Two weeks ago, we presented what Bank of America’s credit strategist Barnaby Martin said was his biggest concern for the remainder of the year: an escalation in trade tensions between the US and Europe.
He argued that an intensification of US-EU trade tensions could drive fears of “Quantitative Failure”. After all, he said, “the Eurozone is a large, open, economy and the ECB has – for political reasons – recently announced the end of QE.” To underscore his case, Martin shows that uncertainty over global trade policy has now risen to levels last seen in late 1994, around the time of NAFTA’s inception. “Therefore, much concern regarding trade is already in markets.”
But why is BofA so worried about global trade when markets seem to persistently put concerns about it on the backburner? Just today, Bloomberg carried a piece that the “Stock-Market Boom Shows Trade War Becoming Background Noise.” The reason, as BofA explains, is that trade tensions put at risk one of the big secular themes of the last few years – namely that of global synchronised growth.
Now, as is well-known, 2017 was the first time since 2006 that all OECD countries posted positive economic growth rates: this is the reason cited by many why market volatility (and excitement) dropped to record low levels as “economic certainty effectively bred market certainty.” The distribution of annual GDP changes across OECD countries since 2004 is shown below.
The problem in 2018, is that while global growth remains strong this year – at just under 4% – there are growing signs that the recovery has become less synchronised, “a concern echoed by the IMF over the weekend at the G20 Finance Ministers meeting. As a consequence, markets have become more fragile in 2018”, according to Martin.
So what are the signs of less synchronized growth?
One place is to look is the extent to which US equities have decoupled from EM equities since May this year.
Trade tensions have depressed global growth proxies, such as Emerging Markets. Yet, the US economy continues to be buoyed by Trump’s significant fiscal stimulus (and note the near record EPS surprise stats from the current US earnings season)
It’s the same in Developed markets: in Europe, after the impressive 0.7% quarterly GDP print at the end of last year, growth slipped to 0.4% in Q1 of 2018. Logically, given Germany’s export focus, the Emerging Market weakness – in particular China – explains some of the loss of Europe’s economic momentum lately.
As we showed it recently, and as BofA does today, the next chart shows the extent to which financial conditions in China have tightened.
Looking at Total Social Financing as a percentage of China M2, one can see that the measure has fallen to a record low.
But the biggest pain remains in EM, where as a result of the soaring dollar, largely a byproduct of US economic power vis-à-vis the rest of the world, and trade tensions rising, the broader EM complex has suffered. Using a chart we first presented in May, Martin then shows the performance of a number of EM currencies versus the US Dollar.
We compare two periods: the 2013 Taper Tantrum and this year’s trade spat. As can be seen, it’s not just those counties with obvious current account imbalances (Turkey, for instance) that have seen worse currency performance this year compared to the Taper Tantrum. Plenty of EM currencies have depreciated more vs. the USD in 2018 than in 2013.
Which brings us to today, and why market are primed for a rally if the trade rhetoric begins to sound more promising, as it would help rekindle the narrative of global synchronised growth. Alas, today’s meeting between Turmp and Juncker will hardly be the starting shot (and not just because Europe is a bureaucratic labyrinth in which it will take months if not years to reach an agreement between the member nations).
But the main reason why nothing will happen – at least not until the market suffers far greater punishment – is that as BofA chief economist Ethan Harris warns, “trade wars rarely end before there are clear economic casualties – and on this front there have been few thus far.”
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