Please find below the notes from GAM Investments’ Weekly Investment Meeting on 18 July 2018 – this week’s speaker was Michael Biggs, who explained why he believes the outlook for global growth remains intact and highlighted the risks of an escalation in the trade war.
After a strong finish to 2017, growth has disappointed as we have progressed through 2018. Both export and global industrial production (IP) growth have slowed, and EM GDP growth appears likely to have weakened in Q2 following a strong Q1. We are expecting a stronger Q3, and at least some stabilisation is required if the case for risky assets is to remain intact. EM growth has been around 1% a quarter, which equates to 4% pa.
The economic surprise indices tell the same story, with DM disappointing in Q1 and EM following suit in Q2. The early signs of stabilisation are there, with surprise indices now returning to zero, PMIs ticking up and container shipping volumes (another useful indicator) having recovered after a downturn earlier this year. This all suggests global growth is intact and it remains an attractive environment for risky assets.
There are some forthcoming data points which will be interesting to watch, namely the ECB bank lending survey on 24 July, flash PMIs on the same day, China industrial profits on 27 July and PMIs on 6 August. These will all give further insight into what Q2 looked like.
The threat to the investment story right now is the trade war. From our perspective, nobody expected it to escalate in the way it has; we have seen something of a tit-for-tat between the US and China. On 4 April the US announced it would put USD 50 billion of tariffs on Chinese goods. China responded by announcing its intention to impose 25% of tariffs on USD 50 billion of US goods. In early July US tariffs on USD 34 billion of Chinese goods took effect, with a reciprocal USD 34 billion of China tariffs on US goods. An additional USD 16 billion of tariffs is due in late July or early August. If that happens China will respond in kind. The US feels it has to have the last word, and it is not clear what will break the cycle. If this keeps escalating it is bad for global growth, however we remain hopeful for a negotiated solution as the bad economics around these tariffs put pressure on politicians to prevent any further escalation.
The impact of tariffs depends very much on the nature of the goods and their substitutability. The US imposed tariffs on washing machines and solar panels, but because domestic production of washing machines could not come online quickly enough we saw an impact in the inflation numbers. On non-consumer goods you do not see this inflationary impact, so for the next round of tariffs on China the US is focusing on intermediate capital goods. But the result is that US companies which import these goods see their costs go up. China, meanwhile, put tariffs on soybeans, which it can import from Brazil and Argentina. This amounted to a transfer from US producers to the Chinese government.
The higher input costs will put pressure on the US government to come to a negotiated solution. We believe the next steps are that the July/August tariffs are almost inevitable. We could see further tariffs imposed by the US in September, with China responding, and in November the US could impose auto tariffs. We do not think these latter two steps are yet priced in by markets.
A trade war is bad for EM local currency debt, but the impact could soften if the US dollar weakens. While slower global growth could cause commodity prices to fall, the major impact on EM FX is what happens to the US dollar. If a trade war causes US growth to disappoint this would be negative for the dollar, but not such a bad outcome for EM.
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