Global markets are having a volatile week, driven most notably by the US and President Trump. Late on Thursday, the Trump administration announced plans to impose tariffs of up to $60billion in annual Chinese imports. Mr Trump stated that the move was designed to address the $375billion trade deficit with China, which he described as “out of control”. Detail is currently lacking, with the list of products on which the US will apply a 25% tariff due to follow within 15 days. However, the US has stated they will target ten key sectors identified by President Xi Jinping’s “Made in China 2025” plan. If the move was designed to provoke, it certainly worked. The Chinese duly issued a first response on Friday, announcing plans for tariffs on $3billion of US imports. If fears of a trade war between the World’s largest two economies were not high before, they most certainly are now.
Markets sold off sharply on the news. The S&P 500 closed 2.5% lower on Thursday, with Asian and European markets following on Friday. The sell-off was not about a potential trade war alone, however. Adding to the weakness was the latest personnel change within the US administration, which saw Trump replace his National Security Advisor. Incoming John Bolton is viewed as bringing an interventionist approach, historically pushing for a harder line on Iran and North Korea. Pentagon staff say that Bolton is quick to advocate military force, a view supported by his role in pushing George W. Bush to invade Iraq. Arguably a trade war is not the only kind of potential conflict that increased in probability yesterday.
This news came while investors were still trying to digest Wednesday’s Federal Open Market Committee (FOMC) meeting. Jay Powell duly delivered a 0.25% rate increase at his first meeting as Federal Reserve Chair. This was fully expected, though the simultaneous release of the Fed’s “dot-plot” (a scatter graph of where FOMC members estimate what the federal funds rate will be over coming years) was of greater interest. While the FOMC’s median estimate for the end of 2018 remained at 2.125% (implying two further hikes this year), longer-term projections appeared to have become more hawkish at first glance. Expectations for year-end rates for both 2019 and 2020 moved higher, as did the Committee’s median expectation for the longer-term.
Theoretically, higher expected US rates imply a stronger Dollar. However, the currency continued its recent weakening post the announcement, and at the time of writing is 0.8% lower in trade-weighted terms this week alone. This is likely due to Powell playing down the importance of the dots, with the Committee seeming to demonstrate increasing openness to growth and inflation temporarily overshooting, implying it would probably take large and persistent upside surprises for the hiking cycle to accelerate significantly. These qualifications gave the statement a more dovish feel, softening the implication of incremental policy tightening implied by the latest dots.
Closer to home, we heard from the Bank of England (BoE) on Thursday. There was little to excite the market, with rates left unchanged at 0.5% as expected. The vote being passed by a 7-2 majority could have been interpreted as somewhat hawkish (the market anticipated a unanimous decision), thereby increasing the probability of a hike in May. Nevertheless, Sterling was little changed following the announcement, with the BoE continuing to anticipate “limited” and “gradual” rate rises. The lack of reaction, of course, should be noted in the context of trade-weighted Sterling having already strengthened 0.8% over the week. This was primarily a function of progress toward the UK and Europe agreeing a Brexit transition deal. Current expectations are for a formal agreement to emerge from the ongoing EU summit before the weekend. It will pay to watch currency closely as developments unfold.