Monday, 27 February 2017

Trump Policies To Cause Market Volatility

Many political developments since Donald Trump’s inauguration have demonstrated a departure from official protocol and generally accepted ‘presidential behaviour’.  Most of these deviations, whether tweets, disrespectful media comments, or outspoken statements to other leaders, have been mocked and ultimately encouraged a micro-analysis of his every move.

One thing that perhaps cannot be faulted regarding his political habits to date: Trump has been true to his word and stuck by the campaign pledges he made.  Indeed he has set off at breakneck speed to implement them.  A potential consequence of this is that he if continues to pursue the policies so heavily discussed during the campaign, soon we could see movement regarding tax policies and proposed tariff implementation.  Exactly what it will do to the Federal Reserve's balance sheet is a major side issue and whether it will pass through Congress, is another, but there is certainly cause for concern.
Possibly the biggest mystery of the Trump presidency so far is how true to his word he will be regarding pledges made on trade protectionism.  After the recent visit from Japanese prime minister Abe there was a distinct lack of media reporting on the subject.  We know little detail about the talks, which is strange considering Trump had previously put Japan in the basket of a currency manipulator and US job destroyer leading to perceived unfair trade imports. Japan was firmly in the tariff crosshairs along with China, Germany, Mexico and any other country that contributes to the US trade deficit. There is no question that this could be the most difficult of his pledges to see through, but any backtracking on promises made could cause uproar from car manufacturers and coal miners alike who are expecting old jobs back. 
Most economists agree that any trade tariffs are bad for mutual prosperity and go against free-market economics which have existed for the last 40 years.  Tariffs make goods and services more expensive for the end consumer and lead to an inefficient allocation of capital and sub-optimal cost bases. It may preserve jobs or reintroduce previously redundant ones in the short-term but in the long run, turnover and profits fall as output becomes uncompetitive and prices rise. Those same preserved jobs ultimately have to go anyway as employers struggle to compete.
There is historical precedent for such a protectionist stance in the form of the Smoot-Hawley Tariff Act of 1930, designed to protect the US economy from cheap foreign imports thereby preserving US jobs, which was believed would subsequently lead to a recovery from the economic depression of the time. The aftermath for markets was a further 10% fall in the S&P 500 and rampant inflation three years later as prices spiralled (although not all of this can be directly linked)  . Imports into the US fell by 60% causing an initial fall in inflation but as other countries subsequently retaliated, inflation spiraled and global trade fell by 30% leading to a global recession. Developed nations saw their exports fall by 30-40% whilst the US suffered most with exports falling by 60%.
It is this experience that most disturbs economists regarding Trump’s anticipated trade policies. Having appointed Peter Navarro to head the newly formed White House National Trade Council, the anti-China thinking seems unlikely to change – it is just a question of how aggressive and vocal it becomes.  As with the travel ban, this could erupt over a weekend from an executive order or a tweet. So far, none of the media splashes have caused market consternation. However, it could only be a matter of time before we encounter a trade proclamation that is truly disturbing, leading to market volatility.
The lack of media substance from the Japanese premier’s visit suggests that Trump’s protectionist ambitions remain in place. To the outside world, it was all smiles, but if Japan is getting 100% US military support, there must surely be extensive negotiating leverage that will be exploited as Trump pursues his trade agenda.  

The current low levels of volatility in the markets look sustainable for about as long as it takes for an incendiary anti-China tweet to be typed.  This most sensitive area of trade conflict is likely to rear its head before long and bring the most contentious of Trump’s policies to the forefront of investor’s minds. It is unlikely to go down well with markets, and investors should prepare themselves for some volatility during the months ahead.

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