of growth of U.S. imports is likely to moderate this year, at least in volume terms. The weakening of the U.S. dollar is likely to increase costs, dampening import incentive. There doesn’t seem likely to be a major food supply shortage. Some of these trends are likely to offset what otherwise would be an increase in imports due to strong growth and rather expansionary fiscal policy.
The recent market selloff with its multiple linked triggers (inflation, fiscal expansion, past FX adjustment) and amplifiers (program trading, volatility funds and instruments, pricey valuations and desire to take profits in tax-mitigating way), seems a good time to take stock of the drivers of the macro and market environment going forward, to update you all on some of the themes/topics/opportunities I’m tracking in 2018 and beyond. The themes and framework are described in this pdf in more detail.
Many of these are longstanding topics that have driven macro and market sentiment in recent years (trade policy, fiscal stance), some may be well choreographed (CB balance sheet adjustment, energy rebalancing), even if likely to be over-estimated as exits approach. Others warrant some additional consideration in a global context (infrastructure development and finance).
I touched on many of these in my 2018 look-ahead in November, and will be updating my views as the months go on. This framework may help me and others identify how the different themes interact. No doubt, new topics will emerge or some of these topics interact.
Bottom line: Macro environment in 2018 still looks set to be relatively benign, with a pickup in global growth, and greater synchronicity of major economies (as laggards begin to catch up). Looking ahead, policy uncertainty (around trade and FX policy) suggest challenges for business planning, and greater costs to consumers, contributing to a slowdown in global growth in 2019-20, suggesting profits should follow suit. Coupled with higher rates and greater competition for capital, debt servicing issues should come more into the fray as the end of expansionary monetary policy facilitates a closer look at sovereign and corporate fundamentals. County selection matters. Price pressures are still likely to be manageable, but greater issuance of debt and equity suggests profit outlook matters. In several EM/Frontiers expect government dominated or secured investment to retain its key place.
I’ll talk more about risk scenarios in the days to come. I look forward to hearing about what I missed, what your signposts are and what scenarios you’re preparing for.
This post shares a few takeaways from my discussions last week in London with policymakers, investors and analysts on MENA and energy. Overall, sentiment was upbeat.There were two big elephants in the room: Saudi Arabia economic and foreign policy activism and the Iran nuclear deal. There remains significant uncertainty around the implementation around those issues, which offsets what is generally a more upbeat outlook in the face of $65-70/barrel crude.
One broader question pervaded my discussions. How much do higher oil prices help? Brent around $70 (or even in the mid 60s) gives significant more room for maneuver and likely will reinforce government driven growth across the GCC as it likely implies less fiscal austerity. It clearly buys time and room for maneuver and spread compression. However, we see only Kuwait and possibly the UAE having scope to resume saving, meaning that regional sovereign funds are likely to receive little new capital as more of the funds are used to support domestic spending. These trends will reinforce the ongoing acceleration of local growth from the 2016-17 pace, much private sector is likely to drag behind as the desire for quick growth brings government actors more into play.
Institutional investors remain constructive on GCC bonds on valuation grounds especially vs Asian alternates and even some of the more liquid CEEMEA names in the USD space. Oman and Egypt seemed to be top picks given that macro environment seemed to be better than feared, allowing some yield compression. $70 brent provides a lot of space for regional external balances and pegs, even if it won’t help fiscal balances much. Expect the GCC to continue to dominate global USD issuance among EM and Frontiers again in 2018, with Qatar joining peers. Going forward, concern may rise about Bahrain, and whether any regional support may not help bond investors.
Oil price and fundamentals: there’s a general consensus that the market is rebalancing and the OPEC + (Vienna agreement) has “worked” and the excess inventories in the U.S. will continue to be drawn down this year, but there is less consensus about the price forecast, which has a wide band around 55-80 this year. This reflects a difference of opinion about the growth in global demand (between 1.1 and 1.7mbd) and the persistence of the production freeze if prices remain high and incentive to cheat rises. On the demand side a key question is whether rising costs will dampen consumption growth (MENA oil producers are one place to watch, as is U.S. and Asian consumers) while shale production is a key place to watch on the supply side.
