One issue investors simply cannot ignore
After being told how well the trade negotiations between China and the US had been progressing, financial markets were shocked when Trump ordered additional tariffs against China after a complete breakdown in negotiations. Further to this, Trump also threatened additional tariffs against Mexico for purely political reasons around immigration, further isolating himself as a school yard bully. The Trade War is the most serious issue to hit markets in a number of years and should not be dismissed in any way. We believe that if it is a protracted standoff, it can take the global economy, already weakening, into the abyss.
We believe that in calling Trump’s bluff, China has lifted the stakes and ‘dug in’ for a protracted fight over trade, but more importantly around technology and the ability (or global race) to control artificial intelligence – a race both parties cannot afford to lose. This was indicated by President Xi’s appearance at the Rare Earth factories (with his lead trade negotiator photographed behind him) followed by a press conference at the monument of the Chinese ‘Long March’, a monument highly symbolic for a nation that will fight despite some initial short term cost. (The Long March was the 1934/35 retreat by the Red Army to avoid Chinese Nationalist Party, 70% of soldiers died in retreat but this horrific historical sufferance gave birth to the modern Communist Party and allowed for the ascent of Mao. Chinese people are proud of this struggle for the greater good of the nation).
In attacking China on trade and technology, Trump seems to have unlocked a bipartisan issue which is now being openly supported by the Democrats. This means both the Chinese and US sides are now effectively ‘dug in’.
We believe this escalation makes it difficult to see a near term deal of consequence, with the June 28th G20 meeting being the nearest point for improvement. The escalation also coincides with a macro environment already in decay. The great hopes of macro ‘green shoots’ had been the re-acceleration of the US and Chinese economies, as well as lifting Asian exports and European economies away from a material slowdown. JCB believes that the longer the trade war continues, the more damage that is inflicted on the global economy and at some near point, even a trade deal resolution will not save us from a global recessionary environment.
Expect the US Federal Reserve to cut rates deeply, following the RBA, RBNZ and Central Bank of India
Markets now stand on the precipice of a possible US Federal Reserve (the Fed) cutting cycle. we expect that inflation is not ‘transitory’ and the continued slowing of incoming data, combined with an equity market that demands accommodation to remain elevated, will force the Fed to cut rates by September. In the Fed cutting cycles of 1987, 1995 and 1998 we only needed 0.75%-1.00% of rate cuts to re-accelerate the economy. However, the Fed cutting cycles of 1985, 1989, 2000 and 2007 we needed 3.00%-5.00% of rate cuts to lift away from recessions. Standing here today, the Fed only has 2.50% of possible cuts. Stanley Druckenmiller, the famed macro investor, thinks the Fed will have used all of that ammunition within 18 months, taking interest rates back to 0.00%. That is entirely possible depending on the length and severity of the trade war. Furthermore, zero might not be low enough as markets may well require additional Quantitative Easing.
These developments are extremely constructive for bond markets around the world.
Three-fold domestic bounce, thank goodness, as Global Trade War will sour all around us
Whilst the market’s recent attentions have been focused on the Trade War, the domestic economy will enjoy a near term bounce from three factors that should help Australia avoid a domestic recession of our own making.
- The surprise return of the coalition government in the May elections has been viewed as a positive for domestic equity and property markets, providing the status quo on dividend franking and negative gearing.
- Adding to the uplift is the re-calibration of loan assessment by APRA regarding stress testing of mortgage lending, likely dropping the threshold from 7.25% to around 6.00% for borrowers, allowing them to borrow more.
- Finally, as predicted for a long time by JCB, the RBA will cut rates to likely 1.00%. This will further ease the pain of consumers, leaving more money in domestic pockets.
The three-fold improvement should immediately flatline any correction in property markets. However, JCB does not believe property will materially rebound or credit creation will come screaming back into vogue. A stabilisation of the property complex is welcome on many fronts, as further weakness risked a disorderly and violent negative feedback loop of forced selling and trapped negative equity.
The timing of such a shot in the arm couldn’t be more welcome. The Australian economy desperately needs some domestic stability at a time when the global picture looks to be souring materially.
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Charles is a co-founder of Jamieson Coote Bonds (JCB) and oversees portfolio management of the Australian and Global High Grade Bond and Dynamic Alpha investment strategies. Prior to JCB, Charles forged a career as a seasoned bond investor from...