No Surprises

11 June 2018

From last week’s perspective – and in terms of what we wrote then – this week bore little in terms
of surprises. The US’ central bank, the Federal Reserve, raised rates by 0.25% for the 2nd time this
year to 2%, which felt entirely justified considering the currently more than robust health of the US
economy.

The Eurozone’s central bank, the ECB, held on to its 0% interest rate and said it was likely to keep
it at that level ‘at least through the summer of 2019 and in any case for as long as
necessary’¦.’. This was probably because they also decided to discontinue further monthly bond
purchases under their QE programme by the end of the year ‘subject to incoming data
confirming the Governing Council’s medium-term inflation outlook’. This confirmed the view
of all those who regard the current slowing of economic growth in Europe as temporary and merely
a counter reaction to last year’s growth overshoot.

Anybody who might have expected a replay of the 2013 Taper Tantrum with severe corrections in
bond and equity markets will have been relieved. Instead, bond and currency markets did not
budge particularly and hovered at the levels they had traded around for the past months. Equity
markets experienced slightly more volatility, but that had less to do with central bank actions and
more with the political dimension we also discussed last week.

Here, US president Trump displayed – as expected – his emotionally unstable side, although more
after than during the G7 summit. Belittling of, and hurling personal insults at democratically elected
leaders of the US’ hitherto closest NATO allies may prove far more damaging to the USA than
withdrawing support to the previously agreed G7 communique on the withdrawal of trade barriers
or the imposition of the first wave of trade tariffs. At the very least it has made it much more difficult
for these politicians to justify any compromises with Trump towards their electorates without indeed
appearing weak.

However, what stock markets actually appeared to take umbrage at, was the administration’s
announcement of applying tariffs of 25% on Chinese imports worth $50 billion from 6 July, which
was immediately matched by Chinese tariffs of the same amount and volume on US imports. Given
the Trump administration had already threatened to retaliate against retaliation with further tariffs
on $100 billion worth of trade, it may be dawning on capital markets that Trump’s approach to trade
negotiations might not be leading to similar success as his defusing of the North Korea situation,
but more likely a tit for tat trade war.

Despite this unsavoury global trade perspective equity markets remained fairly sanguine, with
robust current global trade and strong U.S. economic activity helping investors stay calm or at least
wait until trade sanctions really bite.

For the time being it appears that the buoyant economic present is distracting enough to outweigh
the perspective of a future of global trade decline. And maybe markets are right, given the North
Korea tensions had also previously deteriorated to the point where the actual exchange of
hostilities seemed quite possible. What speaks against this appraisal is that neither the western
leaders nor China’s leader Xi Jinping are quite as driven by gaining Donald Trump’s respect and
attention as Kim Jong-un.

All this tells us that the summer of 2018 may prove less quiet than average, but there is also hope
that politicians everywhere will not want to risk losing the general economic tailwinds they are
enjoying at the moment. The only positive that can be drawn from the dark horizon of trade politics
– and this includes the UK’s Brexit stalemate – is that investors are unlikely to abandon fixed
interest bonds any time soon. This may therefore go some way to explaining why markets took
central bankers’ insistence to continue on their path of monetary tightening quite as relaxed as
they did.