Global oil majors and many in GCC seem to be looking for $65 Brent this year, seeing some increase in shale output, some drawdown in inventories and the risk of a speculative correction. Others especially on the sellside seem to be sharply scaling up their forecasts, with Goldman Sachs pointing to the possibility of $85 by mid-year. In this price environment, expect oil companies revenues to move up but new investment is unlikely to outstrip plans.
Saudi Policy consternation: The Saudi anti-corruption detentions seem to be coming to an end, with reports that $100 billion in assets have been raised, likely a combination of stakes in companies and cash. This turns attention to the many key questions about the new anti-corruption regime, new institutions and the broader economic reform. Will Saudi authorities continue to hike public wages, even if that places a greater burden on the public sector? What will the new legal process be for corruption cases? Where will the new funds be managed? Will these funds be incorporated into the Public Investment Fund (PIF) which is already managing much domestic investment funds and waiting for new foreign issuance. Interest in the Aramco IPO seemed to have died down despite the improved oil valuation with many investors waiting to believe when they see terms. Meanwhile, the general view was that economic growth would accelerate and
The PIF itself is a matter of much interest, with many investors and regional watchers wondering how its asset allocation will evolve, how it will balance the foreign versus domestic investments and how it will balance competing mandates. It is rapidly staffing up and cares about a professional structure, but like many areas of Saudi policy, it is being asked to do a lot at once, with mixed goals.
Iran deal and economic policy: Coming only a few weeks after President Trump’s ultimatum on the nuclear deal and demand that European allies improve the deal, there was a lot of uncertainty on investment outlook. The view from Europe (especially France and Italy) is that the deal is working, and the burden high for changes, and the Iranians seem to be woking had to make sure that they are not blamed for the deal falling apart. This suggests major changes might be a hard task. Some European countries have already chosen to backstop local companies doing business in Iran, though oil companies concede that Iranian domestic policy uncertainty and term preferences pose as much concern as U.S. sanctions. Banks remain very concerned about sanctions and regulatory risk, which may explain the direct support of European firms. Meanwhile local macro issues including the vulnerabilities of the non-bank credit and the battle between government and IRGC suggest that Iran may struggle to benefit from some of the higher energy prices. The recent protests have triggered a less restrictive fiscal policy, with more subsidies remaining in place, and greater domestic leverage from the government.
Qatar: The general view is that the blockade is here to stay for some time and I've written extensively about Qatari resilience to the blockade due to its deployment of past savings. The economy has bounced back, the continued energy trade has provided solace to investors, and support from the U.S. and EU has limited the approach to secondary sanctions by the Saudis/Emiratis. Indeed, the new supply chains with Iran and Turkey look likely to stay. The recent U.S.-Qatar meeting likely increases Qatari leverage. Still, there are losers at home and the public sector is driving economic activity and absorbing more of the loans. These trends are likely to continue, as local rates remain high. The broader costs to GCC coordination and institutional strength are significant. Regional competition is likely to outstrip coordination resulting in lower domestic liquidity.
Finally, natural gas: If anything there was an even wider divide on natural gas fundamentals and price, with energy market representatives differing on whether there is an LNG supply glut, whether new entrants are taking advantage of cheap supplies sufficiently, and whether new supplies will offset. Policy mandates from China and other growing demand suggest that supply may be absorbed, and the market is gradually becoming less regional. I did field a lot of questions about U.S. energy policy and in particular support/demand for coal, which had some gas producers concerned. The pressure on higher cost natural gas producers is likely to remain.
Global markets (especially) US bond markets, gyrated today following reports on two policy areas (Chinese capital and NAFTA/trade policy) that are set to be sources of volatility in 2018. In both cases, the storms in a teacup seemed disproportionate with (the lack of) new information.
Press reports reminded investors about risks that may have been underpriced. U.S. trade policy (and retaliation/choices of plan B) remains to be a major risk for 2018 and beyond, that is, if US policies move beyond bark to meaningful bite. However, they seem much more likely to be sources of friction that cap profits rather than a major risk in and of themselves.
How do today’s reports play into the key themes for 2018+? What triggers could undermine the recent positive sentiment in a more sustained way? What should we expect from Chinese foreign capital allocation and trade policy? I try to answer some of these in this blog (see my 2018 outlook posts for a more general overview.
