I’ve been warning for some time about the economic dangers of protectionism and the potential for retaliatory policies that could stifle free trade. Last week, this threat intensified – and that was just the tip of the iceberg in a week filled with market-moving news. Below I highlight five critical headlines from last week and preview what’s ahead.
- There was significant fallout from the Trump administration’s decision to impose tariffs on steel and aluminum imports into the U.S. Stocks sold off and then gyrated as it appeared the tariffs might be less severe than first expected. However, the situation worsened during the course of the week – first with the resignation of Gary Cohn, Chairman of President Donald Trump’s National Economic Council, and then with the European Union’s announcement that it would retaliate by imposing tariffs on a number of U.S. imports. Other countries, including Japan, also voiced strenuous concerns. We need to be concerned with what the Trump administration has planned going forward in terms of trade policy. With Cohn’s departure and the elevation of Peter Navarro to a more important post, the protectionist wing of the White House seems to have gained the upper hand. This may mean additional protectionist policies, particularly ones directed at China, given the president’s focus on the U.S.-China trade imbalance. I believe such a move would likely result in significant retaliation, especially given that Chinese President Xi Jinping recently grew more powerful, following the removal of presidential term limits by the National People’s Congress. This is only the beginning of what could become an acceleration in tariff wars.
- The White House announced that President Trump is willing to talk to North Korea’s leader, Kim Jong Un. While this meeting may not actually come to fruition, I see it as a positive development as it means a dialing down of rhetoric and less chance of a military conflict – at least for the time being. However, I don’t expect it to have a material impact on stocks – geopolitical events usually don’t. We will have to wait and see how negotiations unfold.
- The European Central Bank (ECB) altered its monetary policy statement by removing language that said it stands ready to increase its bond purchasing if the European Union’s economic outlook deteriorates. Many economists and strategists view this as another small step on the path to normalization. However, I believe it is far more important to focus on ECB President Mario Draghi’s statement that bond purchases will continue until at least September 2018 “or beyond, if necessary, and in any case until the Council sees a sustained adjustment in the path of inflation.” This is quite dovish given that, while the ECB upwardly adjusted its growth forecast for 2018, it noted that “measures of underlying inflation remain subdued and have yet to show convincing signs of a sustained upward trend.” The ECB also made clear that there were significant downside risks to a rise in protectionism. From my perspective, normalization is nowhere in sight.
- The Bank of Canada (BoC) made the decision not to raise rates at its meeting. The BoC has warned about the dangers of protectionism for a while now, and it’s clear those concerns have become more pronounced, especially with the recently announced U.S. tariffs on aluminum and steel. In addition, the BoC appears concerned with recent housing weakness brought on by previous rate hikes as well as home-buying regulations in Vancouver and Toronto. The BoC suggested it would hit the pause button on rate hikes in the near term: “While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed.” Not only has normalization been halted, but it seems possible that the BoC could actually lower rates later this year if the economic situation deteriorates.
- The February U.S. employment situation report was a “Goldilocks” report. Non-farm payrolls were far better than expected at over 300,000. There was notable improvement in labour force participation, which had been an area of real weakness throughout the labour market recovery. But most importantly, the gain in average hourly earnings was modest at 0.1% month over month, and 2.6% year over year. Recall that it was high average hourly earnings in the January U.S. jobs report that set off the market turbulence experienced over the past month. February’s average hourly earnings reading indicates an easing of wage pressure – at least for the time being – which is welcome news to markets that began to fear a significant rise in inflation based on the previous month’s jobs report. But make no mistake – this does not mean volatility will abate. I believe the horse has left the barn and there is no turning back when it comes to a more turbulent and data-sensitive stock market environment.
Four things to watch
Looking ahead, I’ll be watching the following:
- Chinese retail sales and industrial production for January and February will be released this week. China showed signs of a modest slowdown in the fourth quarter, and we will want to see if there is a continuation of that trend. However, if the data suggest the slowdown has continued into the first quarter, I do not expect it to impact markets as investors seem more confident and less skittish about the Chinese economy, especially given the global growth backdrop.
- Eurozone industrial production will be released this week. This will be an important data point for the ECB to follow; in my view, it is likely to support the narrative that eurozone economic growth is accelerating. However, even more important will be the consumer price index release at the end of the week, which will likely support the ECB’s view on low inflation, as articulated in last week’s announcement.
- A number of important inflation readings will be released in the U.S., including the consumer price index, producer price index and Atlanta Fed Business Inflation Expectations Survey. These will be important data points for the Federal Open Market Committee to consider as it attempts to discern where inflation is headed, particularly given conflicting signals – average hourly earnings were modest in the month of February, as noted above, despite the most recent Beige Book suggesting labour market tightness in a number of industries.
- Last week marked the ninth anniversary of the bottom for the S&P 500 Index – and therefore the start of the bull market. As we move forward, the big question is whether there will be a 10th. I think that the bull market will make it to its 10th anniversary, but I anticipate that the year ahead will be quite different than the previous nine, filled with far more turbulence – and more muted returns – in the U.S. Earnings have been strong but valuations have been stretched and monetary policy has been normalizing. The Year of the Chihuahua continues.