zwitserlanden
US trade war could extinguish overheating

US trade war could extinguish overheating

28-03-2018 | Insight

Tariffs could unwittingly act as an antidote to US economic overheating, says Chief Economist Léon Cornelissen.

  • Léon  Cornelissen
    Léon
    Cornelissen
    Chief Economist

Speed read

  • Trump tax cuts and spending plans could overheat the economy
  • Trade wars offer a potential counter-balance, cutting growth
  • New Fed chairman remains cautious about future rates policy

President Donald Trump has flown in the face of traditional economic theory by pushing through tax cuts and higher spending when the US economy is already strong. This has prompted new Federal Reserve (Fed) Chairman Jerome Powell to be cautious about future rates policy.

However, the potential effects of tariffs on imports into the US, and particularly a trade war with China could end up reversing any extra growth from the stimulus, Cornelissen warns. The outcome means more uncertainty for investors, he says.

“The policy mix chosen by US policy makers is not exactly what the doctor would order for an economy running at or close to full employment,” says Cornelissen. “Expansive fiscal policy, a combination of tax cuts and higher spending could of course drive the unemployment rate even lower. But the chances are high that it will mostly precipitate in higher inflation, demanding more aggressive monetary tightening.”

“According to the Fed median forecast, unemployment will fall to 3.6% in the next two years – the lowest level since the late 1960s – and almost 1% lower that the Fed’s own estimate of the longer-term jobless rate. However, these worries about the composition of the macroeconomic policy mix are not incorporated in the official views of the Fed.”

“Although policy makers sound increasingly upbeat about the US economy in the near term, raising their median forecast for economic growth in 2018 to 2.7% from 2.5%, and for 2019 to 2.4% from 2.1%, these forecasts remain well below 3%. Longer term, they have kept their forecast unchanged at 1.8%. This doesn’t display much optimism about the longer-term effects of the recent tax legislation.”

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

Fed views are mixed

This concern has already been reflected in the inaugural remarks of the new Fed chairman, Jerome Powell, who replaced Janet Yellen in February. “He conceded in his first press conference after the March Federal Open Market Committee (FOMC) meeting that elements in the tax legislation could lift investment, and with that productivity, as well as labor force participation,” says Cornelissen.

“But he also said US central bankers held a wide range of views on the size of the effects of the tax cuts. These remarks are illustrative of the general caution expressed by the new Fed chairman, who took the opportunity to play down the importance of the central bank’s higher median interest rate forecasts (inevitably given its rosier economic forecasts), and to stress the uncertainties surrounding the economic outlook.”

“Logically, the Fed is still projecting only three rate rises this year, although three instead of four has become a close call on the basis of the famous ‘dot plot’. ‘It is too early’ is the mantra preferred by the cautious Powell, who is keeping his cards close to his chest and tends towards continued dovishness, implicitly accepting an inflation target overshoot. This policy is probably much to the liking of the one who has appointed him (Trump) to replace an equally dovish Janet Yellen.”

“I would argue that US growth and inflation will turn out to be higher than the Fed is currently predicting, necessitating a much tighter monetary policy – but there is one important caveat. And that is the possibility of the break-out of a damaging worldwide trade war which could dampen world GDP growth significantly and easily extinguish any overheating fears.”

Chinese tariffs may hurt

Cornelissen says the initial tariffs on steel and aluminum were a hastily announced improvisation, and possibly a last-minute attempt to influence the March Congressional election in Pennsylvania in favor of the Republican candidate, a move that turned out to be in vain as the Democrat won. “These tariffs are also too small to have any macroeconomic significance,” he says.

“More serious are the measures targeted solely on China. The US firstly announced a 25% tariff on at least USD 50 billion-worth of imports from China in aerospace, information communication technology and machinery. Secondly, Trump initiated a World Trade Organization (WTO) case against Chinese technology licensing practices, which is odd in the light of concurrent US attempts to hollow out the WTO by vetoing the appointment of judges to its Appellate Body, in effect the supreme court of world trade. Thirdly, the US is imposing new restrictions on Chinese investment in the US in sensitive technology sectors.”

“What is most likely to lie behind the tariffs is what analysts consider to be a broader objective from the White House to disrupt a high-level Chinese strategy called ‘Made in China 2025’. In other words, the current US administration wants to slow down the inevitable ascent of China, and that makes it unlikely that the unpredictable US president – who has very broad powers on trade policy – will back down in some kind of face-saving deal. A tit-for-tat trade war between the US and China will damage global GDP in many unpredictable ways.”

Subjects related to this article are:

Important legal information

The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.

The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.

Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.

Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.

This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.

I Disagree