Happy New Year! This year I managed to read more books. In honor of the season and my new blog, I’ve selected a few (non-fiction books) books among the 80+ I read/listened to in 2017 that stayed with me through the year and provoked further thought or discussion.
It was tough to pick. The list is heavily skewed by my attempt to find tools to better understand the evolving policy agenda of Trump’s America and which public and private institutions might provide a source of resilience. I also read a lot ahead of and during my trips to Australia, Italy (Puglia) and Romania, though only one book made the cut.
Honorable mentions to Judith Flanders' Christmas: A Biography, which highlights how Christmas almost always was more a secular than religious holiday and one where commercial interests were quick to define tradition. Dani Rodrik’s Straight Talk on Trade, and Ray Hartley's Ramaphosa: the Man who Would be King, which were part of my unfinished holiday reading. They respectively are key guides to assess upcoming trade negotiations and reviews that will punctuate 2018 and useful background for the continued fight over South Africa’s leadership and institutions. But those are a matter for 2018.
In no particular order:
A Most Enterprising Country: North Korea in the Global Economy Justin V Hastings (2016).
This was the most distinctive of the materials I turned to when I sought to get up to speed quickly on North Korea’s economy, its trade with China, Russia and others and the impact of sanctions. Hastings deconstructs internal and cross border trade including the development of hybrid (public and private) shell companies used across the DPRK-China border. A good read to understand the varied interests in China as sanctions are set to deepen.
The Gatekeepers: How the White House Chiefs of Staff Define Every Presidency (2017) by Chris Whipple.
With 2017 being a year of much tumult in the White House and general understaffing in the federal government, Whipple’s book one of two on chiefs of staff was a useful guide. He combs through a half century of U.S. political history to talk about the evolution of the chief of staff role and how administrations floundered when the gatekeeper role was weakened o circumvented. The discussions bringing together reflections of past chiefs to inform their successors were particularly strong – and welcome in today’s partisan air.
Ideas Industry: How Pessimists, Partisans and Plutocrats are Transforming the Marketplace of Ideas Daniel Drezner (2017)
Dan Drezner deconstructs many key institutions in “think tank land”, a complicated set of policy bodies, mostly in the U.S of which he (and increasingly I, am a part. These bodies are one of several providing institutional memory in the U.S. policy arena – all the more so given understaffing in key departments. Given the challenges of funding and mandates, the book is a key read and highlights some areas of caution.
Capitalism Without Capital : The Rise of the Intangible Economy Johnathan Haskell and Stian Westlake (2017)
Over the last few years we economists have spent a lot of ink assessing why fixed investment has been so weak, intangible investment (in branding, internal processes and R&D have been a regular explanation. Haskell and Westlake pull together extensive academic and policy work on intangible investment. It’s a rare economic book that very clearly describes economic theory for non-economists. Worth a read for anyone trying to understand providing some explanations for low productivity, My homework for next year will include trying to extend some of its charts to countries in the emerging world.
The Imagineers of War: The Untold Story of DARPA, the Pentagon Agency that Changed the World Sharon Weinberger (2017)
This book filled key gaps in my understanding of DARPA (long one of the Pentagon’s Research bodies) – which I knew only as an institution I was only vaguely - because of its role in sponsoring the projects that developed the internet, drones and other military equipment, as well as attempts to seed similar institutions in energy and intelligence (ARPA-E and IARPA). This book rectifies this neglect. Weinberger’s book suggests that some of the successes reflect benign neglect of key research priorities, alignment with key foreign policy goals (rather than narrow technical ones) and highlights the cases of over-reach (use of counter-insurgency techniques, especially in South Asia) At heart this is a story of evolving institutions, and highlight the challenges of changing mandates.
Curry: A Tale of cooks and Conquerors. Lizzie Collingham This book uses food to tell Indian history, especially interactions with the Colonial European powers. An interesting if external take on South Asian history. Don’t read while hungry.
Latinos of Asia: How Filipino Americans Break the rules of Race Anthony Christian Ocampo (2017). Ocampo’s book takes as its subject Filipino immigrants and their sympathies with Latino communities they have often intermingled with – with Catholicism, and family networks. A good Input into the diversity of Asian immigrant communities. The book could have benefited from a bit more editing to summarize some of the academic claims.
