Abu Dhabi, UAETuesday 22 October 2019

US and China are running out of time to prevent a global slowdown

Trade dispute uncertainties are weighing down economic growth

US President Donald Trump and Jerome Powell. The Federal Reserve is set to "vaccinate" the US economy against a slowdown with the first interest rate cut in a decade. AFP
US President Donald Trump and Jerome Powell. The Federal Reserve is set to "vaccinate" the US economy against a slowdown with the first interest rate cut in a decade. AFP

The main cause of market nerves over the last year or so has been the trade dispute between the world’s largest economies, namely the US and China. On July 6 of last year, President Donald Trump’s administration imposed the first China-specific tariffs amounting to 25 per cent on $34 billion (Dh125bn) worth of goods imported from the Asian giant. In the following months, the tariffs between the US and China kept rising along with heightened trade tensions.

Since the tariffs were first imposed, President Trump and President Xi Jinping met twice at the G20 Summit, once in December and once at the end of June when they agreed to restart the stalled negotiations. US and Chinese trade negotiators spoke by phone earlier this month to discuss next steps, but progress has stalled yet again on disagreements over how much to ease restrictions on Huawei.

The US Federal Reserve remains unconvinced that global growth can bounce back from the trade dispute uncertainties.

Hussein Sayed, FXTM

In the meantime, there have already been several market impacts. Perhaps the most important of these is that the US Federal Reserve remains unconvinced that global growth can bounce back from the trade dispute uncertainties. In keeping with the cautious approach from other global central banks, the Fed appears set on a dovish course towards a 25-50 basis-point interest rate cut in the short-to-medium term. In central bank terms, a dovish stance means keeping a low interest-rate regime in the financial system, making it easier for borrowers to get low-interest loans. This means another step towards monetary easing in the US, and stock markets welcomed the prospect of a continuation of the low-interest rate environment.

The Dollar Index, on the other hand, is back above 98 at time of writing, after plunging below 97 pressured by a discouraging perception of the US economy because of the Federal Reserve’s caution. The US dollar saw a sell-off as investors moved their resources to other safe-haven asset classes like gold. The precious metal marched over the $1,420 mark after a significant market event on July 10. Federal Reserve Chairman Jerome Powell supported an “insurance” interest rate cut during his testimony to Congress on that day. This cut is intended to make sure that businesses keep borrowing and investing in the economy. The central bank is worried about businesses reducing investment or holding back on salary increases and prices.

Last month, the Federal Reserve lowered its inflation forecast to 1.5 per cent from 1.8 per cent, citing “moderate” rather than “solid” growth. The Federal Reserve’s caution is echoed by China’s central bank, which chose reverse repos out of its toolbox to support liquidity in the financial system, while maintaining a prudent monetary policy that’s neither too tight nor too loose.

Stock markets may take to central banks easing in a celebratory way, revelling in the prospect of low interest rates and easier borrowing. However, at this stage of the economic cycle during signs of a downturn, pockets of weakness may develop and have a disproportionate drag on the overall economy. The US subprime crisis and the housing bubble was one such example in 2007, coming as it did amid an overleveraged financial system and global slowdown.

While it’s virtually impossible to predict black swan events, the international trading system is taking a lot of strain and only a definitive trade agreement between the US and China can restore full market confidence in the health of the supply chain and the company revenues dependent on sales. Trade tariffs may boost government revenues but the pressure cooker in the private sector businesses could explode in unexpected ways, damaging sectoral economic growth.

One of the affected sectors in the US and China is manufacturing. In the US, the manufacturing sector slowed to a three-year low last month, and the ISM index of factory activity fell to 51.7 from 52.1 in May, the third monthly drop in a row. If the gauge drops below 50 it indicates a contraction in the sector, which accounts for 12 per cent of the overall economy.

The US and China are running out of time to prevent a definitive global slowdown. The impact on the UAE could be seen if the central bank decides to mirror the Federal Reserve’s position on reducing interest rates, in addition to the weaker USD potentially boosting oil sales as the exchange rate becomes more affordable. The caveat here is always centred around global demand for oil which may drop if a slowdown accelerates in worldwide manufacturing sectors.

Hussein Sayed is the chief market strategist at FXTM

Updated: July 30, 2019 10:08 AM

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