Since the start of 2017 financial markets have mostly focused on the expected positive impact of the US presidential election outcome - tax cuts, repatriation of company profits and deregulation - and paid less attention to the outlook for global trade amid the new President's protectionist rhetoric.
In his inaugural speech US President Trump did not present a cohesive economic plan, leaving markets facing a lot of uncertainty about future policy. At the same time, clear differences of opinion remain between the president and the Republican-dominated Congress.
We believe global trade, which is already distinctly sluggish, could come under further pressure. With the positive news about the new President's policies now mostly discounted in the markets and taking into account the downside risks, our asset allocation remains cautious. In our portfolios we have implemented an underweight in US high-yield corporate bonds versus cash since the fundamentals for this asset class have weakened, while risk spreads have narrowed.
Global trade under pressure
Ever since the Great Financial Crisis of 2008/09, global trade growth has been sluggish relative to GDP growth. According to the IMF overall weakness in economic activity, and particularly in business investment, has been the main culprit. Other causes, according to the IMF, are the waning pace of trade liberalisation, growing political risks and the slower pace – and occasional reversal of – globalisation. We would add the reduced availability of trade credit due to financial regulation and a reduction in China’s competitiveness as a result of rising wages. Consequently, the share of international trade in global GDP has stopped rising (see Exhibit 1 below).
Exhibit 1: Changes in world real imports and global GDP (% YoY) for the period between 1960 and 2016
We do not expect international trade to contribute more to global GDP any time soon. Sluggish growth in business investment is truly a global phenomenon. The number of restrictive measures on global trade has steadily increased in the past few years. President Trump’s protectionist streak is not likely to help either. Pressuring companies to invest in the US instead of abroad may benefit local employment, but it would also raise prices for US consumers. It adds to the slowdown in globalisation. Actual tariffs on imports, or a ‘border tax’ system for companies which would exempt exports from taxes and would no longer count imports as deductible costs, would further limit global trade. Obviously there is a risk of retaliation by other countries.
In Europe, Brexit also poses a risk to trade
In a major policy speech on 17/01/17, UK Prime Minister Theresa May leant toward a hard Brexit. This would give the UK full control of immigration and free it from the jurisdiction of the European Court of Justice, but at the price of access to the EU’s common market. The UK could negotiate trade deals with other countries and apparently this is on the agenda when May meets Trump on 27/01/17, but trade deals take time to agree and the eurozone is the biggest importer of UK goods.
Apart from a weak British pound, the consequences of Brexit have started to show up in inflation. The UK's Retail Price Index (RPI) excluding mortgage payments rose to 2.7% in December. Admittedly, energy was a driver, but the core CPI, which excludes energy and food prices, also rose 1.6%. Consumer confidence has fallen recently and retail sales growth slowed sharply in December, albeit from a strong pace. In our view the full impact of Brexit is yet to be revealed.
There has been some improvement in global trade recently, mostly in nominal terms. In the second half of 2016 nominal global trade growth weakened as prices deflated. This price deflation has now abated. But in real terms trade growth still looks quite sluggish. This would mean that export-led growth has become a bigger challenge for emerging markets. With advanced credit cycles slowing in some of these countries, we do not generally foresee a strong revival of economic growth in emerging economies.
To read more about this subject, we recommend an article written in June 2016, Economic outlook for the rest of 2016 – part 1 of a trilogy