Out of the Flames: The Remarkable Story of a Fearless Scholar, a Fatal Heresy, and one of the Rarest books in the World (2002) Nancy and Lawrence Goldstone
My pilgrimage to Romania gave me the push to finally read this book which had long been languishing on to read list and it was well worth the wait. The book is required reading ahead of a Transylvanian pilgrimage, but also an amazing account of reformation history across central Europe. Beyond its tale of continual pushing of religious boundaries, it also details some early breakthoughs in biology. The tale of the book’s creation, the religious and political challenges it provoked and its eventual reappearance is a great read of literary detective work.
Saudi Arabia released its 2018 budget with great fanfare today, including a meaningful increase in spending directly and via off-balance sheet funds such the public investment fund (PIF). With the oil sector no longer a drag and the non-oil sector benefiting from government pump-priming, economic growth should accelerate, from near-recessionary levels, part of a broader trend among oil producing nations. Still, private sector contribution is likely to lag as credit demand struggles, government funds dominate and questions remain about the rules of the game after the anti-corruption crackdown. Changes to energy policy are unlikely.
The budget included the largest planned spending (figure 1) of any budget, 978 billion riyal ($260 billion) and an additional 150 billion riyal in spending from various development funds. It comes close to the actual spending peaks of the early 2010s boom years. Given the spending increase in Q4, and a tendency to overspend budgets, actual spending in 2018 may again outstretch plans and in the longer 5 year plan. Adding in the spending from the PIF, there's likely to top that. This will reinforce the bounceback in growth after several years of moderate recession and austerity. It may be less effective in generating private sector activity, which is likely to lag consumption and government investment.
Figure 1: Actual and Government Spending (USD billion)
Source: Saudi Arabian Ministry of finance, Author's Calculations
The more expansive stance is not unique to Saudi Arabia. Most of its GCC and energy producing peers will also have more expansive or at least less austere budgets in 2018, helped by stronger oil and gas prices and still relatively easy global credit conditions that make it easier to issue debt. In Nigeria and Russia as well as Bahrain and Oman, less austerity is likely rather than stimulus. Still these decisions reinforce several trends for 2018 including a belated recovery for many commodity producing nations (catching up to the broader expansion seen in 2017), a bottoming out/improvement in EM investment and some pickup in inflation. All of these generally support EM and local equity over bonds.
I wrote earlier about some elements of the consensus macro view and some risks to those views (and my own). A key part of tracking consensus (and identifying out of the consensus views), is keeping track of the questions investors and others are asking each other. I'll plan to gather some of these on an ongoing basis through the year to track the evolution of concerns and identify what consensus might be missing.
Key dilemmas remain mostly focused on policy choices and whether any policies might upend the macro resilience and market performance. Could this resilience fade? What would be the trigger? As typical queries are most prevalent on U.S. and Chinese policy, geostrategic issues, especially in the Middle East and North East Asia.
Global growth: is this the best we can get? What does that mean for asset returns? Will this pace of global growth be sufficient to create enough jobs in populous EM/Frontier countries o will it exacerbate political stresses and reinforce price pressures?
Impact of US fiscal policy: questions include the impact of the policies on U.S. and global demand, including the relative performance across sectors, across regions (especially in areas like New York, New Jersey and California) most vulnerable to the non-deductability of state tax, the impact on external balance and U.S. capital account? When would we worry about US debt finance ability?
Monetary policy transition (in terms of leaders and policy stance): Will the Fed/others overtighten to compensate? What credits are most vulnerable? Will the new board members shift policy? Many countries want to lag the Fed and would appreciate the weaker currency that may result, will they be able to do or will limitations of macro prudential measures call for a different trend?
Trade trends: Will any of the many trade agreements set in motion changes in supply chains? Are countries like Brazil finally opening up? Will measures increase the costs of compliance with different regulations (digital trade, localization , cybersecurity). Other policies (fiscal and monetary) are likely to have more effect but could the questions on the rules defer/front-load investment? Is there a new round of investment protection coming?
