22 October 2018
Richard Jerram, Chief Economist, Bank of Singapore Member of OCBC Wealth Panel
- Buoyant US economy is sucking in imports
- US trade deficit will rise, regardless of tariffs
- China remains focus; autos a risk
Rising concern over US trade friction with China has been cited as a factor behind the recent increase in financial market volatility. This might simply be finding an explanation to fit the facts, as markets had previously been untroubled by intensifying trade tensions, but the issue is not going away. The large multinational firms that tend to be listed on the stock market are unavoidably more exposed to trade friction than the economy.
President Donald Trump appears to think a country is losing if it is running a trade deficit.
Regardless of the poor economic logic of this view, developments over the coming year are likely to show the US as an even bigger “loser”. This gives a high risk of a continuation or intensification of trade friction.
The overheating US economy is at the heart of the rising trade deficit. Fiscal stimulus is boosting demand in an economy facing capacity shortages, as shown by the unusually low unemployment rate. In a textbook response, some of that extra demand will be satisfied by increased imports, so the trade deficit will widen. This has already started and at some point it should weigh on USD.
One positive aspect is that US demand is helping to support growth in the rest of the world, which might help some emerging markets. However, this is offset by the risk that they come into the crosshairs of Trump’s trade policy.
China is clearly at the top of the list for US tariffs, accounting for nearly half of the trade deficit. Next in line are Mexico, Japan and Germany, although the combined deficit with these three is around half of that with China. Friction with China seems qualitatively different, as it reflects a growing super-power rivalry, rather than a negotiation for more equal market access.
Mexico looks safe after the recently-updated NAFTA agreement. Rather than focussing on Japan or Germany specifically, it seems more likely that restraints on automobile imports address a large part of the imbalance (US auto imports are $365bn compared to exports of $161bn).
Tariffs on autos are currently under investigation and that could be disruptive for two reasons. First, Europe is likely to retaliate in kind. Second, it is hard to find substitutes, so the impact on US prices will likely be significant. US consumers paid the price of restrictions on Japanese car exports in the 1980s. In the case of tariffs on China, it is relatively easy to shift demand to, say, Vietnam or Mexico so overall US import prices do not rise too much. However, if the end result is negotiation, compromise and (eventually) more liberal trade then short-term pain could bring longer-term gain.
In theory, the Fed should not respond to a one-off change in the price level due to tariffs. However, in a hot economy it will be wary of knock-on effects pushing up underlying inflation. If price expectations rise, the Fed will be under pressure to tighten more aggressively.
Prediction markets are putting 2:1 odds on the Democrats taking control of the House of Representatives at the mid-term elections. If so, this will restrict many areas of Trump’s domestic policy-making. However, trade policy is largely under the control of the president, so we should not expect friction to abate.
Weak financial markets could persuade Trump to back away from further action on tariffs. However, he seems determined to try to pin any blame for volatile markets on the Federal Reserve, which could indicate an intention to persist. The probable rise in the US trade deficit over the coming year – to record levels – will give him plenty of fuel to feed his discontent.
Important Information
This material is not intended to constitute research analysis or recommendation and should not be treated as such.
Any opinions or views expressed in this material are those of the author and third parties identified, and not those of OCBC Bank (Malaysia) Berhad (“OCBC Bank”, which expression shall include OCBC Bank’s related companies or affiliates). OCBC Bank does not verify or endorse any of the opinions or views expressed in this material. You should beware that all opinions and views expressed are subject to change without notice, and OCBC Bank does not undertake the responsibility to update anyone with any changes to the opinions and views expressed.
The information provided herein is intended for general circulation and/or discussion purposes only and does not contain a complete analysis of every material fact. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Without prejudice to the generality of the foregoing, please seek advice from a financial adviser regarding the suitability of any investment product taking into account your specific investment objectives, financial situation or particular needs before you make a commitment to purchase the investment product. In the event that you choose not to seek advice from a financial adviser, you should consider whether the product in question is suitable for you.
OCBC Bank is not acting as your adviser. This material is provided based on OCBC Bank’s understanding that (1) you have sufficient knowledge, experience and access to professional advice to make your own evaluation of the merits and risks of any investment product and (2) you are not relying on OCBC Bank or any of its representatives or affiliates for information, advice or recommendations of any sort except for specific factual information about the terms of the transaction proposed. This does not identify all the risks or material considerations that may be associated with any of the investment products. Prior to purchasing the investment product, you should independently consider and determine, without reliance upon OCBC Bank or its representatives or affiliates, the economic risks and merits, as well as the legal, tax and accounting characterisations and consequences of the investment product and that you are able to assume these risks.