Valuation: Are US equities really expensive or are there drivers/buyback trends that justify valuations ? What about knock-on effects? is the credit downgrade cycle over in commodity producers?
China's policy space: Chinese authorities have plenty of tools to use but will doing so cap growth and undermine asset performance? Will Chinese corporate, government and quasi government bonds find buyers at a reasonable price? What will be the drivers of growth beyond 2018? Will Chinese export growth further undermine transpacific trade?
Europe risks? is Brexit irrelevant aside from the UK? Are the European banking systems and sovereigns solid enough? Has there been enough deleveraging? How concerning are signs of overheating in Eastern/Central Europe? Is the convergence story back on? Will Europe shift over to more domestic demand?
What’s going on in Saudi Arabia/the Middle East? Lots of questions about the Aramco IPO, the divergence between economic reforms and political approach. What is the strategy from the Saudi/Abu Dhabi nexus? What is the U.S. strategy in the region? Will the market absorb the planned bond and equity issuance (the latter is likely to increase significantly in 2018)? Will any pegs break in the next two years (watch Oman). Is the GCC completely irrelevant as a body? Will regional SWFs continue to turn inward? What are the new investment rules in the wake of the Saudi anti-corruption measures? Will the Qatar blockade just fade away as the country adjusts (and recent data suggests its a vey slow bleed) and other countries continue to trade with the country (see UK and French economic and military coordination).
Like many people I’ve spent a lot of time over the last week at “2018” Outlook events, reading and writing outlooks. At the risk of adding to the deluge, its worth a few reflections about the status of consensus and where triggers might diverge.
Almost everyone I've spoken to over the last few months is upbeat and sees a continuation of the “synchronized global expansion,"* benign liquidity conditions and pricey valuations getting even more pricey after gains. Some countries and sectors look less resilient, but the general view is quiet positive.
Some are a little worried about 2019 or H2 2018 or Q4 2018 when the effects of balance sheet adjustment might begin to be more priced and when questions escalated on what might be the new drivers of growth. In this context, regulatory uncertainty especially around trade and investment policy might reinforce recent investment trends, as some corporations and households hold off on spending.
With OPEC members and friends (and the ever growing energy journalist cohort) meeting in Vienna, it seems apt to look at the economic adjustment of some of the participating oil producers. While most would gain from rising prices. Russia, and Iran, smaller GCC countries (Kuwait, UAE and even Qatar) as well as some U.S. producers would look to be the relative winners. The slowbleed of capital outflows, external and fiscal deficits are likely to moderate across most of the other producers including Saudi Arabia, Oman, let along more vulnerable countries like Nigeria, Angola which are still struggling with the aftermath of their FX policies. With U.S. and global interest rates edging up, expect continued rate and sovereign risk divergence.
I spent some days last week in Waterloo, Toronto and Ottawa to give some presentations and try to better understand Canadian trade policy. With Canadians playing a starring role in the previous week’s excitements in Vietnam the week before last on TPP-11 or the Progressive Comprehensive TransPacific Partnership (CPTPP), it seemed a good time to better understand how the Canadians are viewing the trade outlook and especially its “progressive” element. A joint trade symposium from CIGI, the University of Ottawa and the University of Calgary provided a very timely place to discuss.
Interlocking nodes of trade talks in Asia, the Americas and Europe, suggest trade and investment policy will dominate much of the diplomatic energy over the next year, suggesting that trade and investment risks will remain relevant for markets perhaps more so if asset valuations become more stretched. Ongoing trade reviews, especially NAFTA and disputes are perpetuating uncertainty for business making it harder to plan. This uncertainty, along with rather limited changes in macro policy in major global economies (across the G20), suggest a cap on global growth and global trade acceleration next year. And a downside risk from a major trade measure (more likely from Washington) remains in the frame.
What I took away from my time in Ottawa was that Canada’s “progressive” trade agenda is still being defined in terms of scope, that Canada is slowly working towards some regional Plan Bs, which also extend to the security front, where the Caribbean and Venezuela are concerned. These will likely do more to extend investment and other economic norms, but will be harder to enforce as long as U.S. policy is moving to challenge those norms.
Rachel's musings on macroeconomic issues, policy and more.